CONTENTS
INTRODUCTION ............................................................................. 4
Qualified Retirement Plans ................................................... 4
Summary of Types Of Plans ................................................. 6
Retirement Income Sources ................................................. 8
PENSION PLANNING ................................................................... 10
Payment Methods: Selection Considerations ..................... 10
Lifetime-Only (Single Life Annuity) Method ......................... 10
Automatic Surviving Spouse Method .................................. 11
Optional Methods ............................................................... 11
Selecting a Method ............................................................. 12
Pension Maximization ......................................................... 16
TAXATION OF PLAN DISTRIBUTIONS ........................................ 22
Ordinary Income ................................................................. 23
Lump Sum Distributions ..................................................... 25
Direct Transfer .................................................................... 26
Rollover .............................................................................. 27
20% Withholding Tax on Employee Distributions From
Qualified Retirement Plans ............................................ 29
Exceptions To The 10% Penalty Tax For Persons Under
Age 59 ½ ....................................................................... 30
Annuitizing: Substantially Equal Periodic Payments ........... 31
INDIVIDUAL RETIREMENT ACCOUNTS ..................................... 33
Traditional Deductible IRA .................................................. 34
Traditional Non-Deductible IRA .......................................... 36
Roth IRA ............................................................................. 36
Roth Conversions ............................................................... 37
Investing in an IRA ............................................................. 38
Withdrawals from an IRA .................................................... 39
ANNUITIES ................................................................................... 42
RETIREMENT FUNDING PREFERENCE .................................... 44
Retirement Planning
2
SOCIAL SECURITY ...................................................................... 46
Fully Insured Status ............................................................ 47
Estimating Your Social Security Retirement Benefit ........... 48
Cost-Of-Living Increases and Social Security Benefits ....... 50
Maximum Retirement Benefits ............................................ 50
Full Retirement Age ............................................................ 51
Early Retirement ................................................................. 52
Delayed Retirement ............................................................ 53
When to Take Your Benefit? ............................................... 54
Social Security Earnings Test ............................................. 56
Taxation of Benefits ............................................................ 58
Additional Benefits .............................................................. 60
Applying for Social Security ................................................ 61
APPENDIX .................................................................................... 62
Time Value of Money .......................................................... 62
Present Value of a Future Amount ...................................... 63
Future Value of a Lump Sum .............................................. 64
Future Value of an Annuity .................................................. 66
Present Value of an Annuity ................................................ 67
Disclaimer
This publication is designed to provide accurate and authoritative information in
regard to the subject matter covered. It is provided with the understanding that
the author is not engaged in rendering legal, accounting, investment or other
professional advice. If legal or other expert assistance is required, the services
of a competent professional person should be sought.
No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying,
recording, or otherwise, without the prior written consent of the copyright holder.
Limited license for reproduction for personal use by the employee is granted.
All rights reserved, © LJPR, LLC, 2009.
Retirement Planning
3
INTRODUCTION
Qualified Retirement Plans
Qualified retirement plans are Congressionally approved retirement
plans that have several major tax benefits.
•
The employers may deduct contributions for income tax
purposes.
•
Employees do not include plan contributions in gross
income.
•
The earnings on the plan’s investments accumulate on a taxdeferred basis.
•
When the funds are distributed at retirement age, they may
be eligible for favorable tax treatment.1
•
Taxpayers may be in a lower income tax bracket after
retirement.
•
Two Principal Types of Plans
Qualified Retirement Plans can generally be classified as either
Defined Benefit or Defined Contribution plans.2
Defined Benefit plans specify the monthly benefit each participant
will receive at retirement age. The plan sponsor estimates how
much must be contributed each year to accumulate the funds
necessary to provide for each participant’s future benefit. Interest
rates, ages of participants and other factors will have an effect on
the annual funding requirement. The amount of the annual
contribution is generally determined by an actuary. The employer
bears all investment risk under Defined Benefit plans.
______________________________________________________
1
10-year income averaging. Beginning in the year 2000, 5-year
averaging is no longer available. Those born before 1936 will still be
able to elect 10-year averaging or capital gain treatment.
2
However, some plans have features of both types.
Retirement Planning
4
Defined Contribution plans generally specify a percentage of
current salaries the employer will contribute into the plan each year.
Retirement benefit values will depend on employer contributions,
investment return and the number of years until a participant retires.
In contrast to Defined Benefit plans, the investment risk of Defined
Contribution plans is borne by each participant.
•
What Is The “Best” Type of Plan?
There is no “best” type of plan. Each type has unique features and
benefits. When employees can choose the type of plan, the best
plan depends on personal goals and circumstances. Because
qualified retirement plans are sponsored by employers, the type of
plan offered depends on employer goals and cash flow.
Retirement Planning
5
Summary of Types of Plans
•
Defined Benefit Plans
As previously mentioned, under a Defined Benefit (DB) plan, the
employer contributes an “actuarially determined amount” sufficient
to pay each participant a benefit at retirement. Each participant’s
benefit is determined by a specific formula. Plan sponsors choose
among several types of benefit formulas, and then apply that same
formula for all participants. Types of benefit formulas include a flat
percentage of compensation, a percentage that increases with
years of service, a percentage that changes at certain
compensation levels, as well as other formulas. Often, the benefit
formula includes years of service and final compensation.
Defined Benefit plans generally favor older employees, because the
employer must contribute more each year to ensure their future
benefits will be funded during the shorter period until retirement.
