You're there. The magic day has arrived. The desk has been cleared, all personal mementos have been carted home, and you have received the proverbial gold watch. All that's left is to get with the Personnel Direction to tie up some remaining loose ends, and then you're out the door forever.
The Personnel Director smiles sardonically as you enter his office and says, "We just need you to fill out a few forms, and you'll be on your way. Tell us how you want to take your money, sign this irrevocable option form, and you're out of here. You've got to make the choice on your own, though.
I can't advise you at all. You know why: liability issues, fiduciary responsibilities, lawyers, etc. But you're a bright guy. After all, you managed to last a whole career here, didn't you? You'll figure it out. Just tell me how you want to handle your distribution in the next five minutes, though, okay? I'm a busy guy and can't spend all day chewing the fat with ex-employees."
Making that choice is a piece of cake isn't it? Just grab the money and run, right? It isn't often that you see six-or-seven figure sums staring you in the face, and it's all yours. Snatch that check, deposit it in your bank, and board that cruise liner to luxury land.
You can work out the nitty-gritty with your tax advisor at the end of the year. Right now your better half is waiting with luggage in hand and the camera slung over her shoulder. Get a move on, guy, 'cause time's a-wasting!
Now, don't be too hasty, or you may be in for a very rude awakening. This choice is a one-time decision. Go the wrong way now, and you could very well lose about half of the money you've accumulated through your working career.
The taxman would steal it away while you weren't looking. This decision is not one that can be ignored or left to the last minute. You must know all of your options, and you must know the tax impact of each choice. Without that knowledge, it's too easy to make a mistake that could haunt you for the rest of your life.
For most of us, the sums that become available at retirement are the largest amounts of money that we will control in our entire lives. The decision on how we handle that money is probably the most important one we will make, as well. Knowing that, you need to know that this is one of the times in our lives when it makes sense to consult the experts.
In this case, about six months prior to retirement we would see a skilled tax practitioner who's experienced in retirement plan distributions. We would have that expert run the various scenarios for us to see the potential results. Then, armed with that knowledge, we would choose the option that best fits our personal situation.
How much would that cost? Anywhere from $200 to $750 is a good guess. Measure that against a possibly huge loss from your retirement stash, and most people would agree the advice is well worth the cost.
Generally, normally, usually, the best choice for a retirement plan distribution is to transfer that money to an Individual Retirement Account. By doing so, the tax-deferred status of that sum continues and we reduce our current tax burden.
Be aware, though, an IRA is not always the right choice, which is another reason to seek expert tax advice regarding these distributions. Once the money is in the IRA, it is subject to IRA rules. That's no problem when a person is older than 59 ½. We're free to withdraw as much money as we want at any time, and we will only pay ordinary income taxes on that sum. But what if you retire at a younger age?
Retire at age 55 or older, but younger than age 59 ½, and two factors come into play. At age 55, you may retire and receive qualified retirement plan proceeds without penalty. You will pay ordinary income taxes on any sum you keep.
Put that money in an IRA, though, and now you must play by those rules. Take money out of the IRA, and you'll pay ordinary taxes plus a 10% early withdrawal penalty because you are under age 59 ½. Bummer! You don't want to pay taxes all at once on your retirement plan money. You want the tax deferral of the IRA.
You don't want to pay that lousy 10% penalty on IRA withdrawals. And you still need money to live on each year until you can get at the IRA. What do you do? Add another reason to go see the tax consultant, Fool. You have several options, but to choose one of them you need to know their ramifications. The expert can outline them for you.
You could keep just enough money from your retirement plan to live on until you reach age 59 ½, and transfer the rest to the IRA. You'd have to pay taxes on the sum you keep, though. You could transfer all the money to the IRA and then make withdrawals under Section 72(t) of the Internal Revenue Code.
That's an exception that allows you to avoid the 10% penalty. But do that and you have to live with the income the computations produce, which may not be enough cash. Further, you have to take that income for the longer of five years or until you reach age 59 ½. Therefore, once started, you can't stop at will. What's the best choice? Ask your tax consultant.
A great way to build up your retirement income is to invest in the stock market.
domingo, 24 de junio de 2007
UNCLE SAM’S PART
Conventional wisdom holds that it's almost always better to invest in a tax-deferred vehicle like a 401(k) plan or IRA than in an after-tax investment. This gospel holds that even if the initial investment itself is made with money that's already been taxed, the earnings accumulate untaxed, and this adds immeasurably to the positive power of compounding.
Because your earnings (and often the contribution) are untaxed until you begin withdrawing money in retirement, the government is in effect providing you leverage in the investment. This boost thus allows you to amass far more money for retirement than you could in a taxable alternative.
Additionally, you control when it gets taxed, and at what rate, by deciding on the amount of the withdrawal and when to take it. By contrast, in conventional investments, you are taxed on all money going in and on all dividends and gains in the year they are received.
All things being equal, that general idea is true. But all things are not equal. When should you elect to invest in a tax-deferred vehicle as opposed to a taxable alternative? Use the plan at least up to the level where you obtain the maximum matching contribution from your employer. Don't turn down that free money.
Let's say your employer matches any contribution up to 6% of your salary. Most people would contribute that 6%, but beyond that they would compare the returns available in the plan investments to those outside of the plan.
Here's a simple comparison between a tax-deferred investment like a 401(k) plan and an ordinary taxable investment. Let's assume that ultimately you'll withdraw all your money from the tax-deferred account, and you'll be taxed on that amount at today's marginal tax rates.
Of course, it's not quite that simple because, in reality, you'll decide how that money eventually comes out -- maybe all at once, maybe piecemeal, leaving the rest to compound. But for this simplistic analysis, let’s just say it’s enough. Let's also agree that all gains in the taxable account will be taxed at ordinary rates, even though we know that at least half would be taxed at the lesser capital gains rate.
For our example:
TR = your marginal tax rate
Ra = the return you expect in the after-tax investment
Rp = the return you expect in the tax-deferred investment
Any earnings in the after-tax account will be taxed. Therefore, the equivalent rates of return in a tax-deferred or after-tax account can be expressed as (1-TR) * Ra = Rp, which can be restated as Ra = Rp / (1-TR).
