Small business owners: increase retirement savings with individual 401(k)
July 25, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
If you’re self-employed or own a small business, you’ve probably considered establishing a retirement plan. If you’ve done your homework, you likely know about simplified employee pensions (SEPs) and savings incentive match plans for employees (SIMPLE) IRA plans. These plans typically appeal to small business owners because they’re relatively straightforward and inexpensive to administer. What you may not know is that in many cases an individual 401(k) plan may be a better deal for you. An individual 401(k) plan is worth considering if you’re looking to set up your first retirement plan or increase tax-preferred savings.
What is an individual 401(k) plan?
An individual 401(k) plan (also known as a solo 401(k)) can be implemented only by self-employed individuals or small business owners who have no other full-time employees (an exception applies if your full-time employee is your spouse). If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you will typically have to include them in any plan you set up, so adopting an individual 401(k) plan will not be a viable option.
What makes an individual 401(k) plan attractive?
- Contribution levels can generally be higher than SEP or SIMPLE
- The employee part of your contributions can be designated as Roth or traditional regardless of income level
- Easy to set up at most discount brokerages without a lot of extra costs
With an individual 401(k) plan you can elect to defer up to $16,500 of your compensation to the plan for 2011 as either Roth or traditional contributions ($22,000 if you are age 50 or older by the end of the calendar year). In addition, your business can make a maximum tax-deductible contribution to the plan of up to 25 percent of your compensation (slightly less than that if you are a sole proprietor or unincorporated).
There are other details to be aware of, so consult your tax or financial advisor prior to establishing a plan.
Maximizing Social Security Survivor’s Benefits
April 25, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
When you think of Social Security, you probably think of retirement. However, Social Security can also provide much-needed income to your family members when you die, making their financial lives easier.
Your family may be entitled to receive survivor’s benefits based on your work record
When you die, certain members of your family may be eligible to receive survivor’s benefits (based on your earnings record) if you worked, paid Social Security taxes, and earned enough work credits. The number of credits you need depends on your age when you die, however, no one needs more than 40 credits (10 years of work) to be “fully insured” for benefits.
Survivor’s benefits may be paid to:
- Your spouse age 60 or older (50 or older if disabled)
- Your spouse at any age, if caring for your child who is under age 16 or disabled
- Your ex-spouse age 60 or over (50 or older if disabled) who was married to you for at least 10 years
- Your ex-spouse at any age, if caring for your child who is under age 16 or disabled
- Your unmarried children under 18
- Your unmarried children under 19, if attending school full time (up to grade 12)
- Your dependent parents age 62 or older
This is a general overview–the rules are more complex. For more information on eligibility requirements, go to www.ssa.gov.
How much will your survivors receive?
An eligible family member will receive a monthly survivor’s benefit based on your average lifetime earnings. The higher your earnings, the higher the benefit. This monthly benefit is equal to a percentage of your basic Social Security benefit. The percentage depends on your survivor’s age and relationship to you.
If your family member is already entitled to social security benefits based on his or her own record, he or she will be able to receive whichever benefit is higher – survivor benefits based on your record or benefits based on the family member’s own record.
For example, at full retirement age or older, your spouse may receive a survivor’s benefit equal to 100 percent of your basic Social Security benefit. If your spouse was already receiving social security based on his or her own record when you died and his or her monthly benefit was lower than yours, your spouse would be able to switch to your benefit.
If you delay filing for social security benefits past full retirement age, your spouse’s survivor benefit would also be higher because of your delayed retirement credits. Any delay up until age 70 increases the base for future social security cost-of-living adjustments. This has a powerful multiplier effect on both the standard of living during your lifetime and for your surviving spouse’s lifetime.
You can get an estimate of how much your survivors might be eligible to receive by filling out a request form at your local Social Security office, visiting www.ssa.gov, or reviewing you Social Security Statement.
Before filing for Social Security, consider the many different filing options available to you and ensure that you select the one that provides the best combination of current income, longevity protection, and survivor security for your situation. Keener Financial Planning provides analysis of different filing scenarios and recommendations on which one is most beneficial for you in the context of your overall retirement plan.
Your Retirement Savings Game Plan
April 6, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
I will be offering a free Keller retirement planning workshop at the public library on Tuesday, April 19.