•
Cash Balance Plan The Cash Balance Plan is technically a
Defined Benefit Plan. A hypothetical cash account is
maintained for each employee participant. At separation or
retirement, the plan benefits can be paid in cash or an
income stream.
•
Defined Contribution Plans
There are several variations of defined contribution plans. Some of
the more common ones include:
•
Money Purchase Pension The employer contributes a
specified percentage of the participating employee’s salary
each year. Whatever that fund grows to is what the retiring
employee receives, either as a lump sum or a monthly
income.
Retirement Planning
6
•
Target Benefit Pension Plan The target benefit plan has
elements of both the defined benefit and defined contribution
plans. The initial contributions are determined as if the plan
were a defined benefit plan, while the defined contribution
plan annual contribution percentage and dollar amount
limitations apply to the actual contributions.
•
Traditional Profit Sharing Plan Similar to the money
purchase pension, except that contributions do not need to
be a specific percentage and they do not need to be made
every year, as long as they are “substantial and recurring.”
•
Stock Bonus Plan Similar to the traditional profit sharing
plan. The plan may, but is not required to, invest primarily in
the employer’s stock.
•
Employee Stock Ownership Plan (ESOP) Like a stock
bonus plan, to which the employer can contribute company
stock instead of cash. The plan must be primarily invested in
company stock.
•
401(k) or 403(b) Plans Also called a cash or deferred
arrangement, this plan is a retirement savings plan that is
funded by employee contributions and matching
contributions from the employer. Employee contributions
can be from pre-tax, after-tax or a combination. The
maximum employee pre-tax contribution for 2007 is $15,500
(increases by $500 annually thereafter) and a catchup
contribution of $5,000 is available for persons age 50 or
older.
Retirement Planning
7
Retirement Income Sources
At retirement, we have basically four sources of retirement
income available to us:
•
Pension Income from company-sponsored retirement plans;
•
Social Security;
•
Accumulations from tax-deferred savings, like IRAs, 401(k)
or 403(b) plans, and other Tax Deferred plans; and
•
Individual savings and investment for retirement, such as
savings accounts, stocks, bonds, mutual funds and rental
property.
Each of these building blocks provides a necessary part of our
financial security at retirement. Pensions generally provide the
largest portion of most retirees’ income. Note that pensions are
funded by employers. However, participants may also make
contributions. Social Security also adds to retirement income. The
amount of a retiree’s Social Security benefit depends on the
amount of career earnings. Unfortunately many people rely solely
on their pension and Social Security for retirement. They theorize
that if they pay off all of their debt before retirement, a smaller
retirement income will be sufficient. Of course, other future retirees
use this approach as an excuse for failing to plan.
Retirement Planning
8
Instead of blindly depending on a pension and Social Security, you
can plan for your retirement. For example, you could set your
retirement income goal as a percentage of your current income, or
a dollar amount, adjusted for inflation. Under this approach, you
might decide that $50,000 per year, or 90% of current income, will
provide an adequate life-style, if that amount keeps pace with
inflation. Considering the size of these amounts, it becomes
evident that your pension and Social Security may be insufficient to
reach the goal. As a result, you may need to contribute additional
funds to your retirement nest egg. The most efficient ways for
most employees to add to their retirement funds are tax-deferred
saving programs, like 401(k) or 403(b) plans and IRAs, These types
of plans allow employees to save money while deferring taxes. This
tax deferral greatly enhances overall return on contributions.
The last leg of a financially secure retirement is your personal
saving and investing, earmarked to enhance your retirement
security. Financial assets to include in your retirment funding may
include mutual funds, stocks, bonds, real estate and bank
investments. Many people also consider paying off a mortgage an
investment, since the cash flow normally associated with the
payment (the principal and interest portion) may now be used for
other retirement expenses.
Other modules in this program will discuss investments, so we will
focus on financial aspects of retirement benefits in the materials
that follow. You may find it helpful to refer to the Investments
module for an excellent review of investment concepts.
Retirement Planning
9
PENSION PLANNING
Payment Methods: Selection
Considerations
One critical financial planning decision is to select the payment
method of pension benefits. Most pensions will have a variety of
benefit payment methods, including the single-life annuity and the
automatic surviving spouse method of payment. Among the
payment methods available, only the “lifetime-only” method gives
you 100% of your monthly benefits. All other methods allow your
spouse or another beneficiary to continue collecting a percentage of
your benefits after your death. Because payment of survivor
benefits may continue to your beneficiary after your death, benefits
during your lifetime will be reduced.
Lifetime-Only (Single Life Annuity)
Method
This method is usually automatic for single employees and optional
for married employees. The lifetime-only method of payment gives
you 100% of your benefit until your death. Your spouse, family or
beneficiaries will normally not receive any benefits under this form
of payment unless your total pension payments at time of death are
less than your contributions, plus interest, to the plan. If this is the
case, your own contributions plus interest, less the benefits that
were paid to you, would be paid to your beneficiary or estate.
Note: If you are married, your spouse must consent in writing if you
choose the Single Life Annuity form of payment.
Retirement Planning
10
Automatic Surviving Spouse Method
If you are married, the automatic surviving spouse method will
provide you and your spouse with a reduced benefit during your
lifetime and will provide a benefit for your surviving spouse.
Depending on the pension plan, the reduction may be uniform (like
10%, regardless of age), or age-based. Your spouse may receive a
percentage of the reduced benefit (but not less than 50%), or the
entire reduced benefit (called a "Joint and 100% Survivor" option.)
