March 2010 Newsletter
March 9, 2010 by Jean Keener, CRPC, CFDP · 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.
February 2010 Newsletter
February 9, 2010 by Jean Keener, CRPC, CFDP · Leave a Comment
The February newsletter is now available. It includes an update on January stock and bond market performance, the first article in a two-part series on how to tap into your home equity for retirement income, a preview of a new financial planning service, and more. Click here to read the newsletter.
Pension Max: Is it right for you?
December 15, 2009 by Jean Keener, CRPC, CFDP · 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, CRPC, CFDP · 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.
Who should consider Roth conversion
September 18, 2009 by Jean Keener, CRPC, CFDP · 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.
Paying the Bills: Potential Sources of Retirement Income
August 18, 2009 by Jean Keener, CRPC, CFDP · Leave a Comment
Planning your retirement income is like putting together a puzzle with many different pieces. One of the first steps in the process is to identify all potential income sources and estimate how much you can expect each one to provide.
Social Security
According to the Social Security Administration (SSA), more than 9 of 10 people aged 65 or older receive Social Security benefits. However, most retirees also rely on other sources of income.
The SSA sends you an estimate of your benefits each year. The closer you are to full retirement age, the more accurate that estimate will be. For a rough estimate, you can use the calculator on the Social Security website (http://ssa.gov).
Your Social Security retirement benefit is calculated using a formula that takes into account your 35 highest earnings years. How much you receive ultimately depends on a number of factors, including when you start taking benefits. You can begin doing so as early as age 62. However, your benefit may be 20% to 30% less than if you waited until full retirement age (65 to 67, depending on the year you were born).
As you’re planning, remember that the question of how Social Security will meet its long-term obligations to both baby boomers and later generations has become a hot topic of discussion. Concerns about the system’s solvency indicate that there’s likely to be a change in how those benefits are funded, administered, and/or taxed over the next 20 or 30 years. That may introduce additional uncertainty about Social Security’s role as part of your overall long-term retirement income picture, and put additional emphasis on other potential income sources.
Pensions
If you are entitled to receive a traditional pension, you’re lucky; fewer Americans are covered by them every year. Be aware that even if you expect pension payments, many companies are changing their plan provisions. Ask your employer if your pension will increase with inflation, and if so, how that increase is calculated.
Your pension will most likely be offered as either a single or a joint and survivor annuity. A single annuity provides benefits until the worker’s death; a joint and survivor annuity provides reduced benefits that last until the survivor’s death. The law requires married couples to take a joint and survivor annuity unless the spouse signs away those rights. Consider rejecting it only if the surviving spouse will have income that equals at least 75% of the current joint income. Be sure to fully plan your retirement budget before you make this decision.
Work or other income-producing activities
Many retirees plan to work for at least a while in their retirement years at part-time work, a fulfilling second career, or consulting or freelance assignments. Obviously, while you’re continuing to earn, you’ll rely less on your savings, leaving more to accumulate for the future. Work also may provide access to affordable health care.
Be aware that if you’re receiving Social Security benefits before you reach your full retirement age, earned income may affect the amount of your benefit payments until you do reach full retirement age.
If you’re covered by a pension plan, you may be able to retire, then seek work elsewhere. This way, you might be able to receive both your new salary and your pension benefit from your previous employer at the same time. Also, some employers have begun to offer phased retirement programs, which allow you to receive all or part of your pension benefit once you’ve reached retirement age, while you continue to work part-time for the same employer.
Other possible resources include rental property income and royalties from existing assets, such as intellectual property.
Retirement savings/investments
Until now, you may have been saving through retirement accounts such as IRAs, 401(k)s, or other tax-advantaged plans, as well as in taxable accounts. Your challenge now is to convert your savings into ongoing income. There are many ways to do that, including periodic withdrawals, choosing an annuity if available, increasing your allocation to income-generating investments, or using some combination. Make sure you understand the tax consequences before you act.