There are many uncertainties in saving for retirement right now. Even if you never plan to retire, planning for that day when work becomes optional still carries a lot of unknowns. In this workshop, we will cover how you can take control of your retirement plans by focusing on your personal savings, investing, and tax efficiency. This workshop is designed for those more than 5 years away from retirement. We will cover how to:
- determine retirement income needs
- assess the gap between guaranteed sources of retirement income and your spending needs
- prioritize retirement savings and investing strategies to fill the gap
- review which savings methods are most tax-efficient for your situation
- calculate if you’re on track for your retirement goals
- create a plan flexible enough to accommodate future uncertainty
The workshop is free, but RSVP is encouraged for planning purposes to library@cityofkeller.com. A drawing for a free copy of The Investment Answer by Daniel C. Goldie and Gordon S. Murray will also be held.
How to Structure Retirement Income
March 12, 2011 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
I’m providing a free personal finance workshop at the Keller Public Library on Tuesday, March 15 at 6:30 pm on Structuring Your Retirement Income. This retirement income workshop is designed for residents of Keller and surrounding areas who are in or near retirement.
Investing for retirement income is different than accumulation. To help you with this transition, we will cover:
- differences in investing for accumulation and retirement drawdown
- coordinating your portfolio withdrawal strategies with other sources of income
- how to make decisions on pensions and annuities
- how to balance investing for protection against inflation and market fluctuations
- changes you need to start making in your portfolio 3 years before retirement
RSVP to library@cityofkeller.com for planning purposes. A drawing will be also held for a free copy of Daniel Solin’s The Smartest Retirement Book You’ll Ever Read.
Social Security File-And-Suspend Strategy
August 13, 2010 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
If you’re married and looking for opportunities to increase retirement income, you may want to look closely at your Social Security benefits. One opportunity for maximizing Social Security income, called “file-and-suspend,” may enable a married couple to boost both their retirement and survivor’s benefits.
What is file-and-suspend?
Generally, a husband or wife is entitled to receive a Social Security retirement benefit based either on his or her own earnings record (a worker’s benefit), or on his or her spouse’s earnings record (a spousal benefit), whichever is higher. But under Social Security rules, a husband or wife who is eligible to file for retirement benefits based on his or her spouse’s record cannot do so until his or her spouse begins receiving benefits. However, there is one exception–someone who has reached full retirement age may choose to file for retirement benefits, then immediately request to have those benefits suspended, so that his or her eligible spouse can file for spousal benefits.
File-and-suspend is a strategy that may be used in a variety of situations, but is commonly used when one spouse has much lower lifetime earnings, and thus will receive a higher retirement benefit based on his or her spouse’s earnings record. (A husband or wife’s spousal benefit may be as much as 50% of what his or her spouse is entitled to receive at full retirement age.) Using this strategy not only allows the eligible spouse with lower earnings to immediately claim a higher (spousal) retirement benefit, but can also increase the amount of available survivor protection. The spouse with higher earnings who has suspended his or her benefits can accrue delayed retirement credits at a rate of 8% per year (the rate for anyone born in 1943 or later) up until age 70. Because a surviving spouse will generally receive a benefit equal to 100% of the retirement benefit the other spouse was receiving (or was entitled to receive) at the time of his or her death, suspending a benefit to accrue delayed retirement credits may substantially increase the survivor’s benefit.
Example
Let’s look at one hypothetical example of how filing for, then suspending, Social Security benefits might help a married couple increase their retirement income and survivor’s benefits.
Henry and Julia are a married couple living in Keller, TX. Henry is about to reach his full retirement age of 66, but he wants to postpone filing for Social Security benefits. At full retirement age his monthly benefit will be $2,000, but if he waits until age 70 to file, his benefit will be $2,640 (32% more) due to delayed retirement credits. However, his wife Julia, who has had substantially lower lifetime earnings than Henry, wants to retire in a few months at her full retirement age (also 66). Based on her own earnings record, Julia will be eligible for a monthly benefit of $700, but based on Henry’s earnings record she will be eligible for a monthly spousal benefit of $1,000 (50% of Henry’s entitlement).
So that Julia can receive the higher spousal benefit as soon as she retires, Henry files an application for benefits, but immediately suspends it. That way, he can also continue to earn delayed retirement credits, which will result in a higher monthly retirement benefit for him later.
Using the file-and-suspend strategy not only increases Julia and Henry’s retirement income, but it also offers increased survivor protection. Upon Henry’s death, Julia will be entitled to receive 100% of what Henry was receiving (or was entitled to receive) at the time of his death. So by suspending his own retirement benefit in order to increase it through delayed retirement credits, Henry has ensured that Julia will receive a survivor’s benefit that is up to 32% higher for the rest of her life should he die first. (Note, though, that this hypothetical example is for illustrative purposes only and does not account for cost-of-living adjustments or taxes.)