Using a Joint and Survivor payment method, upon your death, your
spouse will receive a benefit for the remainder of his/her life.
Optional Methods
Many companies allow you to increase the survivor percentage
(usually up to 100%) by taking a larger reduction in your monthly
benefit during your life. Other companies allow a sum certain to be
paid to your beneficiaries. These options will be charged against
your regular pension benefit.
Retirement Planning
11
Selecting a Method
All payment methods are based on Unisex actuarial tables, that is,
tables that do not have separate mortality for men and women.
However, equal employment law and biology do not necessarily
agree. Given the statistics of a large number of individuals of equal
age and health, a female will generally outlive a male.
If a male employee is married, under a joint and survivor annuity
(which is the method required by law), his wife will receive a
percentage of their reduced benefit upon his death. So, depending
on their ages, he will probably receive 90-95% of the full pension
amount during his lifetime. Upon his death, she will probably
receive a survivor benefit of 65% of the joint pension. Thus, he will
receive a pension of 90-95%, and she will receive a survivor benefit
of 59-62% of the originally computed pension. They give up 5-10%
for his lifetime to get 59-62% after his death for her lifetime.
As we noted, males generally have shorter life expectancies than
their female counterparts of equal health. For a married male
employee with a wife of equal age or younger, the survivorship
option is financially a good deal: You give up 5-10% of your benefit
during your joint lives, so your spouse may receive 59-62% for her
remaining lifetime.
For female employees, however, the math doesn’t work as well.
For equal age spouses, the female will generally outlive her
husband. This means that they will give up 5-10% for her lifetime in
exchange for a lower probability that any benefit will be payable to
the surviving husband.
Retirement Planning
12
•
Health Issues
Our discussion of joint and survivor options has ignored health
issues. So far, we have assumed that both spouses are of equal
health. Selection of a payment method may be influenced when
the spouses’ health conditions differ. For example, if the working
spouse has a terminal illness, the importance of the survivor benefit
increases.
•
Joint and 100% Survivor
Another payment option is the joint and 100% survivor method.
This method reduces the normally computed pension by the actual
actuarial cost and pays the surviving spouse the same amount the
pensioner received during his or her retirement. In cases involving
terminal illnesses or major health problems, this method may prove
to be the most beneficial.
Retirement Planning
13
Comprehensive Example:
John is 58 and his life expectancy is 27.0 years. Millie, his wife, is
55 with a life expectancy of 29.6 years. Their pension benefit is
$3,000 per month, for life. (Life Expectancies are derived from IRS
Tables).
SINGLE LIFE: The single life annuity will be $3,000 for the
employee’s lifetime. Let’s assume for our example that John is the
pensioner. John and Millie will get $3,000 per month for John’s life,
which is 27.0 years, according to a life expectancy chart. Upon
John’s death, Millie will receive no further pension payments.
The Present Value of this sum, at 8% interest, is $397,730.
AUTOMATIC SURVIVING SPOUSE METHOD: Under the normal
Joint and Survivor format for John’s company plan, John and Millie
would take a reduced pension for John’s lifetime; then Millie would
receive 60% of the reduced amount. John and Millie would get
$2,850 while John is alive (a 5% reduction), and Millie would
receive $1,710 (60% of $2,850) after John’s death for her life.
The Present Value of this sum is $397,200.
OPTIONAL SURVIVING SPOUSE METHOD: In certain cases of
adverse health or other circumstances, an optional surviving
spouse method will provide a greater survivor benefit. John’s
company plan will allow John to provide a survivor benefit with a
reduction. Under this arrangement, John and Millie will receive
$2,590 per month while John is alive, and Millie will receive $2,286
after John’s death for her life expectancy.
The Present Value of this sum, at 8% interest, is $358,288.
Retirement Planning
14
SURVIVING BENEFICIARY METHODS: Other options for payment
are the 50% and 100% surviving beneficiaries methods. These
methods may be particularly attractive when the spouse may survive
the pensioner or the pensioner is single with a dependent. Let’s
suppose Ardella is 58 and single. Her brother, Jerome, is 55. Ardella
would like Jerome to get a survivor benefit. Let’s assume that Ardella
will receive $3,000 if she takes a single life annuity. She is concerned
about her health, and providing for her brother.
Examples of Surviving Beneficiary methods:
50% Surviving Beneficiary:
Benefit during Ardella’s life:
$2,613
Survivor Benefit (for Jerome)
$1,307
100% Surviving Beneficiary:
Benefit during Ardella’s life:
$2,314
Survivor Benefit (for Jerome)
$2,314
NOTE: the law requires that any method that does not provide a
survivorship option for the spouse must be consented to by
the spouse. Any consent must be in writing, signed by the spouse
and notarized. In the case of a single person, no consent is
required to elect the single life payment. Survivorship options are
generally available to single plan participants as well.
Retirement Planning
15
Pension Maximization
As we mentioned, your age and the age of your spouse are
important factors in determining which payment option to select.
Remember, federal law requires you to include your spouse in your
pension unless your spouse consents otherwise. Let’s look at an
example so we can evaluate the best alternative. Keith is 55 years
old and has worked at his company for over 30 years. He has
decided it's time to retire. His wife Sarah is also 55.
Keith estimates that his pension will be about $4,000 per month if
he and Sarah decide to take the Single Life Annuity.