All right now uncross those eyes. This formula gives you the rate of return you need in an after-tax account to equal the return you would get in a tax-deferred account after it, too, had been taxed at some point in the future. Let's take an example.
Let's say I'm in a 28% federal tax bracket, that I get no matching contribution from my employer or have already reached the maximum match, and that I deposit $100 into my tax-deferred account. I expect to earn 10% on that deposit. What rate of return do I have to get in an after-tax investment to equal what I'm getting in that plan?
Well, by using the formula, I get:
Ra = Rp / (1 - TR)
Ra = 0.10 / (1 - 0.28)
Ra = 0.10 / 0.72 = 0.138888 = ~13.89%
Therefore, if I deposited $72 in an after-tax investment (the equivalent of $100 deposited in a tax-deferred account) and I earned at least 13.89% on that investment, I would do just as well after taxes as I would in a tax-deferred investment earning a 10% return. If I could get more than 13.89%, I would do better.
Need a little proof? In the tax-deferred account a $100 deposit would earn $10 at a 10% return, giving a total of $110. Withdrawing that $110 and paying taxes at 28% would leave $79.20. $72 in an after-tax account would earn $10 at 13.89% or $7.20 after taxes, leaving $79.20 total in that account after taxes.
Use a 401(k) or similar plan to get the maximum employer matching contribution available. Beyond that level, compare your before-tax and after-tax investment options and select the one that provides the highest after-tax return.
But remember this: If you choose an alternative to the 401(k), then you must be just as dedicated and disciplined within that investment as you would have been within the 401(k). That means you must make your deposits in that investment each and every payday without fail.
It also means your deposit must increase at the same time and at the same rate as your pay does. Fail to adhere to that regimen, and you will neither equal nor beat the 401(k). The 401(k) demands these contributions and increases via automatic payroll deduction, so to keep pace with or to better that vehicle you must apply the same technique in any alternative.
The Taxpayer Relief Act of 1997 provides a unique opportunity to those of us who have reached the maximum contribution we wish to make to our employer plans. It's called a Roth IRA and may be established anytime after January 1, 1998.
With a Roth IRA, you may make a nondeductible deposit of up to $2,000 per year, allow the earnings to accumulate tax-free through the years, and ultimately withdraw all of the proceeds tax-free. This is an excellent vehicle for monies to be invested outside of an employer-provided plan.
Many people think the following phrase is true: "Retirees enjoy a lesser tax burden than those who work.” That may have been true in the grey and distant past, but it certainly isn't true now. Today, many retirees end up in exactly the same marginal income tax bracket after retirement as before. That situation will definitely be true for those who follow a Foolish path in their retirement planning.
Nevertheless, retirees as a group do tend to pay the taxman less in absolute dollars than they did before. Common sense should tell us why: they have less taxable income. The money they live on usually comes from savings (taxable), pensions (taxable), and Social Security (potentially taxable in part).
The addition of Social Security, which is never fully taxed, reduces the actual taxable income. Thus, a retiree could draw exactly the same annual income as she did when she worked, but pay less total dollars in taxes because part -- if not all -- of the Social Security income is received tax-free. Despite paying less dollars, though, that same retiree will still be in the same marginal tax bracket, albeit at the lower end of that range.
Throw some work in the mix and the plot thickens. Wages from work get taxed as usual. Social Security is trimmed as the retiree exceeds the maximum earnings limit for the year. In extreme cases, work could cause a confiscatory tax of over 80% on those wages when ordinary income taxes are added to the Social Security forfeiture. Kind of makes one wonder why anyone would want to work under that scenario, doesn't it?
If you're looking for a greatly reduced tax burden in retirement, forget it. The best you will achieve is a lower average tax rate on all the money flowing into the household for the year. Compute that rate by dividing your total taxes by all of your income, both taxable and nontaxable. For many retirees, the significant proportion of that income represented by untaxed Social Security payments does indeed cause the average tax rate to drop.
When and how does Social Security get taxed, you ask? The computation, like all Infernal [sic] Revenue Service requirements, is a tad complicated. In fact, they have a special worksheet just for that purpose. The math starts with your Adjusted Gross Income.
To that you add one-half of all Social Security benefits and all unearned income received during the year. The latter almost always comes from tax-exempt interest received from municipal bonds (a favorite retiree investment). If the computed total is larger than $25,000 (single) or $32,000 (married filing jointly), then up to 50% of the Social Security benefit will be taxed. If the amount is larger than $34,000 (single) or $44,000 (married filing jointly), then up to 85% of the Social Security benefit will be taxed.
To determine the exact amount that will be taxed; you must complete the handy-dandy worksheet supplied by the IRS for that purpose. Doesn't that sound like fun?
OK! Now we know retirees have to pay taxes, too. But don't they get any breaks? What happened to the senior citizen discounts? Surely the government can't be that cruel. What is this, the Spanish Inquisition? Heck, I remember Gram and Gramps each getting an extra personal exemption because they were older than age 65. That's just gotta be there for today's retirees, too, right?
Uh... well... actually, no it's not. It's true that exception did exist at one time, but it got wiped out during one of the efforts by Congress to "simplify" our tax laws. Our leaders left something in return, though.
Currently, those over age 65 who do not itemize deductions on their income tax return get a higher standard deduction than a similar filer who is younger. The amount varies each year just as the regular standard deduction does. Hey... it isn’t much, but at least it's something. Provided, that is, you don't itemize on your tax return after you retire. Retirees who itemize get zilch.
There is one more situation in which retirees possibly can lessen their tax burden, and that's in the area of real estate taxes. Many states will grant real estate tax exceptions to homeowners of a specified age, usually age 60 or older.
These exceptions vary and may take the form of a partial exemption, a waiver, a freeze on assessment rates, or a suspension of payment until death. For those pressed for income, investigation in this area is definitely warranted to determine what the state of residence will permit.
While it's highly unlikely the tax can be avoided completely, it's equally true that when cash is tight, every dollar counts. In financial situations like that, every dollar not given to the taxman is a dollar earned.
As my daddy says, "There was a time when you saved up for your old age; now you save up for April 15th." I guess he's telling the truth. He's been retired for over 20 years now, and he still screams when he pays Uncle Sam.
