LifeStages...Retirement
RETIREMENT ISSUES...A GROWING CONCERN FOR 76 MILLION AMERICANS!
So you are thinking about retirement. Maybe you will work part-time…not because you have to but because you want to. In a recent survey by American Association Of Retired Persons – AARP , it was noted that just over half (53%) of the respondents stated that their definition of retirement includes working for enjoyment, not money, and 42 percent report that their retirement definition includes having to do some kind of work to help pay the bills. In this same survey, it list the specific occupations that pre-retirees are most likely to be considering for retirement. They included teaching, office support, craft work, retail sales, consulting, farming ranching, nursing and other health services work
2008 Opens The Gate!
The first Baby Boomers i.e. people born between 1946 and 1964 will start to receive social security checks in 2008. Retirement issues are a growing concern for these 76 million Americans.
Do The Math To Determine The Effect Of How Early Retirement
We agreed that it should be a goal that working in retirement will be a decision you make and not a necessity. But for what ever the reason you decide to work in retirement…you need to do the math to determine the effect of how early retirement would affect your social security retirement benefits. For example if you retire early and work, $1 in benefits will be deducted for each $3 you earn above $34,440 in 2007. By the way, the Maximum Monthly Benefit in 2007 is $2,118 at your
Normal Retirement Age –NRA and the Estimated Average Monthly Benefit: $1,044…NRA. Keep in mind that once you have reached or passed “full retirement age,” there is no reduction in Social Security benefits as a result of earned income.
But … Don’t Forget About Taxes
Your part-time income combined with Social Security and
“Required Minimum Distributions” (RMDs) from qualified plans such as your company’s pension plan may push you into a higher tax bracket.
Planning Your Flows of Retirement Income
How much retirement income do you need in retirement? My answer is …it depends. I want you to think expenses…not income. When you retire, technically you do not have earned income. Yet you must cover the same expenses the day after retirement as the day before retirement. So how much of you Pre-retirement expenses you want to cover?
Will It Be Enough?Here’s a rule of thumb…actually two:
- Rule of Thumb #1: The first of thumb is to simple take your pretirement expenses and use a replacement ratio of 60% to 80% of pre-retirement income. Charlie Lee is planning to retire one year from now. He makes $100,000 a year. He feels that he needs about 80% of his pre-retirement income in retirement. This amounts to $80,000.
- Rule of Thumb #2: “Multiply by 25” rule.
Quickly determine how much you will need to fund your retirement using the following 4-step process:
Step 1: Estimate your retirement expenses. (Some experts recommend an amount equal to 70% to 80% of your working income.)
Step 2: Determine how much your Social Security benefits will be by referring to your annual Social Security Administration statement.
Step 3: Identify how much you will need to meet your estimated retirement expenses in addition to your Social Security income.
Step 4: Multiply that amount by 25 for a general estimate of how much you'll need at retirement to sustain your income over a 25- to 30-year period at a 4% annual withdrawal rate.
Shelby needs $65,000 of her pre-retirement income in retirement. She has determined that her Social Security benefits will be $15,000 annual by referring to her annual Social Security Administration statement. Shelby needs to make up $50,000.
Lets Do The Numbers:
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“Multiply by 25” Rule
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Total Annual Return On All Investments:
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8%
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Assumed Inflation Rate For That Period:
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4%
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(8%-4% =4%) Inflation Adjusted Annual Return:
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4%
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Now divide the 4% into 1.00, giving you 25:
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25
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Multiply the annual expense in retirement by 25:
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$ 50,000
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We have arrived at the lifetime expense of :
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$ 1,250,000
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$50,000 x 25 = $1.25 Million
The general estimate of how much Shelby will need at retirement to sustain her income over a 25- to 30-year period at a 4% annual withdrawal rate will be 1.2 million dollars.
Helpful Online Retirement Calculator Calculators
Use the following retirement calculator to estimate what you'll need for retirement.
- Retirement Quiz: Will You Be Able to Afford Retirement? Take the AARP Quiz
- Go to: American Association Of Retired Persons – AARP at www.aarp.com
- Go to: Bloomberg: Bloomberg is the leading global provider of stock market data, news and analytics
- Go to: NASD: We oversee the activities of nearly 5,100 brokerage firms, about 172,000 branch offices and more than 664,000 registered securities representatives.
- Smart 401(k) Investing... Advice from The NASD
Tax Consequences - Premature Distributions from Tax-Deferred Savings Plans
When I address an audience of practicing or aspiring Financial Services Professionals, I quickly get their attention by reminding them that our mission is to create tax problems for our clients. After they snap to attention and I get several frowns, I make them smile by saying that the critical mission objections are to help our clients to grow, manage and protect their wealth. As we build wealth, we attract tax issues. Yet we have answers…don’t we?. They then laugh and give a resounding YES!
If you have done the things that you and your Financial Services Professional agreed to in terms of Financial Objectives and Goals…chance are you will have to consider the tax impact on drawing down your retirement wealth.
Here a few pointers:
Your retirement plan(s) offers you several choices if you retie early. The real question is simply this: Do you know the tax consequence of taking premature distributions from tax-deferred savings plans. Be careful as some choices may mean you have to pay income taxes and/or income tax penalties on your distribution.