If they decide to take the 50% Survivor Annuity, Keith will get
$3,750 per month (about 94% of $4,000) and Sarah would be
eligible to get $1,875 per month or $22,500 for her lifetime in the
event that Keith dies before she does. (Here, we assume that,
should Sarah predecease Keith, his pension would be restored to
$4,000 per month after her death). In other words, Keith’s pension
would be reduced by $3,000 per year ($250 per month for 12
months) so that Sarah will be eligible to receive $22,500 per year, if
Keith were to die first.
Before we continue, it is important to realize that these dollar
amounts are assumed amounts available to Keith and Sarah
through a Defined Benefit pension plan. The numbers we are
about to use are assumptions and estimates as to alternatives
available.
Keith and Sarah consider their good health, look at the mortality
tables and estimate that he has about 25 years to live and she has
about 30 years to live. They want to calculate what would happen if
they decide upon the Single Life Annuity, and invest the same
amount of money per year that they would have given up had they
selected the 50% Survivor Annuity.
Retirement Planning
16
Assuming Keith lives a normal life expectancy of 25 years and can
invest the money and earn an average of 8% annually, they would
end up with $219,318. This is calculated by using the Future
Value of an Annuity table in the “Appendix” section in the back of
the book. We look down the chart to 25 years and across to 8%.
The Factor is 73.106. If we multiply the savings of $3,000 per year
times the factor of 73.106, we come up with a result of $219,318.
Now that Keith has lived 25 years, Sarah has approximately five
additional years to live. If Sarah takes payments from this
$219,318 investment for the next five years, assuming that she can
still earn 8% on the balance, she would be able to draw
approximately $54,930 per year for the next five years. This can be
calculated by taking the investment of $219,318 and dividing it by
the factor of 3.9927, which is derived from the Present Value of an
Annuity chart found in the Appendix ($219,318 ÷ 3.9927 =
$54,930).
This is a very risky alternative. It is advantageous under the
following situations:
1. If Keith and Sarah do live as long as expected and earn 8%,
Sarah would have more money per year under this option.
2. If Sarah dies first, Keith will receive his full pension and be
able to use the investment account, and therefore have
more money per year.
On the other hand, it has the following disadvantages:
1. If Keith dies prematurely, Sarah would be left without
sufficient funds.
2. If Keith and Sarah do not earn 8%, or for some reason they
decide to spend the money for something along the way,
Retirement Planning
17
Sarah would be left unprotected.
A safer way would be for Keith to buy life insurance. The question
then becomes, how much life insurance? We can estimate the
amount of coverage needed. The 50% Survivor Annuity would pay
Sarah $22,500 per year after Keith’s death. This means if Keith
died immediately after retirement, Sarah would need enough
money to provide an income equivalent to $22,500 per year for 30
years. For purposes of this calculation we will again assume Sarah
is able to earn an average of 8% on her investments.
Using the Present Value of an Annuity table in the “Appendix”,
the factor is 11.2578. We find this by looking across to 8% and
down to 30 years. Then we multiply the 11.2578 times the $22,500
per year Sarah would have received as a survivor benefit. The
result is the approximate amount of life insurance Keith would need
to buy. Keith would initially need about $253,301 of coverage. The
question is, could Keith buy more than $253,301 of life insurance at
age 55 for an annual premium of $3,000 (the amount they would be
giving up in an annual pension if they were to elect the 50%
Survivor Annuity)?
Retirement Planning
18
The advantages are numerous. First, Sarah would receive the life
insurance proceeds free from federal income taxes. The survivor
annuity would have been fully taxable each year. Second, if both
Keith and Sarah lived to normal life expectancy (25 and 30 years
respectively), once Keith died, Sarah would have the $253,301 to
last her the remainder of her life, which theoretically is five years.
Every year that Keith lives, so does Sarah. The result is that she
will still get the same amount of money to use over a shorter period
of time. In essence she gets a raise as long as Keith lives. This
sounds like a great deal for Sarah. Keith won’t mind living longer
either! Third, if Sarah were to predecease Keith, then Keith is
already receiving his maximum pension, and would no longer need
the life insurance policy. He could start to draw against the policy,
or cash it in assuming they purchased permanent insurance. Under
this scenario, it would be a more favorable situation for Keith
because he would get some extra money from the policy. Lastly,
whether Keith and Sarah decided to take the life annuity or the joint
life annuity, if they die simultaneously or shortly after one another, there
would be no further benefit paid from the pension. If they decided to
purchase the life insurance, their children or other heirs would receive
the life insurance proceeds. If they elected the 50% Survivor Annuity,
their heirs would not be eligible to receive any pension benefits.
CAUTION: If you are not in good health, you may not be able to
qualify for life insurance. Make sure you can get enough insurance
at the proper price before your spouse signs off on your pension
benefit.
Now the question becomes, what type of policy do I purchase?
There are two broad types of policies available: term and cash
value. Each has its own advantages and disadvantages. Term is
less expensive initially, but gets more expensive later if we wish to
keep the coverage level. For example we may pay $300 per year
for a $100,000 term policy at age 52, and $1,200 for the same
coverage ten years later. For yearly renewable term, the premiums
will go up each year as we get older. As an alternative we may
purchase a ten year level premium policy for $450 per year, and as
long as we are healthy, renew after ten years for about $900 per
year. If we’re not healthy in ten years, the policy is still renewable,
but for about $1,400 per year for the next ten years.