Let's wind up with another old saw, "Only two things are certain: death and taxes." So you pay some taxes. It's better than the alternative, no?
When you retire, you’ll be presented with papers to sign regarding any bonuses or pension funds.
Because your earnings (and often the contribution) are untaxed until you begin withdrawing money in retirement, the government is in effect providing you leverage in the investment. This boost thus allows you to amass far more money for retirement than you could in a taxable alternative.
Additionally, you control when it gets taxed, and at what rate, by deciding on the amount of the withdrawal and when to take it. By contrast, in conventional investments, you are taxed on all money going in and on all dividends and gains in the year they are received.
All things being equal, that general idea is true. But all things are not equal. When should you elect to invest in a tax-deferred vehicle as opposed to a taxable alternative? Use the plan at least up to the level where you obtain the maximum matching contribution from your employer. Don't turn down that free money.
Let's say your employer matches any contribution up to 6% of your salary. Most people would contribute that 6%, but beyond that they would compare the returns available in the plan investments to those outside of the plan.
Here's a simple comparison between a tax-deferred investment like a 401(k) plan and an ordinary taxable investment. Let's assume that ultimately you'll withdraw all your money from the tax-deferred account, and you'll be taxed on that amount at today's marginal tax rates.
Of course, it's not quite that simple because, in reality, you'll decide how that money eventually comes out -- maybe all at once, maybe piecemeal, leaving the rest to compound. But for this simplistic analysis, let’s just say it’s enough. Let's also agree that all gains in the taxable account will be taxed at ordinary rates, even though we know that at least half would be taxed at the lesser capital gains rate.
For our example:
TR = your marginal tax rate
Ra = the return you expect in the after-tax investment
Rp = the return you expect in the tax-deferred investment
Any earnings in the after-tax account will be taxed. Therefore, the equivalent rates of return in a tax-deferred or after-tax account can be expressed as (1-TR) * Ra = Rp, which can be restated as Ra = Rp / (1-TR).
All right now uncross those eyes. This formula gives you the rate of return you need in an after-tax account to equal the return you would get in a tax-deferred account after it, too, had been taxed at some point in the future. Let's take an example.
Let's say I'm in a 28% federal tax bracket, that I get no matching contribution from my employer or have already reached the maximum match, and that I deposit $100 into my tax-deferred account. I expect to earn 10% on that deposit. What rate of return do I have to get in an after-tax investment to equal what I'm getting in that plan?
Well, by using the formula, I get:
Ra = Rp / (1 - TR)
Ra = 0.10 / (1 - 0.28)
Ra = 0.10 / 0.72 = 0.138888 = ~13.89%
Therefore, if I deposited $72 in an after-tax investment (the equivalent of $100 deposited in a tax-deferred account) and I earned at least 13.89% on that investment, I would do just as well after taxes as I would in a tax-deferred investment earning a 10% return. If I could get more than 13.89%, I would do better.
Need a little proof? In the tax-deferred account a $100 deposit would earn $10 at a 10% return, giving a total of $110. Withdrawing that $110 and paying taxes at 28% would leave $79.20. $72 in an after-tax account would earn $10 at 13.89% or $7.20 after taxes, leaving $79.20 total in that account after taxes.
Use a 401(k) or similar plan to get the maximum employer matching contribution available. Beyond that level, compare your before-tax and after-tax investment options and select the one that provides the highest after-tax return.
But remember this: If you choose an alternative to the 401(k), then you must be just as dedicated and disciplined within that investment as you would have been within the 401(k). That means you must make your deposits in that investment each and every payday without fail.
It also means your deposit must increase at the same time and at the same rate as your pay does. Fail to adhere to that regimen, and you will neither equal nor beat the 401(k). The 401(k) demands these contributions and increases via automatic payroll deduction, so to keep pace with or to better that vehicle you must apply the same technique in any alternative.
The Taxpayer Relief Act of 1997 provides a unique opportunity to those of us who have reached the maximum contribution we wish to make to our employer plans. It's called a Roth IRA and may be established anytime after January 1, 1998.
With a Roth IRA, you may make a nondeductible deposit of up to $2,000 per year, allow the earnings to accumulate tax-free through the years, and ultimately withdraw all of the proceeds tax-free. This is an excellent vehicle for monies to be invested outside of an employer-provided plan.
Many people think the following phrase is true: "Retirees enjoy a lesser tax burden than those who work.” That may have been true in the grey and distant past, but it certainly isn't true now. Today, many retirees end up in exactly the same marginal income tax bracket after retirement as before. That situation will definitely be true for those who follow a Foolish path in their retirement planning.
Nevertheless, retirees as a group do tend to pay the taxman less in absolute dollars than they did before. Common sense should tell us why: they have less taxable income. The money they live on usually comes from savings (taxable), pensions (taxable), and Social Security (potentially taxable in part).
The addition of Social Security, which is never fully taxed, reduces the actual taxable income. Thus, a retiree could draw exactly the same annual income as she did when she worked, but pay less total dollars in taxes because part -- if not all -- of the Social Security income is received tax-free. Despite paying less dollars, though, that same retiree will still be in the same marginal tax bracket, albeit at the lower end of that range.
Throw some work in the mix and the plot thickens. Wages from work get taxed as usual. Social Security is trimmed as the retiree exceeds the maximum earnings limit for the year. In extreme cases, work could cause a confiscatory tax of over 80% on those wages when ordinary income taxes are added to the Social Security forfeiture. Kind of makes one wonder why anyone would want to work under that scenario, doesn't it?
If you're looking for a greatly reduced tax burden in retirement, forget it. The best you will achieve is a lower average tax rate on all the money flowing into the household for the year. Compute that rate by dividing your total taxes by all of your income, both taxable and nontaxable. For many retirees, the significant proportion of that income represented by untaxed Social Security payments does indeed cause the average tax rate to drop.
When and how does Social Security get taxed, you ask? The computation, like all Infernal [sic] Revenue Service requirements, is a tad complicated. In fact, they have a special worksheet just for that purpose. The math starts with your Adjusted Gross Income.