Points to consider
- Deciding when to begin receiving Social Security benefits is a complicated decision. You’ll need to consider a number of scenarios, and take into account factors such as both spouses’ ages, estimated benefit entitlements, and life expectancies.
- Ask a financial professional to help you weigh the tax consequences of delaying Social Security income.
- Using the file-and-suspend strategy may not be advantageous when one spouse is in poor health or when Social Security income is needed as soon as possible.
- The spousal benefit will be reduced if the spouse claiming it is under full retirement age.
March 2010 Newsletter
March 9, 2010 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The March 2010 Newsletter is now available. It includes an investment market update, Part II in my series on how to tap into your home equity in retirement, considerations in evaluating an early retirement offer, information on 2009 tax deduction for 2010 Haitian relief contributions, 2011 tax rate proposals found in the federal budget, credit card act provisions, and a reminder on the deadline to take advantage of the home buyers credit. Click here to read it.
Pension Max: Is it right for you?
December 15, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
If you’re near retirement and have a pension, you may be considering a pension max strategy. With all the variables involved, it can be challenging to determine if it’s really in your best interest.
First – what is pension max?
Pension max is used by married couples to increase their net retirement income while still protecting the surviving spouse’s income in the event the pension recipient dies first. Basically, the pension recipient elects a single life pension instead of one with a survivor benefit for their spouse. This results in a higher monthly pension benefit. Then the pension recipient purchases life insurance to allow the surviving spouse to replace the pension income in the event that the pension recipient dies first. In some situations, this approach can result in a higher net retirement income if the cost of the needed life insurance is less than the increased pension benefits.
Pension max always results in more premiums for the insurance company, but doesn’t always result in more income for you. How do you decide if it’s in your best interest?
First — at the risk of stating the obvious — if you’re not married, there’s no reason to consider it. Depending on your estate goals and health, there may be other strategies that make sense.
Second – the health and age of the pension recipient matters a great deal. If the pension recipient is in excellent health and can likely qualify for preferred life insurance rates, pension max has a lot better chance of being a good idea.
Third – you need to determine how much and what kind of life insurance is needed to replace the income. As the pension recipient gets older, less life insurance death benefit will be required to replace the pension income. Usually some combination of tiered term-life policies and a small amount of permanent insurance fit the bill.
Fourth – the surviving spouse should have an idea of how they will use the life insurance death benefit to replace the pension income. For many, a single-premium immediate annuity makes the most sense, however other draw-down investment scenarios can also be considered.
Fifth – you need to consider taxes in your calculations on both the life insurance benefit and the increased pension benefit.
- Life insurance death benefits are generally not subject to income taxes. With an unlimited marital exemption, the estate tax will not be an issue when the first spouse dies. However, depending on the overall size of the estate and the death benefit, it could be an issue when the second spouse dies.
- The increased pension benefit will be subject to income taxes. So when you’re comparing the net effect on your income, you need to calculate how much your pension will be worth after taxes because you will be paying the life insurance premiums with after-tax dollars. This is an easy area to ignore, but depending on your tax bracket the effect of taxes can make or break the plan.
Sixth – consider the convenience factor. If there’s just a very small financial benefit to using a pension max strategy in your situation, it may still make sense to forego it. You need to weigh the simplicity of just taking the pension against the extra effort of going through life insurance underwriting and paying the premiums ongoing.
If you’re seriously considering using a pension max strategy, it’s a good idea to have an uninterested third party talk through the analysis with you. A fee-only financial advisor who doesn’t have a big insurance commission at stake based on your decision will be able to offer objective advice. And even though you spend some money on the advice, it may help you save much more over the long term and at very least feel confident that you made the right decision based on your unique situation.
Funding early retirement
October 26, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Most are familiar with the magic ages of 59 ½ when you can start withdrawing from retirement savings without paying the 10% IRS penalty and 62 when you can start taking social security. But sometimes retirement comes before these ages either voluntarily or involuntarily, and you may need income. In those situations, many are not aware that you still have options to tap your retirement savings without penalties.
The first option is available if you are at least age 55 and you stop working for your employer. If your employment terminates during or after the year you turn 55, you are eligible to start drawing funds from that employer’s 401(k) without penalty. If you have multiple retirement accounts, this exception doesn’t apply to all of them. It only applies to those employer retirement accounts where you “separate from service” after turning 55. If you roll the employer plan funds into an IRA, the exception also no longer applies. For qualified public safety employees who take a distribution from a government defined benefit plan, this exception kicks in at age 50.
