Retirement Planning
& FAQs
Everyone wants a golden retirement. But saving for retirement is no easy task.
The baby boomer generation is graying. More and more people are approaching
retirement age. With Social Security's assets being consumed and the number of
workers that will support it shrinking, we will have to rely more on our
personal savings when it's time to retire.
Today, we have a myriad of options to help each of us prepare for the golden
years. Yet, without a specific plan of action, many people find themselves
falling short when it is time for them to live off of their life's work.
Click below to learn about some of the most powerful retirement strategies,
including:
Take the time to review your options, and ensure that you're prepared when
it's your turn to retire. And when you're ready to speak with a professional
about saving for retirement, call us at 800.482.5347.
Annuities are flexible insurance contracts designed to provide income and help
you achieve long-term savings goals. And these are not unused financial
vehicles: last year alone, annuity sales topped $200 billion.
Much like a CD is a contract between you and a bank, an annuity is a long-term
contract between you and an insurance company. In essence, the same company
that insures your home or protects your family may also help you save for
retirement.
After making a single lump-sum premium payment, or a series of periodic
payments, individuals can then receive regular annuity payments from the
insurance company. These payments can be made over a definite period of time,
or they can last a lifetime.
Payments to the annuity owner can also be tailored to begin after the contract
has been established for a number of years, or they can begin immediately
after the first premium payment is made.
A
Myriad of Options
Tax-deferral is not the only reason why annuities have mushroomed in
popularity. While they typically have maturity dates of 5-7 years, annuities
require no medical exams, and can usually be opened by filling out a basic
annuity contract.
Today, there are hundreds of annuities to choose from, designed for different
retirement goals. When it comes to fixed annuities, insurance companies
sometimes offer higher intial rates to attract would-be buyers, while other
companies promise consistent interest rates throughout the life of the annuity
contract. Rates, maturity periods, and death benefits are just some of the
options to look for in a fixed annuity.
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Annuity Flexibility
Annuities are one of the most flexible savings vehicles today. You can use
after-tax money to deposit into an annuity, or you can fund your annuity by
rolling-over qualified money.
For
example, traditional IRA and 401(k) owners can transfer their accounts into a
qualified annuity, which maintains their tax-preferred status. In some cases,
annuities will offer fixed interest rates, added death benefits, or other
features from the insurance company that are not available in a qualified
retirement plan.
Non-qualified (or "after-tax") annuities are just as popular. Because no
rollover from another account is involved, non-qualified annuities often
require less time to establish. In addition, when you withdraw funds, you'll
only pay taxes on your accrued interest, since your principal was already
taxed once before (when you earned it).
Up
until this point, we've focused primarily on options available during the
accumulation phase. But what about the payout phase, when the annuity returns
its value to you? Fortunately, annuities can also provide incredible
flexibility during the payout phase, as well.
When the payout phase begins, you can opt to receive your annuity's value in
one lump-sum, or you can elect to receive a steady stream of payments in
regular intervals (e.g. monthly, quarterly, etc.).
If
you decide to opt for a regular stream of payments, many insurers will allow
you to have annuity payments last for a set amount of time (such as 10 or 20
years). Many contracts also allow you to receive payments for as long as you
and your spouse live.
For
many annuity owners, having indefinite payments for the rest of your life
provides a predictable source of income.
As
a rule of thumb, the longer your payment period, the smaller your payments
will be. These conditions are clearly spelled out in the terms of the annuity.
Want more flexibility? Some annuities are designed to be immediate annuities.
Immediate annuities have no accumulation phase whatsoever. They begin paying
you in regular increments the moment you purchase the contract.
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Choices to Consider
When shopping for an annuity, there are several considerations that must be
weighed.
Immediate vs. Deferred Income
When it comes time to withdraw your money out of an annuity, you have a
variety of payment options to choose from. The insurance company can pay you
either in a lump sum, make periodic payments, or guarantee you a lifetime of
income on a tax-advantaged basis. Depending on the annuity contract you
purchase, the choice is yours.