To that you add one-half of all Social Security benefits and all unearned income received during the year. The latter almost always comes from tax-exempt interest received from municipal bonds (a favorite retiree investment). If the computed total is larger than $25,000 (single) or $32,000 (married filing jointly), then up to 50% of the Social Security benefit will be taxed. If the amount is larger than $34,000 (single) or $44,000 (married filing jointly), then up to 85% of the Social Security benefit will be taxed.
To determine the exact amount that will be taxed; you must complete the handy-dandy worksheet supplied by the IRS for that purpose. Doesn't that sound like fun?
OK! Now we know retirees have to pay taxes, too. But don't they get any breaks? What happened to the senior citizen discounts? Surely the government can't be that cruel. What is this, the Spanish Inquisition? Heck, I remember Gram and Gramps each getting an extra personal exemption because they were older than age 65. That's just gotta be there for today's retirees, too, right?
Uh... well... actually, no it's not. It's true that exception did exist at one time, but it got wiped out during one of the efforts by Congress to "simplify" our tax laws. Our leaders left something in return, though.
Currently, those over age 65 who do not itemize deductions on their income tax return get a higher standard deduction than a similar filer who is younger. The amount varies each year just as the regular standard deduction does. Hey... it isn’t much, but at least it's something. Provided, that is, you don't itemize on your tax return after you retire. Retirees who itemize get zilch.
There is one more situation in which retirees possibly can lessen their tax burden, and that's in the area of real estate taxes. Many states will grant real estate tax exceptions to homeowners of a specified age, usually age 60 or older.
These exceptions vary and may take the form of a partial exemption, a waiver, a freeze on assessment rates, or a suspension of payment until death. For those pressed for income, investigation in this area is definitely warranted to determine what the state of residence will permit.
While it's highly unlikely the tax can be avoided completely, it's equally true that when cash is tight, every dollar counts. In financial situations like that, every dollar not given to the taxman is a dollar earned.
As my daddy says, "There was a time when you saved up for your old age; now you save up for April 15th." I guess he's telling the truth. He's been retired for over 20 years now, and he still screams when he pays Uncle Sam.
Let's wind up with another old saw, "Only two things are certain: death and taxes." So you pay some taxes. It's better than the alternative, no?
When you retire, you’ll be presented with papers to sign regarding any bonuses or pension funds.
EMPLOYER PLANS
You've done your homework and now you know how much you have to accumulate to be able to retire and live comfortably. What now? The next step is to milk your employer for everything you can.
No, we don't mean that you should confiscate post-its for at-home use or try to create a black market for hole punchers. We're talking about retirement plans.
Most mid-size and large employers have a retirement plan in place for their employees. Many have two and some three or more. These plans come in a wide variety of flavors, some good and some not so good. All of these, though, can help you achieve your retirement desires if you understand them fully and integrate them into your planning.
Remember that employee handbook you received on the day you were hired -- the drab document you tucked away under some papers next to the half-eaten Snickers bar? Dig it out, dust it off, and read it. Buried in those pages you will find a summary plan description of the retirement plan(s) available to you as an employee.
Those pages will tell you what kind of plan you have, when you become eligible to participate, and the ultimate benefit you will receive. Is it boring reading? You betcha! But what you'll find in those pages is your FREE MONEY.
What will that free money look like? It might be called a "defined benefit plan" or a "company pension" -- phrases used to describe one type of plan commonly offered by employers. In this vehicle, employers typically do all the funding with no contributions by employees.
The final benefit is determined by a formula often based on years of service, an average wage, and a percent of pay. For instance, the plan could say your final benefit will be a "joint and 50% annuity calculated as 1.5% times your years of credited service times the average of your last three years' base annual wage."
What does that mumbo-jumbo mean to you? It means that with 30 years of service, at retirement your pension will replace 45% of your average annual wage for the last three years of work. It means it's less money you have to save each year between now and retirement because your employer is relieving you of part of that burden. And that means more of your resources can be devoted to other goals that are also important, like maybe putting the kids through college.
The summary plan description will also tell you your options at retirement. You may be able to receive a lump sum payment instead of a lifetime annuity. That way, if the plan has no automatic cost of living adjustment to the annuity payment, you can invest the money to achieve that growth.
Maybe you can take an annuity that will give a surviving spouse more than half your benefit after you die, something like two-thirds or 100% instead. And the summary plan description will tell you how long you have to be on the job until the money is 100% yours (the vesting schedule); it will tell you what happens if you leave your job before retirement, and what happens should you leave this world earlier than you anticipate.
This is all valuable information because it helps to refine the assumptions we must make in the calculation of our retirement needs.
Say your company offers a 401(k) plan. Take out your 401(k) summary plan description and look for:
• When you may participate
• The types and perhaps the risks of the investment options you have within the plan
• How often you may switch between those options
• Whether early withdrawals for hardships or personal loans are permitted
• What distribution options are available when you separate or retire
• How much your employer will contribute to the plan on your behalf, and when you will vest in those contributions? This is the FREE MONEY.
Why is it free? For one, your contributions to a 401(k) plan help reduce your tax bill because they don't count against your taxable income for the year. That means tax-free money towards your retirement savings.
Of far more importance, though, is an employer's contribution on your behalf. While these contributions will vary from employer to employer, typically employers match your contribution from 50 cents on the dollar up to 6% of your pay. That means if you put in 6% of your paycheck, your employer will match that by contributing 3%. (That's 3% of your paycheck in free money.)
You should jump at this opportunity. Rarely, if ever, should you turn it down. We know there is no risk-free, untaxed way to get an immediate 50% return on our money in any alternative investment we can make. Sure, most 401(k) plans use high-cost, mediocre performing mutual funds as their investment of choice.
Yet, even there, the immediate return of 50% on our money in every year we contribute would take years to top in anything else. Spurn this offer by an employer, and you exchange needless risk and taxes to leave found money on the table. When it comes to 401(k) plans, you should follow this path by grabbing all the free money your employer offers. What better way to lessen your savings burden?
You will still have to worry about taxes and things of that nature.
No, we don't mean that you should confiscate post-its for at-home use or try to create a black market for hole punchers. We're talking about retirement plans.