Retirement Planning
19
Some people buy decreasing term. They will start out with the same
amount of insurance, but are willing to reduce the amount of coverage
each year. Their logic is that the longer they live, the less money will
be needed to protect the surviving spouse. This is true because the
spouse’s life expectancy shortens each year. In our example, Keith
needed $253,301 of life insurance at age 55 to provide Sarah with
$22,500 per year for 30 years. This assumed an 8% annual rate of
return. After Keith lived ten years, in theory, Sarah would have only 20
years remaining to live. Using the $22,500 and the present value of
an annuity for 20 years at 8%, the amount of insurance is about
$220,907 ($22,500 times 9.8181). Ten years later, when Sarah’s life
expectancy is about ten years, it becomes $150,977 ($22,500 times
6.7101). After Keith lives 25 years, Sarah has about five years left to
live. The factor for five years and eight percent is 3.9927. If we
multiply the 3.9927 factor times the annual survivor benefit of $22,500
that the pension would have provided, it is $89,836. The cost for a
decreasing term policy for the above example should be closely
compared with using yearly renewable term, in which you can elect
each year how much, if at all, you want to reduce the coverage.
Cash value insurance is more expensive, but the premiums may be
set up to remain level. One advantage of cash value insurance is
that the policy may be “paid-up” after a certain number of years.
The benefit of this arrangement is that we can then enjoy our full
pension. Another advantage is that if we keep the coverage level,
our spouse might be able to get a higher income than the 50%
Survivor Annuity would have provided. If our spouse died first, we
could get the cash value from our policy and increase our monthly
income. We might even decide to keep the insurance and change
the beneficiary to our children.
Retirement Planning
20
One problem with buying life insurance is that our spouse might
outlive the money. This could happen because she lives longer than
we calculated, which is normal life expectancy, or because she can’t
earn the rate of interest we used in our assumption. It is usually wise
to extend the life expectancy assumption and use a conservative rate
of interest. Another problem with buying life insurance is that many
companies use current mortality assumptions or current interest rates.
These numbers may change in the future and require higher
premiums at a later date when they may be less affordable. Try to get
as many guarantees as possible if you decide to buy life insurance.
CAUTION: Insurance policies and companies vary greatly in their
policy provisions. Compare several policies before making a
decision on which to buy. Make sure you have obtained
satisfactory coverage before a spouse “signs-off” on your pension
benefits.
If an agent says something that sounds too good to be true, ask for it
in writing on the company’s stationery.
Retirement Planning
21
TAXATION OF PLAN
DISTRIBUTIONS
When you take a distribution from a qualified retirement plan, you are
required to pay tax on the “taxable amount.” Depending on the type of
contribution, your distribution may or may not be taxable.
Taxable
-
Before-Tax Contributions
Company Matching
Contributions
Rollover Contributions
Investment Earnings
(on all contributions)
Non-Taxable
- After-Tax Contributions
Taxable distributions will generally have one or a combination of three
tax treatments:
1. They will be treated as ordinary income;
2. They will be treated as a Lump Sum Distribution (and may
be eligible for a specifically defined special tax treatment); or
3. They will continue to be tax-deferred if transferred or rolled
over into an IRA or another employer’s tax-qualified
retirement plan.
Note: If you receive a distribution from a qualified plan, and you do
not elect a “direct rollover,” the taxable portion of the distribution is
subject to a mandatory 20% income tax withholding from any cash
distributed.
Retirement Planning
22
Ordinary Income
Having your distribution treated as ordinary income is usually the
most expensive option. Adding your distribution to your ordinary
income could very well take you from a 15% federal income tax
bracket to an even higher tax bracket. Also, unless you will be at
least age 55 in the calendar year you are separating from company
service, you could be subject to a 10% penalty tax for distributions
before age 59 ½.
Example: Steve is 54. He retires, taking a $120,000 taxable
retirement plan distribution, and has other income of $80,000. He
does not transfer his distribution into an IRA or another employer’s
qualified retirement plan. Steve will pay tax on the distribution at his
marginal rate (probably a portion as high as almost 35%), plus pay
a 10% penalty tax (plus applicable state taxes).
Retirement Planning
23
Income Tax Tables for 2008
Single Taxpayers
If Taxable
But not Over
Income Is: Over
$0
$8,025
8,025
32,550
32,550
78,850
78,850
164,550
164,550
357,700
357,700
Married Taxpayers Filing Jointly
If Taxable
But not Over
Income Is: Over
$0
$16,050
16,050
65,100
131,450
65,100
200,300
131,450
200,300
357,700
357,700
Head of Household
If Taxable
But not Over
Income Is: Over
$0
$11,450
11,450
43,650
43,650
112,650
112,650
182,400
182,400
357,700
357,700
Married Filing Separately
If Taxable
But not Over
Income Is: Over
$0
$8,025
8,025
32,550
32,550
65,725
65,725
100,150
100,150
178,850
178,850
The Tax Is
$0
802.50
4,481.25
16,056.25
40,052.25
103,791.75
Plus
10%
15%
25%
28%
33%
35%
The Tax Is
$0
1,605.00
8,962.50
25,550.00
44,828.00
96,770.00
Plus
10%
15%
25%
28%
33%
35%
The Tax Is
$0
1,145.00
5,975.00
23,225.00
42,755.00
100,604.00
Plus
10%
15%
25%
28%
33%
35%
The Tax Is
Standard Deduction: Single = $5,450
Head of Household = $8,000
$0
802.50
4,481.25
12,775.00
22,414.00
48,385.00
Plus
10%
15%
25%
28%
33%
35%
Married/Joint = $10,900
Married/Separate = $5,350
$1,050 each if over 65 or blind, $2,100 if both
$1,350 for single or head of household, $2,700 if both
Personal Exemption: $3,500 each
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Of the
Amount Over
$0
8,025
32,550
78,850
164,550
357,700
Of the
Amount Over
$0
$16,050
65,100
131,450
200,300
357,700
Of the
Amount Over
$0
11,450
43,650
112,650
182,400
357,700
Of the
Amount Over
$0
8,025
32,550
65,725
100,150
178,850
Lump Sum Distributions
A Lump Sum Distribution is the payment to you, within one calendar
year, of your entire balance in a qualified retirement plan. You must
have separated from service from your company in order to be
eligible to receive a lump sum distribution. If you receive a lump-sum
distribution, you may be able to make a one-time election to figure the
tax on the payment by using 10-year averaging. Averaging often
reduces the tax you owe because it treats the payment as if it were
paid over ten years. Furthermore, the tax on the distribution is
computed separately from your other taxable income so that you are
not pushed into a higher tax bracket.