Qualified vs. Non-Qualified
Annuities can accommodate qualified or non-qualified money. For instance,
suppose you are switching jobs and need to move over a 401(k). However, you
already have an IRA and are looking to diversify your portfolio. You can
reduce your portfolio exposure by rolling into an annuity, and not be forced
to lose your money's tax advantages.
In
another scenario, suppose you receive an inheritance of $20,000. If you don't
need the money right away and want to build a long-term nest egg, consider
putting the inheritance into an annuity. You'll gain the advantage of
tax-deferral. Plus, when it comes time to withdraw from your non-qualified
annuity, you'll only be taxed on the accumulated interest, not the principal
itself.
Insurance Company
The
quality of the insurance company is important, especially when purchasing a
fixed annuity. Working with a respected, highly-rated insurer can help
eliminate default risk, and ensure a retirement income when you need it most.
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All
annuities, share several common benefits. Here's a summary of what annuities
can bring to your retirement portfolio:
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Ideal for Estate Planning:
Proceeds from annuities pass directly to your beneficiaries without the
delay, expense, and publicity of probate in most states. If you've ever had
a loved one's estate go through this time-consuming legal process, you know
just what kind of advantage this is.
-
The Power of Tax Deferral:
Because you do not pay taxes on earnings every year, your annuity is able to
work harder thanks to tax-deferral. You will have to pay taxes on earnings
when you withdraw your annuity's gains, but at least you can decide when
that happens.
-
No Contribution Limits:
contributions to other retirement savings vehicles, like 401(k)s and
Individual Retirement Accounts, are strictly limited. Annuities, however,
offer tremendous flexibility. You can contribute as much as you want, up to
the limits imposed by the insurer, to take advantage of tax-deferral inside
the annuity. Plus, you can add to your annuity contract at any time.
-
Flexible Payment Options:
Unlike 401(k)s and IRAs, which require that you begin making withdrawals at
age 70 1/2, you may be able to wait much longer with annuities. When you do
decide to begin receiving payments, you can usually select one of the
following methods: Lump Sum distribution (a one-time payment) Periodic
distributions (you can take money only when you need it)
Systematic distributions (an amount is sent to you at regular
intervals)Annuitization (guaranteed for the rest of your life)
Different distribution methods behave differently when it comes to taxes; for
instance, Lump Sum, Periodic, and Systematic distributions exhaust all
earnings (which are taxable) before tapping principal. Under annuitization,
each payment consists of both principal and interest, spreading your tax
liability evenly among payments.
Through these distribution options, you have complete control over when you
will pay taxes on your earnings.
Annuities are not perfect when it comes to tax control. If you should pass
away while your annuity is accumulating, all deferred taxes on your growth
will become due, reducing your annuity's value.
-
Easy To Start and Maintain:
Usually, a simple application, a check, and your signature begins your
annuity. And, at the end of each year, you will not receive a 1099 for
income earned within your annuity contract. That's one less thing to worry
about when April 15th rolls around.
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Other Features:
Annuities also do not offset Social Security benefits like bond, CD, and
other investment income does.
Annuities are easy to establish and often come with a "free look period." Your
state of residence or the annuity contract will define a length of time
(usually 30 days) where can cancel your contract if you decide it's not right
for you.
You
can even exchange older, non-performing annuities into a newer fixed annuity
with no tax consequences, thanks to Section 1035 of the Internal Revenue Code.
If
you are a conservative investor looking for a consistent way to build your
retirement savings, then fixed annuities may be the answer for you.
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For
nearly two decades, tax-deferred annuities have enjoyed remarkable popularity.
Most tax-deferred annuities require a single premium payment in the beginning,
which then accumulates on a tax-deferred basis.
However, annuities are not perfect. For instance, if you should pass away
while your annuity is accumulating, all deferred taxes on your growth suddenly
become due. Annuities with substantial growth could be reduced significantly,
and your children and grandchildren could end up with a fraction of your
annuity's value after taxes.
For
retirement savers looking to preserve a little more wealth for their family,
there may be a solution: a type of life insurance policy known as a Modified
Endowment Contract (MEC).