You Have Three Distribution Options
- Keep Your Money in the Current Plan: You can leave your savings in your employer’s retirement savings plan if your account balance has more than the minimum required e.g. $5,000.. Keep in mind that you may be subject to the Minimum Distributions Rules that apply when you reach age 70 1/2 or when you retire, whichever comes later.
- Transfer Your Money to Another Retirement Account: You can move your money into another tax qualified retirement account, such as an Individual Retirement Account.
- Take Cash Distribution in a Lump Sum or Installments: You can choose to have your money paid to you in one lump sum, or in installments of a fixed amount or over a set number of years, if the plan permits this. Keep in mind that you will have to pay income taxes on cash distributions, and you may also have to pay a 10% penalty for early withdrawal.
Exceptions To The “Prior to age 59½” Rule
There are two exceptions to the “Prior to age 59½” rule which invokes the 10 percent federal income tax penalty on taxable amount.
“72(T)” Exception…The Substantially Equal Periodic Payments Rules
Substantially Equal Periodic Payments (SEPP) allows individuals who have invested in an IRA or another qualified retirement plan to withdraw funds prior to the age of 59 1/2 and avoid income tax and early-withdrawal penalties. As we mentioned earlier, an individual who removes assets from a plan prior to age 59 1/2 will face taxes on any income generated by the fund. Interest income or capital gain is taxed and will also be subject to a 10% penalty. With substantially equal periodic payments, the funds are placed into an SEPP plan that pays the individual annual distributions for five years or until he or she turns 59 1/2 whichever comes last.
Because the IRS requires individuals to continue the SEPP program for a minimum of five years, this is not a solution for those who seek penalty-free short-term access to retirement funds. If you cancel the plan before the minimum holding period expires, you will be required to pay the IRS all the penalties that were waived on amounts taken under the program, plus interest. SEPP programs are not permitted under employee-sponsored qualified plans, such as 401(k) plans.
Separation From Service After Age 55 Exception
Your plan can provide for payment of retirement benefits before the normal retirement age. If your plan offers an early retirement benefit, a participant who separates from service before satisfying the early retirement age requirement is entitled to that benefit if he or she meets both the following requirements. 1. Satisfies the service requirement for the early retirement benefit. 2. Separates from service with a nonforfeitable right to an accrued benefit. The benefit, which may be actuarially reduced, is payable when the early retirement age requirement is met.
Pension Protection Act Lets Workers 62 Or Older Receive Payments
There are approximately 76 million baby boomers and only 44 million GenXers trailing them. The 2006 Protection Act lets workers 62 or older receive payments from their traditional defined-benefit pension plans even if they are still working. The law, which took effect Dec. 31, 2006, helps employers retain older workers who otherwise would have to leave to get their pension benefit. The Treasury Department intent was to put defined-benefit plans on a more equal footing with 401(k) and other defined-contribution plans, which generally let workers withdraw money while still working after age 59 1/2. The hope is to stave off a skilled workers shortage in America. The first Baby Boomers i.e. born between 1946 and 1964 will start to receive social security checks in 2008.
Drawing Down Assets in Retirement
Rule Of Thumb: Make withdrawals from taxable assets before tax-deferred assets
To leave a legacy: Tap taxable accounts first as they may enjoy a stepped-up basis at death. Because withdrawals from tax-deferred accounts are taxed at ordinary income rates, many experts recommend prolonging tax deferral as long as possible.
Social Security: Other Considerations
Earlier we discussed the need to do the math to determine the effect of how early retirement would affect your social security retirement benefits. Here we want to remind you that a surviving spouse may receive survivor Social Security benefits as early as age 60. Also benefits are reduced if the surviving spouse works and exceeds the income threshold. The surviving spouse may receive only one
Social Security benefit.
If a child or spouse on your record works while receiving benefits, the same earnings limits apply to him or her as apply to you. Your child or spouse's earnings affect only his or her own benefits. They do not affect your benefits or those of any other beneficiaries on your record.)
Transferring Retirement Wealth -Three Critical Documents
Three Critical Documents Everyone Should Have: 1. Will, 2. Living Will and 3. Power of Attorney
- A Will: allows you to choose how your assets will be distributed. In the absence of a will, state law will control how assets are distributed and may cause an undesired result. In other words, where there’s a Will, there’s a way. When there is no Will, it’s their way!
- A Living Will: is the document that allows you to choose in advance the types of medical care that you do or do not want when you are unable to make such decisions yourself.
- Power of Attorney: is the document that allows you to choose who will manage your assets in the event that you are incapacitated.
Why Name a Beneficiary?
If no beneficiary is named, assets pass into the estate and may impact taxation for heirs. Assets may also go to unintended people i.e. relatives or strangers. Caution!!! Beneficiary designations can override the intentions written in the will. Please consult with your attorney.
You need to make the right choices in planning retirement. The right choice begins with making informed decisions.
We hope the information we have shared with you helps!
This article contributed by James M. Robinson CFP
Jim is a Financial Services Professional and author. He is published and has recently authored the revealing playbook: Changing Faces – America’s Wealth Advisors.
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