Ten-Year Averaging - A participant is eligible if:
•
born before January 2, 1936 and
•
a plan participant for at least 5 years.
The tax is computed as if the distribution were received over 10
years, using 1986 tax rates for a single taxpayer.
Note: Different rules may apply to a distribution of your employer’s
company stock. You should consult your tax advisor for details.
Following is a chart with the approximate taxes on Lump Sum
Distributions, using ten-year averaging (using 1986 rates for a
single individual, as required):
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Amount of
Lump Sum
$25,000
$40,000
$50,000
$75,000
$100,000
$150,000
$200,000
$250,000
$300,000
$400,000
$500,000
10-Year
Average
$1,801
$4,187
$5,874
$10,310
$14,471
$24,570
$36,920
$50,770
$66,330
$102,602
$143,682
% Tax
7.2
10.5
11.7
13.7
14.5
16.4
18.5
20.3
22.1
25.7
28.7
Direct Transfer
You may elect to transfer the taxable portion of your plan balance
directly to another employer’s qualified plan or to a self-directed IRA.
Transfer means to have the taxable portion of your distribution from
the plan transferred by the administrator to the trustee of the receiving
qualified plan or IRA. With a transfer, the participant does not
physically take possession of the taxable money. The check is not
payable directly to the participant. Instead, it is payable to the
receiving trustee for the benefit of the participant’s IRA or another
employer’s qualified plan, such as a 401(k) or 403(b). Participants
may make unlimited transfers among qualified plan and IRA trustees,
as long as the participant does not take possession of the money, and
as long as the receiving plan accepts direct transfers. Any after-tax
contributions in your account would be distributed to you, and would
not be subject to any income tax.
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Rollover
Rollover means to take physical possession of all or part of the
taxable portion of your distribution from the plan and roll it over to
another qualified plan or IRA. Rollovers occur when the check for
the taxable distribution is payable to the participant. Participants
taking a lump-sum or rollover distribution from a qualified plan will
receive a distribution of their taxable portion less a 20% withholding
tax. As long as the participant rolls over the entire amount of the
taxable portion to another tax-qualified plan or IRA, within 60 days,
he will receive a refund of the withholding tax when he files his
income tax return the following year. The 20% withholding tax
applies only to distributions from employer Pension and 401(k) or
403(b) plans, and does not apply to rollovers from IRAs. Rollovers
may be done only once in a 12 month period. Rollover IRAs are
the most popular vehicle for these types of distributions.
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•
Distributions are not taxed until withdrawn from the
retirement plan, an IRA or another employer’s qualified plan.
•
Transfers are the preferred method to further defer tax on
distributions from retirement plans, since there is no
withholding tax on transfer amounts.
•
A regular rollover, as described above, should be viewed as
a last resort. For example, if you change your mind within 60
days after receiving a taxable total distribution, to further
defer tax on the distribution, you could roll it over into an IRA
or another qualified retirement plan. In this scenario, to defer
tax on the total taxable amount of the distribution, you would
have to rollover the 20% withholding tax as well.
•
If you withdraw funds from an IRA before 59 ½, you may be
subject to a 10% penalty tax unless you qualify for one of the
exceptions described on the following pages.
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•
Rollovers may be done only once in a 12-month period.
•
Transfers may be done an unlimited number of times between
trustees.
•
Distributions from IRAs are NOT eligible for special forward
averaging. However, Rollover IRAs may act as a conduit. A
conduit IRA is an IRA in which a lump sum from a previous
employer’s qualified plan is “parked” and later rolled into
another qualified plan, such as a 401(k) or 403(b). For
example, if Sue leaves her employer and rolls her
distribution to an IRA, she can later roll that IRA into her new
employer’s savings plan as long as the funds have not been
commingled with other “Contributory IRA” funds and as long
as her new employer’s plan accepts rollovers.
•
The IRS stipulates that required minimum distributions from
qualified plans must commence by April 1st following the
year in which you reach age 70 ½, if you have separated
from service. If you do not take the required minimum
distribution, a portion of the money may be subject to an
additional penalty tax of 50%.
•
A working employee older than age 70 ½ does not have to
take a required minimum distribution from that employer’s
qualified plan until he/she actually separates from service.