Most mid-size and large employers have a retirement plan in place for their employees. Many have two and some three or more. These plans come in a wide variety of flavors, some good and some not so good. All of these, though, can help you achieve your retirement desires if you understand them fully and integrate them into your planning.
Remember that employee handbook you received on the day you were hired -- the drab document you tucked away under some papers next to the half-eaten Snickers bar? Dig it out, dust it off, and read it. Buried in those pages you will find a summary plan description of the retirement plan(s) available to you as an employee.
Those pages will tell you what kind of plan you have, when you become eligible to participate, and the ultimate benefit you will receive. Is it boring reading? You betcha! But what you'll find in those pages is your FREE MONEY.
What will that free money look like? It might be called a "defined benefit plan" or a "company pension" -- phrases used to describe one type of plan commonly offered by employers. In this vehicle, employers typically do all the funding with no contributions by employees.
The final benefit is determined by a formula often based on years of service, an average wage, and a percent of pay. For instance, the plan could say your final benefit will be a "joint and 50% annuity calculated as 1.5% times your years of credited service times the average of your last three years' base annual wage."
What does that mumbo-jumbo mean to you? It means that with 30 years of service, at retirement your pension will replace 45% of your average annual wage for the last three years of work. It means it's less money you have to save each year between now and retirement because your employer is relieving you of part of that burden. And that means more of your resources can be devoted to other goals that are also important, like maybe putting the kids through college.
The summary plan description will also tell you your options at retirement. You may be able to receive a lump sum payment instead of a lifetime annuity. That way, if the plan has no automatic cost of living adjustment to the annuity payment, you can invest the money to achieve that growth.
Maybe you can take an annuity that will give a surviving spouse more than half your benefit after you die, something like two-thirds or 100% instead. And the summary plan description will tell you how long you have to be on the job until the money is 100% yours (the vesting schedule); it will tell you what happens if you leave your job before retirement, and what happens should you leave this world earlier than you anticipate.
This is all valuable information because it helps to refine the assumptions we must make in the calculation of our retirement needs.
Say your company offers a 401(k) plan. Take out your 401(k) summary plan description and look for:
• When you may participate
• The types and perhaps the risks of the investment options you have within the plan
• How often you may switch between those options
• Whether early withdrawals for hardships or personal loans are permitted
• What distribution options are available when you separate or retire
• How much your employer will contribute to the plan on your behalf, and when you will vest in those contributions? This is the FREE MONEY.
Why is it free? For one, your contributions to a 401(k) plan help reduce your tax bill because they don't count against your taxable income for the year. That means tax-free money towards your retirement savings.
Of far more importance, though, is an employer's contribution on your behalf. While these contributions will vary from employer to employer, typically employers match your contribution from 50 cents on the dollar up to 6% of your pay. That means if you put in 6% of your paycheck, your employer will match that by contributing 3%. (That's 3% of your paycheck in free money.)
You should jump at this opportunity. Rarely, if ever, should you turn it down. We know there is no risk-free, untaxed way to get an immediate 50% return on our money in any alternative investment we can make. Sure, most 401(k) plans use high-cost, mediocre performing mutual funds as their investment of choice.
Yet, even there, the immediate return of 50% on our money in every year we contribute would take years to top in anything else. Spurn this offer by an employer, and you exchange needless risk and taxes to leave found money on the table. When it comes to 401(k) plans, you should follow this path by grabbing all the free money your employer offers. What better way to lessen your savings burden?
You will still have to worry about taxes and things of that nature.
WHAT WILL IT COST
Pundits say you will need 60% to 85% of your gross household income today to sustain the same lifestyle after you retire. In theory, the higher your income today, the closer you are to the lower end of that scale. Fair enough, but you should look at this issue in a slightly different fashion.
Sure, we could sit down to a long, drawn-out process in which we look at our expenses and try to anticipate what they would be in retirement. But why bother? After all, retirement is a long way off, and we have no real idea of what those expenses will be then.
You do, though, know that you live comfortably today (we hope) and that it's unlikely you'll be saving money or paying FICA (unless you choose to work) after you retire. Therefore, excluding those items from your gross income, you can come up with a number that's fairly close to what it would take to sustain your current lifestyle.
Simply put, you want a retirement income that equals our gross income today less all savings and all FICA taxes.
But you still have to decide what income you will need in retirement to live the way you want. Some folks can get by on much less than they use now, while others may decide they want more. It's a personal choice for all of us. So, pick a number.
Now, let's talk about inflation. How much does our retirement savings have to be in the year we retire after it has been adjusted for inflation over the years between now and then? What should that inflation rate be anyway?
For how many years will you draw that income? Should it keep pace with inflation throughout those years? Will you draw down your starting retirement portfolio to support your income needs or just live off the earnings while never touching the principal? If you can answer those questions, then you can determine the starting portfolio you need at retirement to support you for the rest of your life.
We're getting into the realm of some pretty sophisticated calculations based on several assumptions that, if changed, could radically alter our results. What we need is a quick-and-dirty way to give us an idea of what we need to do to get started. We'll save the more esoteric efforts for later.
So forget about inflation for the moment. Ignore Social Security and any company pension you may get. Pretend your money gets no return now or after retirement. But do count whatever you have saved for retirement as of today.
Let's say that amounts to $20,000. Further, let's say you want an annual income of $30,000 in today's dollars after you retire. You expect to retire in 25 years, that you will live 20 years after you retire, and that you expect to meet your maker waving your last dollar bill.
How much do you need to amass by the start of your retirement to support yourself in your golden years, and how much do you have to save each year between now and then to get there?
Let's see. You need $30,000 a year for 20 years, so that comes to $600,000 needed in the first year of retirement. You already have $20,000 of that, so that means you're only $580,000 short. Divide the shortage by the 25 years you have to save it up, and you discover you only have to cough up $23,200 annually between now and the time you retire to a life of leisure.
Too much is omitted from this simple approach to provide a meaningful answer to the question at hand. Worse, the answer we do get makes the whole idea of saving for retirement seem to be an impossible task, but this is far from true.
To do things right, we must take a cold, hard, objective look at our desired income, subject it to a rational choice of assumptions, and make some detailed calculations.