Some of the factors you’ll need to consider when planning how to tap your retirement savings include:
- How much you can afford to withdraw each year without exhausting your nest egg. You’ll need to take into account not only your projected expenses and other income sources, but also your asset allocation, your life expectancy, and whether you expect to use both principal and income, or income alone.
- The order in which you will tap various accounts. Tax considerations can affect which account you should use first, and which you should defer using.
- How you’ll deal with required minimum distributions (RMDs) from certain tax-advantaged accounts. After age 70½, if you withdraw less than your RMD, you’ll pay a penalty tax equal to 50% of the amount you failed to withdraw.
Some investments, such as certain types of annuities, are designed to provide a guaranteed monthly income (subject to the claims-paying ability of the issuer). Others may pay an amount that varies periodically, depending on how your investments perform. You also can choose to balance your investment choices to provide some of both types of income.
Inheritance
One widely cited study by economists John Havens and Paul Schervish forecasts that by 2052, at least $41 trillion will have been transferred from World War II’s Greatest Generation to their descendants. (Source: Why the $41 Trillion Wealth Transfer Is Still Valid) An inheritance, whether anticipated or in hand, brings special challenges. If a potential inheritance has an impact on your anticipated retirement income, you might be able to help your parents investigate estate planning tools that can minimize the impact of taxes on their estate. Your retirement income also may be affected by whether you hope to leave an inheritance for your loved ones. If you do, you may benefit from specialized financial planning advice that can integrate your income needs with a future bequest.
Equity in your home or business
If you have built up substantial home equity, you may be able to tap it as a source of retirement income. Selling your home, then downsizing or buying in a lower-cost region, and investing that freed-up cash to produce income or to be used as needed is one possibility. Another is a reverse mortgage, which allows you to continue to live in your home while borrowing against its value. That loan and any accumulated interest is eventually repaid by the last surviving borrower when he or she eventually sells the home, permanently vacates the property, or dies. (However, you need to carefully consider the risks and costs before borrowing. A useful publication titled “Reverse Mortgages: Avoiding a Reversal of Fortune” is available online from the Financial Industry Regulatory Authority.)
If you’re hoping to convert an existing business into retirement income, you may benefit from careful financial planning to minimize the tax impact of a sale. Also, if you have partners, you’ll likely need to make sure you have a buy-sell agreement that specifies what will happen to the business when you retire and how you’ll be compensated for your interest.
With an expert to help you identify and analyze all your potential sources of retirement income, you may discover you have more options than you realize.
Annuities: Retirement Income Option
December 5, 2008 by Jean Keener, CRPC, CFDP · Leave a Comment
Everyone like a guarantee. Unfortunately, in the financial services industry they’re few and far between. And those that are available often come with a steep price — if you can even figure out what the price is.
- Life only. Payments continue during your lifetime, but stop at your death.
- Period certain. Payments are made for a fixed period of time (e.g., 5, 10, 15, 20 years). If you die prior to the end of the chosen period, your beneficiary will continue to receive payments for the remainder of the fixed period.
- Life with a period certain. Payments are made for the rest of your life or a minimum period of time. If you die prior to the end of the minimum payment period, the beneficiary you name in the annuity will receive the payments for the remainder of the period certain, but no longer. If you outlive the period certain, payments will end at your death.
- Joint and survivor. Payments are based on the lives of two people, typically you and your spouse. When either of you dies, payments continue to be made to the survivor. This option can also be combined with a period certain option, in which case payments will continue until both of you have died or for the minimum period of time you select, whichever is longer.
- Installment refund/cash refund. If you die prior to receiving at least the return of your investment in the immediate annuity, your beneficiary will receive an amount equal to the difference between what you invested and what you received. Your beneficiary will receive this amount in either a lump sum (cash refund) or periodic payments (installment refund).
The amount of each SPIA payment you get can be affected by the payment option you select. For example, a 60-year-old man who invests $100,000 in an immediate annuity may receive annual payments of $7,260 for the life only option, $6,696 for life with a period certain of 20 years, or $7,920 for a fixed period of 20 years. (This example is for illustration purposes only and does not reflect actual insurance products or performance, nor is it intended to promote a specific company or product.)