20% Withholding Tax on Employee
Distributions from Qualified Retirement
Plans
As mentioned on the previous pages, a participant’s distribution will
be reduced by the 20% tax withholding, if the participant elects to
take the distribution in cash. If the participant then rolls the
distribution into an IRA or another employer’s qualified plan, the
amount withheld must also be added to the rolled-over distribution
to avoid taxation. That is why it is better to make a direct transfer.
Example: Tom has $50,000 of taxable money in his plan. He elects
to take a cash distribution in March of the current year. He receives
a distribution of $40,000 ($50,000 less $10,000 withholding). If Tom
wants to avoid taxation, he must roll $50,000 into an IRA or another
employer’s qualified plan. This means that Tom will have to come
up with $10,000 from other sources to put into the IRA or qualified
plan. The $10,000 withheld would be refunded to Tom the next
year when he files his tax return.
If Tom rolls over only $40,000, the $10,000 withheld would be
treated as a taxable distribution. If Tom separates from service
prior to age 55, receives the payment before age 59 ½ and does
not roll it over, in addition to the regular income tax, he will have to
pay a penalty tax of 10% on the taxable portion. The 10% penalty
tax does not apply if Tom separates from service during the
calendar year he reaches age 55 and takes a distribution of his plan
account.
If you take your distribution of employer stock in whole shares,
there will be no withholding on whole shares. However, fractional
shares will be sold and subject to withholding.
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Exceptions to the 10% Penalty Tax for
Persons Under Age 59 ½
If you receive a distribution before age 59 ½ you may be subject to
a 10% penalty tax, unless the distribution is:
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30
•
made to a person who separates from service in the
calendar year he/she will be age 55 or older.
(Note: This exception does not apply to IRAs.)
•
if you become disabled and can furnish proof.
•
directly transferred/rolled over to an IRA or another
employer’s tax-qualified plan.
•
made under a Qualified Domestic Relations Order (QDRO).
•
received as part of a series of substantially equal lifetime
periodic payments (annuitized).
•
used for qualified educational expenses for yourself, spouse,
children or grandchildren. Tuition, fees, books, supplies, room
and board expenses qualify if the person is at least half-time.
•
used to pay unreimbursed medical expenses in excess of
7.5% of adjusted gross income.
•
used to purchase health insurance of an unemployed
individual.
•
used to pay expenses incurred by qualified first-time
homebuyers, up to the first $10,000.
•
IRS seizure for payment of tax.
Annuitizing: Substantially Equal
Periodic Payments
Under current tax laws, distributions from qualified retirement plans
and IRAs are subject to ordinary income tax. Generally, plan
distributions made prior to age 59 ½ are also subject to an
additional 10% penalty tax. See the exceptions listed previously.
However, participants under age 59 ½ may avoid the 10% penalty
tax on distributions from qualified plans and IRAs by annuitizing the
payments.
•
Payments from the IRA must be part of a series of
substantially equal periodic payments;
•
The payments are calculated to be made at least annually
over the life expectancy of the recipient or the joint life
expectancy of the recipient and the beneficiary; and
•
You must continue the payment method until you reach age
59 ½ or for five years, whichever is longer.
The IRS recognizes three methods of annuitizing:
1. Divide the account balance by an annuity factor that uses
IRS-accepted life expectancy tables and interest rates.
2. Amortize the account balance using a reasonable rate of
return over the appropriate time period (life expectancy).
3. Take a fraction of the remaining account balance each year,
with the starting fraction having a numerator of one (1), and
a denominator of the number of remaining years of the
recipient, using life expectancy (or the joint life expectancy of
the recipient and the designated beneficiary). This is known
as the Required Minimum Distribution method, also used for
age 70 ½ distributions.
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Example 1: Walt has an IRA with a current account balance of
$100,000. His life expectancy is approximately 30 years, and he
assumes a reasonable rate of return of 8% annually. Using the
second method above (amortization), Walt could withdraw $734
each month and avoid the 10% penalty tax.
Example 2: Lisa has an IRA balance of $60,000 and a life
expectancy of 28.7 years. Using the third method, in the first year,
Lisa can withdraw 1/28.7 of the IRA balance ($2,091). In the
second year, she can withdraw 1/27.9 of the remaining balance,
1/27.0 in the third year, and so on based on recalculated life
expectancy.
If either the amortization or the annuitization method is chosen,
there is a one-time, irrevocable election to switch to the
recalculation method. This election was an effort by the IRS to
accommodate taxpayers who were draining their accounts too
rapidly in times of declining market values. Unfortunately, the
recalculation method often produces inadequate income streams.
As always in this area of retirement planning, consult a
professional!
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INDIVIDUAL RETIREMENT
ACCOUNTS
Individual Retirement Accounts (IRAs) are tax-favored retirement
vehicles first introduced under the Employee Retirement Income
Security Act of 1974 (ERISA). Subsequent tax legislation modified
IRA rules, and we now have a number of different opportunities to
save, invest and accumulate money for our retirement needs using
IRAs.
IRAs can be funded in one of two ways: through a tax-deferred
rollover from a qualified plan, or through contributions. There are
now three types of Contributory IRAs, all of which require an
individual to have earned income. The three types:
•
Traditional Deductible IRA
•
Traditional Non-Deductible IRA
•
Roth IRA
Under current law (2007), an individual may contribute the lesser of
$4,000 ($5,000 in 2008) plus $1,000 catch-up contribution if age 50
or older or 100% of earned income, whichever is less, to all
combinations of IRAs during the year. However, certain eligibility
requirements must be satisfied.