The best way to do the calculations is with one of the readily available software packages available commercially, such as Quicken Financial Planner or you can find many different financial calculators online that can help.
Before you use any of these tools, you need some preliminary information. At a minimum, you want to:
1. Decide on the annual income you desire in today's dollars.
2. Pick a retirement date.
3. Determine your lifetime average inflation rate.
4. Determine the average rate of return you expect on your investments before and after retirement.
5. Determine the current market value of all your investments to include regular accounts, IRAs, and company tax-deferred savings plans like 401(k) plans.
6. Obtain an estimate of any company-provided pension benefit.
7. Obtain an estimate of future Social Security benefits
8. Armed with this data, you can determine the annual savings required for you to enjoy the good life. You will also be able to play "what if" games and see the results quickly should you decide to vary things like inflation, rates of return, date of retirement, and desired income.
We'll leave you with one last thought. The earlier you start, the easier it will be for you to amass the dollars you will need on the day you retire.
Say you put $1,000 per year for 25 years into an investment earning 10% annually, you would have $108,182. Wait just five years before starting that process, and on the same date in the future you would end up with $63,002. That $5,000 you "saved" by waiting just cost you $45,180 in tropical drinks.
Your employer can be a great place for you to start with to find the money that you need.
Sure, we could sit down to a long, drawn-out process in which we look at our expenses and try to anticipate what they would be in retirement. But why bother? After all, retirement is a long way off, and we have no real idea of what those expenses will be then.
You do, though, know that you live comfortably today (we hope) and that it's unlikely you'll be saving money or paying FICA (unless you choose to work) after you retire. Therefore, excluding those items from your gross income, you can come up with a number that's fairly close to what it would take to sustain your current lifestyle.
Simply put, you want a retirement income that equals our gross income today less all savings and all FICA taxes.
But you still have to decide what income you will need in retirement to live the way you want. Some folks can get by on much less than they use now, while others may decide they want more. It's a personal choice for all of us. So, pick a number.
Now, let's talk about inflation. How much does our retirement savings have to be in the year we retire after it has been adjusted for inflation over the years between now and then? What should that inflation rate be anyway?
For how many years will you draw that income? Should it keep pace with inflation throughout those years? Will you draw down your starting retirement portfolio to support your income needs or just live off the earnings while never touching the principal? If you can answer those questions, then you can determine the starting portfolio you need at retirement to support you for the rest of your life.
We're getting into the realm of some pretty sophisticated calculations based on several assumptions that, if changed, could radically alter our results. What we need is a quick-and-dirty way to give us an idea of what we need to do to get started. We'll save the more esoteric efforts for later.
So forget about inflation for the moment. Ignore Social Security and any company pension you may get. Pretend your money gets no return now or after retirement. But do count whatever you have saved for retirement as of today.
Let's say that amounts to $20,000. Further, let's say you want an annual income of $30,000 in today's dollars after you retire. You expect to retire in 25 years, that you will live 20 years after you retire, and that you expect to meet your maker waving your last dollar bill.
How much do you need to amass by the start of your retirement to support yourself in your golden years, and how much do you have to save each year between now and then to get there?
Let's see. You need $30,000 a year for 20 years, so that comes to $600,000 needed in the first year of retirement. You already have $20,000 of that, so that means you're only $580,000 short. Divide the shortage by the 25 years you have to save it up, and you discover you only have to cough up $23,200 annually between now and the time you retire to a life of leisure.
Too much is omitted from this simple approach to provide a meaningful answer to the question at hand. Worse, the answer we do get makes the whole idea of saving for retirement seem to be an impossible task, but this is far from true.
To do things right, we must take a cold, hard, objective look at our desired income, subject it to a rational choice of assumptions, and make some detailed calculations.
The best way to do the calculations is with one of the readily available software packages available commercially, such as Quicken Financial Planner or you can find many different financial calculators online that can help.
Before you use any of these tools, you need some preliminary information. At a minimum, you want to:
1. Decide on the annual income you desire in today's dollars.
2. Pick a retirement date.
3. Determine your lifetime average inflation rate.
4. Determine the average rate of return you expect on your investments before and after retirement.
5. Determine the current market value of all your investments to include regular accounts, IRAs, and company tax-deferred savings plans like 401(k) plans.
6. Obtain an estimate of any company-provided pension benefit.
7. Obtain an estimate of future Social Security benefits
8. Armed with this data, you can determine the annual savings required for you to enjoy the good life. You will also be able to play "what if" games and see the results quickly should you decide to vary things like inflation, rates of return, date of retirement, and desired income.
We'll leave you with one last thought. The earlier you start, the easier it will be for you to amass the dollars you will need on the day you retire.
Say you put $1,000 per year for 25 years into an investment earning 10% annually, you would have $108,182. Wait just five years before starting that process, and on the same date in the future you would end up with $63,002. That $5,000 you "saved" by waiting just cost you $45,180 in tropical drinks.
Your employer can be a great place for you to start with to find the money that you need.
WHAT TO THINK ABOUT
When you are thinking about retirement, you need to set a few goals to begin with.
How will you spend your time once you aren’t trudging off to work every day? There are lots of options for every retiree. You need to pick the one that’s best suited to you and one that will keep you busy.
Maybe you want to travel, start or continue a hobby, garden, play golf, dote over the grandchildren, or even climb a mountain or two. The possibilities are limitless. Dare to dream and then make those dreams come true. You’ve worked hard and you deserve a happy retirement. Retirement doesn’t mean you should resign yourself to sitting around talking about your ailments or feeding the pigeons in some park. It should mean freedom to explore life and all it has to offer.
Maybe you will be bored with the idea of not going to work every day. If this is the case, you might be happier working or volunteering once you retire. There are lots of retirees who have started a second or even a third career after retirement. I’m sure there are many ways you can volunteer if you don’t relish the idea of working for money. Almost every organization is begging for persons to volunteer time to help with the many activities and projects.
What about your health once you retire? You should start planning right now for a healthier body. If you smoke, stop. If you’re overweight, take measures to slim down. Start an exercise and nutrition program so you will be as healthy as possible in your older years. Make a commitment to become a healthier, more active person and you will reap the benefits now and later.