In
financial circles, MECs are often compared to annuities because of their
similarities. In fact, MECs are technically life insurance contracts that have
many of the benefits of accumulation found in annuities... but if anything
happens to you, your loved ones will usually receive more than your initial
premium, not less.
The
Basics of MECs
The
same insurance companies that issue annuities also underwrite Modified
Endowment Contracts. MECs are very similar to annuities in terms of
tax-deferred accumulation of your initial premium.
However, the tax code is not very favorable, particularly if the owner passes
away during the annuity's accumulation stage. If that happens, all deferred
income taxes on growth become due.
MECs are able to overcome this by including an insurance "rider" in the
contract, designed to pass the entire account value to your beneficiaries
income tax-free. While specific features will vary by company, MECs offer
several distinct advantages over deferred annuities and other
wealth-accumulation vehicles:
-
MECs avoid income taxes during the accumulation stage of your account;
-
MECs do not force you to make distributions by a particular age, like some
IRAs and 401(k)s;
-
MECs allow you to make withdrawals or loans in cases of emergency;
-
MECs give you the flexibility to choose different options;
-
MECs provide a lump sum payment to heirs that is tax-free;
-
Unlike annuities, MECs can be owned by certain types of trusts without
losing their tax-advantaged status
MECs can provide a retirement income for you, while preserving your legacy for
your loved ones.
Reducing Taxes
The
Internal Revenue Code provides tax advantages for MECs. Insurance products
have always received very favorable treatment by Congress, and MECs are no
exception.
Unlike stocks which are taxed every year, any earnings within your MEC remain
untaxed as long as they stay within the MEC account. You choose when to pay
taxes, since income taxes on the growth of your MEC are due only upon
withdrawal. Over the long haul, this tax-free accumulation can produce
dramatic advantages.
Tax-deferral provides this added value, because of the time value of money.
Compare the accumulation of a jumbo CD and a MEC, and let's assume both are
earning 7%. The CD is taxed on the earnings, reducing your net interest rate.
If you're in the 27% tax bracket, you're actually earning 5.11%.
However, for the MEC, it's a different story. Since income taxes are deferred,
the MEC is credited with the full 7%.
Of
course, CDs have much shorter maturities than MECs, and they're offered by
banks (not insurance companies). CDs are also FDIC-insured, while MECs are
not. Plus, remember that when funds are finally withdrawn from the MEC, income
taxes will be due. However, your MEC money will have worked harder for you,
thanks to the time value of money on your side.
Long-Term Strategy
Tax-deferral is wonderful, but there is a small price to be paid in terms of
liquidity. MECs are able to grow without annual income taxes being paid,
because they are designed for retirement.
Like annuities and traditional IRAs, money placed inside a MEC must remain
there past age 59 1/2. If you make a withdrawal from the MEC before that age,
the IRS will slap a 10% penalty on any withdrawals made. For this reason, they
are not liquid, and should remain in there until you're ready to draw money in
the form of retirement income.
It's important to make a distinction between "liquidity" and "flexibility."
Because MEC money must remain inside the retirement account past 59 1/2 does
not mean you don't have options. To the contrary, many fixed MECs offer a wide
variety of payout options to suit your needs.
Let's not forget that as long as your account is accumulating and no
withdrawals are made, no Form 1099s reporting income will be generated. At the
very least, this maintains a degree of privacy. And, in many states, MECs also
offer asset protection from creditors. If anything happens to you, your MEC
also avoids probate. Resembling an annuity once more, MECs pass probate-free
to your named heirs. This probate bypass will spare your family the time,
expense and public exposure that probate can bring.
When purchasing a MEC, it's important to look at the quality of the issuer. If
you were buying an annuity or life insurance policy, you'd want a highly-rated
insurance company behind your purchase. MECs are no different, since the same
insurance companies that offer traditional life insurance and annuities also
offer Modified Endowment Contracts.
If
you're concerned about your MEC issuer's stability, there are many safeguards
already in place by law.
