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What should you do with your 401(k) money? How much can you expect from Social Security? Do you have enough money to retire early?
If you are seriously considering questions like these, your retirement date is probably in the not-too-distant future. Whether it’s months or years away, you’ll want to think about some key issues. Here are some of important items you need to consider as this new stage of your life approaches.
How Should You Handle Your Retirement Plan Payout?
You will face a very important decision: what to do with the money in your work retirement savings and/or pension plan. You’ll have several options, and an understanding of investment and tax implications is critical to maximizing your retirement dollars.
Distributions from a 401(k), 403(b) or Other Defined Contribution Plan
If you’re retiring with a 401(k), 403(b), or other similar retirement plan, various options are available. If you were born before 1936, an option that offers favorable 10-year forward averaging on taxes upon withdrawal from the plan may be possible. This option is not always available, however, especially if you plan to bequeath your qualified retirement assets to heirs – a lump sum distribution may be required upon death, requiring taxes to be paid.
Another choice is to roll your retirement plan dollars directly into an Individual Retirement Account (IRA). An IRA offers considerable flexibility in estate planning. With this option, you will continue to defer income taxes that would have been due on a distribution and avoid a potential premature withdrawal penalty. You will also benefit from a greater range of investment choices compared to what is offered by most employer retirement plans. IRA withdrawals are subject to ordinary income taxes (even withdrawals of capital gains) and are not eligible for 10-year averaging. Note that there may be a special tax option available if your retirement plan assets are invested in your employer’s company stock.
If you want to withdraw all or part of the funds in your qualified retirement plan, what is the impact? Current income taxes will be due on any money that’s taken but not rolled over into another tax-advantaged plan, such as an IRA. In addition, if you’re under age 591/2, the money may be subject to the 10% premature withdrawal tax penalty. Furthermore, your employer will withhold 20% of your distribution as prepayment of your federal income tax. These taxes, plus the tax-deferred earnings you’ll forgo, can make a cash withdrawal an expensive choice!
A financial professional can help guide you through some of your options.
Payouts from an Employer’s Pension Plan
What about a company pension plan? In many cases, you’ll only be allowed to choose the type of monthly payout you receive. Most often, this means deciding between higher pension payments with no survivor benefits or lower payments with some level of survivor support. If you are married, your employer will probably require you to sign certain documents indicating agreement on the choice of payout.
Some pension plans allow retirees to take their benefit in the form of a lump sum, which can be rolled into an IRA. The tax rules that apply to a lump sum from a defined contribution plan are also generally applicable to a lump sum distribution from a pension plan. |
How Long Must Your Retirement Income Last?
Another important question: How long will you need to stretch out your retirement income? In reality, Americans are living longer than ever before. Today, a woman turning 65 could expect to live almost two more decades. For a 65-year-old man, the average life expectancy is less, or about 811.
These figures will probably extend even further as medical advances continue. Americans continue to retire at earlier ages than previous generations. The average retirement age in the early 1950s was around 67; now it’s about 622. Most Americans nearing their “golden” years can look forward to very long retirements.
Of course, the challenge in all this good news is making sure you have the financial means to comfortably support so many more years of life without a paycheck. As you near retirement, it’s critical to estimate your retirement cash flow. Will your monthly income from sources like Social Security, a pension and retirement savings be enough to pay all your bills? Discovering a gap now could give you the opportunity to make some immediate changes. You may decide work longer or on a part-time basis, boost your savings rate or structure a more aggressive investment portfolio. These are issues you may want to discuss with your financial advisor.
What Impact Will Inflation Have on Your Savings?
Inflation causes slow, steady erosion of purchasing power that is rarely noticed early in a retirement. It is a quiet enemy. Over the years, as expenses grow and incomes don’t, most people can’t help but recognize its accumulating damage.
Although the Consumer Price Index (CPI)—a common measure of inflation—has been relatively low in recent years, it rose to 3.4% in 2000. This was the highest the CPI has been since 1991, when it was pegged at 4.2%3. From a broader perspective, inflation has averaged an annual 3.1% since 1926. Even at this seemingly reasonable rate, the car that costs $20,000 today will command nearly $37,000 in 20 years – almost double!
One of the most effective ways retirees can combat the constant creep in costs is to devote a portion of their savings to investments that grow faster than inflation, namely stocks and stock mutual funds. Over the last 75 years, stocks have averaged an 11% annual return, while long-term government bonds and cash reserves have averaged 5.6% and 3.9% respectively4.
True, one’s portfolio should become more conservative as retirement gets closer. At the same time, even individuals in their early 70s may be looking forward to at least another decade of living. Almost all retirees, regardless of age, need some real growth in the value of their assets. Without it, the combination of taxes, and inflation can only accelerate the depletion of their savings.
What Can You Expect from Social Security?
Despite all the debate on Social Security's demise, it will probably provide some income to you when you retire. It is not intended, however, to cover the full cost of a comfortable future. So how much can you expect to receive? That depends on how much you earned during your most lucrative 35 years of work. To give you an idea, the top benefit for someone retiring |
at age 65 in 2001 was $1,536 a month; the average monthly benefit was $8455.
Your best estimate, though, is the one you'll find on the annual statement that the Social Security Administration has started sending to all workers age 25 and older. Timed to arrive around three months before your birthday, it specifies the benefits you're likely to receive at various retirement ages. It also reviews your earnings history, lists the amounts you and your family would receive if you were disabled or died, and tells you whether you're eligible for Medicare.
If you would like to get this information sooner, you can call 1-800-772-1213 or visit the Social Security Administration's website at www.ssa.gov. When you do receive it, be sure to double-check the reported earnings for each year that you've worked. You will probably want to integrate this data into your retirement planning immediately.
How Much Will You Be Able to Spend Each Year? Estimating how much you can spend in retirement without prematurely depleting your assets is a complex calculation. Your resources, the structure of your portfolio, the returns it generates, taxes, inflation and your life expectancy all come into play.
Remember that withdrawals from tax-advantaged retirement accounts—such as IRAs—are subject to rather complicated IRS rules, which can have significant tax implications. For instance, if you’re retired at age 701/2, you’ll be required to start taking money out of most retirement accounts—regardless of how much you’ve withdrawn prior to that age. While distributions during your lifetime are generally calculated according to the new Uniform Life Expectancy Table, your heirs’ distributions will depend on how you’ve configured your beneficiary designations. With careful planning, you may be able to extend the tax-deferred advantages of your IRA for multiple generations.
It is a good idea to discuss your concerns in these areas with your financial advisor. If adjustments in your planning are in order, they are best made sooner rather than later.
The Importance of Planning
Inflation. Social Security. Medicare. Because so many of the factors affecting your future security are moving targets, preparing for retirement is an ongoing process—one that requires continual refinement. Even after you leave work, you’ll still face decisions with far-reaching economic consequences. Obtaining sound information and knowledgeable advice beforehand can greatly improve your chances of making the right choices.
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Your financial advisor can offer guidance on many decisions you’ll need to make both before and after your retirement. This includes advice on:·
- Structuring an appropriate asset allocation for your retirement portfolio
- Designing a realistic retirement spending strategy
If you are seeking a professional financial advisor, call CPIC at 415-989-1915. |
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