Been putting off medical check-ups? Now is the time to get these done. By taking care of your health in your early years might help with securing health insurance at a reasonable rate once you are older.
Another area that you might need to develop is friends and family. A career sometimes doesn’t leave much time for cultivating friendships or enjoying your family. Once you retire, you will have more time to spend with these people but will they be there for you when that time comes?
Try to make time for family and friends, even if it’s just a few hours a week. The older you get, the harder it is to find and make new friends. If you ignore your family, they might not be there for you when you get older and feel you have more time for them.
So, in addition to investing and saving money for your retirement, now you need to make some additional plans. You need to plan how you might want to spend your retirement, where you might want to spend it, how to be healthy enough to enjoy it, and how to keep your family and friends around to help you enjoy it. This makes retirement planning take a whole new meaning. Retirement shouldn’t be considered an ending, it should just be a continuation of living.
Of course, money is important when you are thinking about retirement. When you don’t have a steady paycheck coming in from week to week, you will still have bills to pay and things that you want to do that will require money.
When you begin to plan for your retirement, ask yourself the following questions:
1. Do you have a pension or retirement plan at your place of employment and are you eligible?
Some companies do not offer retirement or pension plans and some jobs within companies are not eligible for these plans even if they are offered.
2. How much will your pension or retirement plan be worth when you retire?
This information is necessary so you can decide if you need additional savings such as an IRA to supplement your retirement benefits when you decide to retire.
3. If your employer provides a retirement plan, what happens to it if you change jobs?
Your employer can tell you if your retirement plan can be rolled over into an IRA, cashed in, or left with the company if you should leave the company. You will need to decide which is best for you to do.
4. If you retire early, what happens to your retirement plan with your employer?
Your employer can tell you when you are vested with the company and what you can expect to receive in the way of retirement benefits when you decide to retire.
5. Will pension benefits be reduced by Social Security?
In some instances, your benefits could be reduced by the amount of Social Security you draw. Discuss this with your employer to see if this happens with your pension.
6. Look at where your finances are right now. Gather all your financial information into one place and go over it to see what you have and what you need. Look at your benefit plans, social security, veteran’s benefits, and so on. Make a detailed list of your assets, such as real estate and investments. Next list all your liabilities, such as debts, loans, child support, and alimony.
Retirement planning is looking into the future and seeing how much money you’ll need to live a comfortable and satisfying life.
How will you spend your time once you aren’t trudging off to work every day? There are lots of options for every retiree. You need to pick the one that’s best suited to you and one that will keep you busy.
Maybe you want to travel, start or continue a hobby, garden, play golf, dote over the grandchildren, or even climb a mountain or two. The possibilities are limitless. Dare to dream and then make those dreams come true. You’ve worked hard and you deserve a happy retirement. Retirement doesn’t mean you should resign yourself to sitting around talking about your ailments or feeding the pigeons in some park. It should mean freedom to explore life and all it has to offer.
Maybe you will be bored with the idea of not going to work every day. If this is the case, you might be happier working or volunteering once you retire. There are lots of retirees who have started a second or even a third career after retirement. I’m sure there are many ways you can volunteer if you don’t relish the idea of working for money. Almost every organization is begging for persons to volunteer time to help with the many activities and projects.
What about your health once you retire? You should start planning right now for a healthier body. If you smoke, stop. If you’re overweight, take measures to slim down. Start an exercise and nutrition program so you will be as healthy as possible in your older years. Make a commitment to become a healthier, more active person and you will reap the benefits now and later.
Been putting off medical check-ups? Now is the time to get these done. By taking care of your health in your early years might help with securing health insurance at a reasonable rate once you are older.
Another area that you might need to develop is friends and family. A career sometimes doesn’t leave much time for cultivating friendships or enjoying your family. Once you retire, you will have more time to spend with these people but will they be there for you when that time comes?
Try to make time for family and friends, even if it’s just a few hours a week. The older you get, the harder it is to find and make new friends. If you ignore your family, they might not be there for you when you get older and feel you have more time for them.
So, in addition to investing and saving money for your retirement, now you need to make some additional plans. You need to plan how you might want to spend your retirement, where you might want to spend it, how to be healthy enough to enjoy it, and how to keep your family and friends around to help you enjoy it. This makes retirement planning take a whole new meaning. Retirement shouldn’t be considered an ending, it should just be a continuation of living.
Of course, money is important when you are thinking about retirement. When you don’t have a steady paycheck coming in from week to week, you will still have bills to pay and things that you want to do that will require money.
When you begin to plan for your retirement, ask yourself the following questions:
1. Do you have a pension or retirement plan at your place of employment and are you eligible?
Some companies do not offer retirement or pension plans and some jobs within companies are not eligible for these plans even if they are offered.
2. How much will your pension or retirement plan be worth when you retire?
This information is necessary so you can decide if you need additional savings such as an IRA to supplement your retirement benefits when you decide to retire.
3. If your employer provides a retirement plan, what happens to it if you change jobs?
Your employer can tell you if your retirement plan can be rolled over into an IRA, cashed in, or left with the company if you should leave the company. You will need to decide which is best for you to do.
4. If you retire early, what happens to your retirement plan with your employer?
Your employer can tell you when you are vested with the company and what you can expect to receive in the way of retirement benefits when you decide to retire.
5. Will pension benefits be reduced by Social Security?
In some instances, your benefits could be reduced by the amount of Social Security you draw. Discuss this with your employer to see if this happens with your pension.
6. Look at where your finances are right now. Gather all your financial information into one place and go over it to see what you have and what you need. Look at your benefit plans, social security, veteran’s benefits, and so on. Make a detailed list of your assets, such as real estate and investments. Next list all your liabilities, such as debts, loans, child support, and alimony.
Retirement planning is looking into the future and seeing how much money you’ll need to live a comfortable and satisfying life.
SHOULD YOU RETIRE?
Sure you like your job. But if you had the chance to retire early, say at age 50, would you sniff at it? Maybe you really like your black swivel chair. Perhaps you think your work is just too important to leave it behind. The truth is that there are other people out there who can do your job, and you can get the same black swivel chair at Staples!