Once you purchase a MEC, you don't have to keep it forever. Section 1035 of
the Internal Revenue Code allows you to switch from one MEC to another without
incurring taxes on the growth of your MEC. However, if you switch to another
MEC before your guarantee or "maturity" period has expired, you may incur
company-imposed surrender charges. Always check those charges carefully before
choosing your MEC.
Plus, MEC's usually have a death benefit higher than the actual cash value.
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Roth IRAs, unlike traditional IRAs, have a simple premise: you pay income tax
going in, rather than when you pull out.
Named for Sen. William V. Roth from Delaware, the Roth IRA represents an
enhanced level of flexibility for people saving for their retirement.
The
Roth IRA is a type of account that you establish through a qualified broker.
Beginning in 2002, you can contribute up to $3,000 annually to your Roth IRA.
Any contributions that you make to your Roth IRA are considered "after-tax,"
and cannot be deducted from your tax return. However, when it is time for you
to draw money from your account, you will not pay income taxes on the growth
of your account. If you're in a high tax bracket, that can amount to
tremendous savings.
The
Economic Growth and Tax Relief Reconciliation Act of 2001, signed into law by
President Bush, increased the annual amount you can contribute from $2,000 to
$3,000 ($3,500 if age 50 or over). Plus, in 2005, the annual amount increases
to $4,000. And in 2008, the maximum annual contribution rises once again to
$5,000.
Just like a traditional IRA, Roth IRA accounts can hold stocks, mutual funds,
and other types of investments. Retirement-minded investors, looking to build
their nest egg, can open a Roth IRA brokerage account and invest it like they
would any other account. However, unlike other types of brokerage accouts,
your broker will usually ask you to pick a designated beneficiary for your
Roth IRA funds, should you pass away with the account open.
People who are still working and are eligible to contribute more have to think
about what kind of IRA they should contribute to. This is especially true if
you have already accumulated a large IRA, perhaps from the rollover of a
retirement plan, and if you want to know whether you should convert that pot
of money into a Roth IRA.
If
you have accumulated a large traditional IRA, you can elect to convert the
entire account to a Roth IRA. Upon conversion, you must declare the entire IRA
taxable balance as taxable income and pay taxes on it in the year of
conversion. From that point on, the IRA is federal income tax-free during
compounding, and federal income tax-free when you pull money from it (if you
have held the Roth IRA for at least five years, you are age 59 1/2, or meet
other requirements).
If
you are a mature American with a large IRA, you have a big decision. Should
you convert your nest egg to a Roth IRA? In many cases, it makes sense. If you
qualify for a conversion, you may save thousands of dollars for both yourself
and your heirs.
Better to Pay Now or Later?
Are
you better off waiting to pay taxes, or paying them now? For many, paying your
taxes owed now is the smart thing to do. Forget the math... just know that
politicians like to spend other people's money. After all, Uncle Sam could
collect his pound of flesh later, or just a few ounces now. Traditionally, the
U.S. Government prefers to collect its money now, even if the long-term goal
is more reduction of the budget deficit.
In
this era of budget balancing, politicians need collections today to show that
they are working hard to keep the budget balanced.
Looking long-term, Congress may have problems later, but only after our
hard-working politicians are probably long-gone. Congress' short-term outlook
can be turned around to work for you. Even if you already own a traditional
IRA, you can convert it to a Roth IRA. For existing IRA owners, there are
restrictions on conversions. For instance, you can convert only if your AGI
(Adjusted Gross Income) is no more than $100,000 in the year you make the
switch, assuming you're single or married filing jointly.
Who
should not convert their existing IRA to Roth? If your tax bracket is higher
now than your heirs' tax bracket will be when the money is spent. Also, be
very careful if you aren't sure about falling under the $100,000 ceiling.
Converting and then discovering later that your income was higher could blow
up in your face, creating significant tax penalties.
From an estate planning standpoint, if your main goal is to accumulate as much
as you can and leave it for your heirs, conversion can make a lot of sense.
Traditional IRA owners must begin taking distributions by age 70 1/2. However,
Roth IRAs require no minimum distributions each year during the life of the
IRA owner, nor on the life of the IRA owner's spouse. If you want to keep your
money growing on a tax-preferred basis longer, then the Roth IRA may hold your
solution.