Another option is called “substantially equal period payments” or 72(t) distributions. You can start taking funds from your retirement accounts (401(k), IRA, 403(b), etc.) at any age with this option, although it doesn’t apply to any employer retirement plans when you’re still working for that employer. To use this option, you are required to begin taking a “substantially equal” amount each year and continue without variation for at least 5 years or until you reach age 59 ½ (whichever comes later). You have a choice of 3 different calculation methods of your payment. Once you start, you are committed to using the same method for the duration of the payments, with the exception of one adjustment allowed from two of the methods to the third one.
The IRS is quite picky about the precise calculations of 72(t) distributions and imposes steep penalties for any mistakes. An error in one year can cause back-penalties on all previous distributions taken. So you really need to consult a professional to have your distributions calculated. And once you start, you absolutely have to stick with the program.
With either of these options, it’s important to look at the big picture of your overall retirement funding. Starting to withdraw from your savings too early can result in a significantly reduced standard of living later on, or it may be just fine in your situation.
Of course, you will still owe taxes on any distributions taken from tax-deferred accounts, and it’s a good idea to plan for those taxes when considering these strategies.
Quoted in Dallas Morning News on 2010 Roth conversions
October 25, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
I had the opportunity to talk with Pamela Yip, personal finance columnist at the Dallas Morning News, a couple weeks back about 2010 Roth IRA conversions. Her article provides a good synopsis of the changes for 2010, and quotes me on when conversion makes the most sense. Click here to read the article.
Who should consider Roth conversion
September 18, 2009 by Jean Keener, CFP, CRPC, CFDS · 2 Comments
Given the historic opportunity of 2010 to spread the tax payment over 2 years in 2011 and 2012, everyone with a traditional IRA should take at least one look at Roth IRA conversion for next year.
It is most beneficial to you when all of these apply:
- You’ll pay the resulting “conversion” tax with non-IRA funds
- You have 10 years or more before you will be taking distributions from the Roth IRA
- You will be in the same or a higher tax bracket when you start taking those distributions.
But even if only some or none of these apply, it doesn’t mean you should rule conversion out.
There are still many times where it can make sense, and some that don’t. It’s easiest to discuss these by looking at few examples.
I did an analysis for a 64-year-old who didn’t have the money to pay the tax with non-IRA funds, so the taxes were going to come out of his IRA. He also only had 6 years until he planned to start taking distributions. He was going to be in the same tax bracket in 2011-2012 and in retirement. In his situation, he still came out ahead with conversion – having over $1,000 more in after-tax retirement income by converting. He won’t be subject to the 10% penalty on the amount withdrawn to pay the tax because he is over 59 ½. His situation was also helped by not planning to take social security until age 70. If he was already receiving social security benefits, we would have needed to consider any additional income tax implications on his social security benefits for the years he claimed the conversion income.
Another analysis was for a 32-year-old woman. She has a pre-tax employer
401k and was also trying to decide if conversion made sense. She also does not have the funds to pay the taxes with non-401k money, and she would be subject to the 10% penalty by withdrawing funds from the 401k before age 59 ½ to pay the taxes. We estimated her tax bracket in 2011-2012 and in retirement as the same. In her case, conversion did not make sense. But it was quite close. If she believed that her tax rates were going to be higher by the time she retired by even 1%, the conversion would have significantly increased her after-tax income.
One last example – 44 year old. He had a traditional IRA and had money to pay the taxes from a non-IRA account. However, we estimated that his tax bracket in retirement would likely be lower than it is now, by about 3%. In his case, conversion was still a great deal even with the projected lower retirement tax rate. Having all those years of after-tax growth more than off-set the potential for a slightly lower rate in retirement.
If you have a traditional IRA, an analysis is in order.
The above examples illustrate that even when your situation doesn’t meet the “ideal conversion” criteria, it still may make a significant difference in your after-tax retirement income. If you’d like to see the specific calculations on any of the examples listed above, please feel free to contact me and I’d be happy to send them to you.
A few other considerations to keep in mind
If your estate is potentially subject to the estate tax, a Roth conversion can be a powerful planning tool.
The market’s relative “high” or “low” value when you convert is also a factor in how good a deal conversion is – low values mean you pay tax on a lower amount.
There are also opportunities to convert in early 2010 and undo the conversion later based on circumstances or market performance. We’ll discuss this in future posts.