For most people, a 30-year career is quite enough. But is early retirement realistic for you? Let's take a look.
At age 50, the government says you've got about another 33 years to live. That's longer than your entire working career. With life expectancy increasing by leaps and bounds, you may want to think in terms of a 40-year retirement.
Besides travel, golf, fishing, and classes in paperclip art, what else is on the agenda? How much will it cost? Will you have enough to do it all? How much has to come out of each paycheck to raise that stash? Good question!
Have you thought about inflation? After all, peering out 20 years into the future you know that the $50K that looks like a good annual income now will certainly have to be larger to buy the same things then as it does today. But what's inflation going to be through the years? And that's just to get you to the first year of retirement. What impact will it have over the 40 years after that?
Where will you live? With luck, the mortgage will be paid off so all you have to worry about is property taxes. Maybe you'll even sell out and move into a smaller place in a sunnier climate. Sure beats having to shovel snow at age 70, even if it is further away from family and friends. Besides, the kids can always come down for a visit.
You should think about insurance, too. You're probably insured under group policies through work for disability, life, and health coverage right now. In fact, your employer probably kicks in some part of or maybe even the entire premium for that insurance.
Retire, though, and you will most likely lose that coverage. What happens to your spouse if you're inconsiderate enough to die early or (heaven forbid) become permanently disabled? If required to do so, how will you pay for a major illness or hospitalization and all of the attendant physician's bills?
Forget about Social Security or Medicare. You're way too young for either of those to apply. And even if you did qualify, will the assistance be enough for a survivor and/or all the medical bills? If not, what alternatives do you have? And what about long-term care costs?
About now you may be thinking: "Hmmm, perhaps I should have a few more children to support me in my old age." Don't worry, Fool. You needn't sire enough offspring for a soccer team. Our advice? Never leave your job.
We're just kidding, of course. We're confident you can retire at a reasonably young age without having to populate the
Retirement planning entails far more than just picking an age to do so and a beachfront property to do it upon. It requires a hard look at your lifestyle, your resources, and a whole host of factors that we tend to take for granted while we're working. Most, but not all, deal with money issues. As Fools, we face them head on.
First you have to know!!
Retirement: It's nice to get out of the rat race, but you have to learn to get along with less cheese.
~Gene Perret
Now that quote might be humorous, but it doesn’t have to be true. Most people associate retirement with much more than not working. They also think that when you don’t go to the office every day you also don’t get that paycheck either.
Retirement is different things to different people. For those in their 20s, it's a distant dream. For those in their 30s and 40s, it's a minor concern. For those 50 and beyond, it's a reality that must be dealt with. No matter what your age, you should start to prepare for your retirement and the sooner the better.
Retirement planning is about more than investing and saving. It’s also about enjoying your life after you decide to retire from your career or job. To fully enjoy yourself after retirement, you should have a plan on how you will spend your time and where you will live.
You probably should start now to get in shape so you will enjoy a healthy retirement. What about your family, how do they fit into your retirement plans? Your retirement plans should go well beyond finances.
Many young people don’t think that they need to plan for retirement. Heck, I’m only 40 and I don’t really think about planning for retirement. But the reality is that there is no time like the present to start thinking about your future.
Unless you are near retirement age, you will no doubt procrastinate about retirement planning. It’s probably impossible to expect someone in their twenties to make serious retirement plans. Even those with 15 to 20 years left before retirement might have trouble with firm financial plans.
In your twenties, your retirement plans will probably consist of a basic savings program. Retirement is many years away and your thoughts are probably more on buying a house than on retiring.
In your thirties, your thoughts might be on sending your children to college and thoughts of retirement are not important. When you reach your forties, you begin the wonder where the years went and start to consider serious planning for when you retire.
Here, consider, is the key word. If you’re like most people, you consider planning but don’t quite get around to it. Then all at once, you are in your fifties and realization hits. You are near retirement age and haven’t given any thoughts to how you will afford to quit working and enjoy your retirement years.
OK, no matter what your age, there is hope for your retirement plan. Most employers provide a pension plan, the government provides social security, and you might have some investments and real estate. The younger you are the better but with some serious thought, you can pull it off.
Of course, first, you’ll need to commit yourself to quitting in the first place.
~Gene Perret
Now that quote might be humorous, but it doesn’t have to be true. Most people associate retirement with much more than not working. They also think that when you don’t go to the office every day you also don’t get that paycheck either.
Retirement is different things to different people. For those in their 20s, it's a distant dream. For those in their 30s and 40s, it's a minor concern. For those 50 and beyond, it's a reality that must be dealt with. No matter what your age, you should start to prepare for your retirement and the sooner the better.
Retirement planning is about more than investing and saving. It’s also about enjoying your life after you decide to retire from your career or job. To fully enjoy yourself after retirement, you should have a plan on how you will spend your time and where you will live.
You probably should start now to get in shape so you will enjoy a healthy retirement. What about your family, how do they fit into your retirement plans? Your retirement plans should go well beyond finances.
Many young people don’t think that they need to plan for retirement. Heck, I’m only 40 and I don’t really think about planning for retirement. But the reality is that there is no time like the present to start thinking about your future.
Unless you are near retirement age, you will no doubt procrastinate about retirement planning. It’s probably impossible to expect someone in their twenties to make serious retirement plans. Even those with 15 to 20 years left before retirement might have trouble with firm financial plans.
In your twenties, your retirement plans will probably consist of a basic savings program. Retirement is many years away and your thoughts are probably more on buying a house than on retiring.
In your thirties, your thoughts might be on sending your children to college and thoughts of retirement are not important. When you reach your forties, you begin the wonder where the years went and start to consider serious planning for when you retire.
Here, consider, is the key word. If you’re like most people, you consider planning but don’t quite get around to it. Then all at once, you are in your fifties and realization hits. You are near retirement age and haven’t given any thoughts to how you will afford to quit working and enjoy your retirement years.
OK, no matter what your age, there is hope for your retirement plan. Most employers provide a pension plan, the government provides social security, and you might have some investments and real estate. The younger you are the better but with some serious thought, you can pull it off.
Of course, first, you’ll need to commit yourself to quitting in the first place.
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