A
Look at the Numbers
Suppose you own $20,000 of growth stocks in a qualified IRA, and you believe
that you it will be worth $60,000 by the time you spend it.
For
simplicity, you are in a 36% tax bracket now, and expect to be in the same
bracket in the future.
If
your assumptions are correct and you leave your IRA alone, the IRA will grow
to $60,000. After paying $21,600 in taxes, you will have $38,400 of spendable
cash after taxes.
But
suppose, in the beginning, you made the conversion to a Roth IRA. You convert,
using $7,200 from the account itself to pay the immediate tax bill. The
remaining $13,600 triples to $38,400.
The
two outcomes are identical. In this scenario, there's no difference between
the two... unless you were under age 59 1/2, in which case money taken from
the Roth IRA account to pay tax would also be subject to a 10% early
withdrawal penalty.
However, there is another option. Suppose you convert to a Roth IRA in the
beginning, and come up with the $7,200 in initial taxes from some other source
of cash that would not have qualified for tax-deferred compounding.
Assuming the same growth rate, your Roth IRA would have tripled in value to
$60,000 (a full $21,600 more). Best of all, the entire amount would be income
tax-free when you needed to make withdrawals... plus, there would not have
been a 10% tax penalty on money taken from the account if you were under age
59 1/2.
Sure, you're missing that $7,200 from your outside account, and that money
could have grown. However, its growth would've been stunted by the fact you
were paying taxes on the income all along.
Remember: in this case, the "time value of money" is definitely on your side.
The Roth trade is a bad one for Uncle Sam, and a good one for you.
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Retirement Planning FAQs
1. What is a Minimum Required Distribution?
2. How much should I be saving in my 401(k) plan?
3. Should I borrow money from my 401(k) plan?
4. Can I take a loan from my IRA?
5. What should I do with my company retirement money if I am leaving my job?
6. Can I make additional contributions to my Traditional Rollover IRA?
7. My employer already sent me a check for my plan distribution and withheld
20%, can I get that money back?
8. Can I make additional contributions to my Inherited IRA?
9. Can I take a "hardship withdrawal" from my 401(k)?
10. What is the difference between a 401(k) and a 403(b) plan?
11. How will signing up for a 401(k)/403(b) plan affect my take-home pay?
12. What is an employer match?
13. Will investing in my employer's retirement plan affect my Social Security
benefits?
14. Can I join my company's retirement plan if my spouse already contributes
to a retirement plan at work?
15. What is vesting?
Tax-deferral for money in IRAs, 401(k)s, and other qualified retirement plans
eventually comes to an end. By law, under most circumstances, you must begin
taking a required minimum distribution (RMD) annually once you reach age 70
1/2. For tax purposes, these distributions must be considered income. (Of
course, if you have made nondeductible IRA contributions, they are not
considered taxable income when withdrawn.)
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Most financial advisors recommend that you aim to save at least 10% of your
salary. However, if that sounds too tough, try the 1% solution. You start by
saving an amount you can afford, then raise it by one percentage point a year.
For example, if you start by saving 2% of your income, the next year save 3%.
In the third year save 4%, and so on. You'll soon be saving more than you
thought possible.
Others call themselves Financial Planners, but they may only be able to
recommend that you invest in a narrow range of products, and sometimes
products that aren't securities. Before you hire any financial professional,
you should know exactly what services you need, what services the professional
can deliver, any limitations on what they can recommend, what services you're
paying for, how much those services cost, and how the adviser or planner gets
paid.
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A
home-equity loan is often cheaper than a 401(k) loan. If you have a
significant amount of equity in your house and a good credit record, you will
usually be better off taking out a home-equity loan rather than borrowing from
your plan. That's because in most cases you can deduct your home-equity
interest payments from your income taxes, which dramatically reduces the real
cost of the loan. By contrast, interest on a 401(k) is not deductible and IRS
penalties may apply.
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No,
you may not borrow from your IRA. However, once per 12-month period, a
distribution may be taken and rolled back into an IRA within 60 days of
receipt of the distribution. No taxes or IRS penalties will be incurred by the
account holder as long as the distribution is rolled back within 60 days. But,
as always, you should consult your tax-advisor to ensure you do not incur any
IRS penalties.
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If
you're about to receive a payout from your employer's retirement plan, you
need to make an informed decision about placing your funds where taxes and
penalties won't erode them. The most popular choice for sheltering retirement
plan payouts is a Traditional Rollover IRA because it offers several
advantages. With a Traditional Rollover IRA you'll:
-
Avoid taxes and IRS penalties you would incur
if you receive your payout directly
-
Continue to have your money grow tax-deferred
until you retire, when withdrawals may be taxed at a lower rate
-
Have the flexibility, at a later date, to
possibly move your money into a new employer's retirement plan (if funds are
not commingled with other IRA funds)
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You
may make additional contributions to your Traditional Rollover IRA. However,
in doing so, you may forfeit your opportunity to roll over your assets into a
new employer-sponsored retirement plan. This includes cash contributions,
combining an existing IRA with your Rollover IRA and even a 401(k) or 403(b)
payout.
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Yes. If you deposit your check into a Traditional Rollover IRA within 60 days,
with the amount equal to the 20% withheld. If you do not make up the withheld
amount, it will be considered as a distribution and taxed as ordinary income.
It could also be subject to a 10% IRS early withdrawal penalty. By funding
your Rollover IRA within 60 days with 100% of your retirement plan payout, you
may be entitled to a tax credit for the 20% withheld by your employer as a tax
credit when you file your tax return.
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Unless you are the spouse of the decedent and are eligible to treat the IRA as
your own, contributions to Inherited IRAs are not permitted.
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If
you have no other way of getting the money for certain large expenses, you may
be able to withdraw money from your retirement plan. However, restrictions
vary by plan. If you need money for the purchase of a primary home, prevention
of eviction from or foreclosure on your home, payment of certain medical
emergency costs, or college tuition for you or your eligible dependents, you
might be able to take money from your 401(k) retirement plan. But such a
hardship withdrawal will still be subject to taxes and possible IRS penalties.
Your employer may be ultimately responsible for determining whether a certain
instance constitutes an emergency.
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A
401(k) plan is a type of qualified retirement plan offered to you by your
employer under section 401(k) of the Internal Revenue Code. A 403(b) plan is a
somewhat different type of retirement plan, which has many of the same
features of the 401(k) plan, but is offered only to employees of tax-exempt,
non-profit organizations and educational institutions.
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Contributing "pre-tax" money to your employer's qualified retirement plan
reduces your current taxable income by the amount of salary you defer under
the plan. Therefore, you are able to invest more than you otherwise would if
you put your money into a comparable after-tax investment. For example, one
hundred dollars ($100) invested pretax would "cost" you the same as $72
invested after tax (assuming you are in the 28% tax bracket).
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A
big advantage of your employer's retirement plan is that your employer may
match a portion of the contributions you make to the plan. For example, your
employer may make matching contributions of 50 cents for every dollar you
contribute. You will also not be taxed on any matching contributions until you
receive a distribution or withdraw amounts from the plan.
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No.
The amount of Social Security taxes (FICA) paid on your behalf will not be
affected if you reduce your taxable income by contributing to your employer's
retirement plan. These amounts continue to be treated as "wages" and therefore
are subject to FICA taxes.
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Yes, your spouse's participation in an employer's retirement plan does not
affect your ability to participate in your own employer's plan.
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Vesting refers to your right as a participant in a company sponsored
retirement plan to receive a present or future retirement benefit that is not
contingent on you remaining employed by the employer. You will always be 100%
vested in contributions you have made to the plan. Contributions made by your
employer, however, will often vest according to a vesting schedule, where your
vested percentage will increase based on your years of service with the
employer. By law, it can take no longer than seven years of service for you to
become 100% vested in any contributions made by your employer, including
earnings. Vesting schedules vary from plan to plan.
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