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Traditional Deductible IRA
To make a tax-deductible contribution to an IRA, one of two
conditions must be met:
1. You must not be an active participant in a qualified
retirement plan.
If you are not an active participant, your contributions are
deductible regardless of how high your Adjusted Gross
Income is. If you are married and only one spouse is an
active participant, the non-participant spouse may have a
deductible IRA if the combined AGI is $150,000 or less. The
deduction phases out proportionately between $150,000 and
$166,000 of adjusted gross income.
OR
2. Your adjusted gross income must not exceed certain
levels.
Even if you are an active participant, you may take a
deduction for your IRA contribution if your AGI is below
certain limits. Above these limits, your deduction is phased
out. Refer to the following table.
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Phase Out Range for IRA Deductibility
Adjusted Gross Income
Year
Single*
Married/Joint
2008
$53,000 to $63,000
$85,000 to $105,000
2009
$55,000 to $65,000
$89,000 to $109,000
*Single or Head of Household.
Note: Married Filing Separately involves a phase out between $0 and $10,000 of
Adjusted Gross Income.
Planning Pointers
•
•
•
•
•
•
•
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If both spouses are active participants in qualified plans, both
will be subject to the phase out ranges listed above.
If only one spouse is an active participant, the nonparticipant spouse may have a fully deductible IRA if
combined AGI is $159,000 or less for 2008 and $166,000 or
less for 2009.
Contributions may not be made to traditional IRAs starting
in the year a person reaches age 70 ½.
In any case, either or both spouses may have a nondeductible IRA regardless of income, up to the lesser of
$4,000 ($8,000 if married) or 100% of combined AGI.
For all types of IRAs, funds grow on a tax-deferred basis.
However, the tax treatment upon distribution depends on the
type of IRA.
Be aware of the possible 10% penalty tax on distributions
prior to age 59 ½ commonly known as the penalty tax.
Contributions must be made by April 15th of the year
following your filing year.
Traditional Non-Deductible IRA
The traditional non-deductible IRA is available to anyone with
earned income, regardless of AGI or active participation in an
employer-sponsored qualified plan. No income tax deduction is
taken when the contribution is made, but the earnings grow on a
tax-deferred basis. Ultimately, the actual non-deductible
contribution is recovered income tax free. Only the earnings will be
subject to income tax at the time of withdrawal.
Roth IRA
The newest IRA vehicle is the Roth IRA, created under the Taxpayer
Relief Act of 1997. The contributory Roth IRA is non-deductible and
grows tax-deferred, just as a traditional non-deductible IRA. You are
eligible to contribute $5,000 if your adjusted gross income does not
exceed certain limits.
Phase Out Range for Roth IRA Deductibility
Adjusted Gross Income
Year
Single*
Married/Joint
2008
$101,000 to $116,000
$159,000 to $169,000
2009
$105,000 to $120,000
$166,000 to $176,000
*Single or Head of Household.
Note: Married Filing Separately involves a phase out between $0 and $10,000 of
Adjusted Gross Income.
Qualifying distributions from a Roth IRA are totally income tax free. In
order to qualify for income tax free treatment, the Roth IRA must have
been in existence for at least 5 years, and the distribution must be on
account of death, disability, the attainment of age 59 ½, or a first time
home purchase (lifetime limit of $10,000).
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It may be evident that the Roth IRA is preferable to the traditional
non-deductible IRA in all cases where a person is eligible for
either. This is due to the potential for income tax free distributions
from the Roth after 5 years.
Furthermore, a Roth IRA has FIFO (First In, First Out) income tax
treatment. That is, the non-deductible contributions to the Roth IRA
are recovered income tax free first, and any excess is considered
earnings, and thus taxable if not otherwise eligible for tax-free
treatment. As a result, you may withdraw non-deductible contributions
at any time without tax or penalty.
Also, in contrast with traditional IRAs, you are allowed to contribute
to a Roth IRA after age 70 ½, if you have earned income.
Moreover, as noted below, minimum distributions are not required
from Roth IRAs at age 70 ½ as is the case with traditional IRAs. In
fact, you may choose to leave your Roth IRA to beneficiaries
income tax free at your death. Estate taxes, however, may apply.
Roth Conversions
A separate opportunity exists to make a conversion from a
traditional IRA to a Roth IRA. The conversion is a “taxable event”
for income tax purposes, but avoids the 10% penalty tax normally
associated with a distribution prior to age 59 ½. You are eligible to
make the conversion if your adjusted gross income is $100,000 or
less, not counting the conversion amount. The advantage is that,
ultimately, all qualifying distributions from the Roth IRA will be
income tax free, perhaps at a time when your marginal tax bracket
is still relatively high. It is most helpful to use a computer program to
compare which program provides the higher after-tax cash flow.
If you are contemplating a conversion to Roth, it is always
preferable to pay the income tax from funds other than the IRA.
This allows the entire amount converted to continue growing on a
tax-deferred basis, ultimately providing tax-free distributions, if the
standard requirements are met.
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Investing in an IRA
An IRA is an investment for your future retirement. Once you’ve
decided to make an IRA contribution, you need to select the best
investment vehicle for your IRA. Banks, savings and loans, credit
unions, mutual fund sponsors, brokerage firms, registered investment
advisors and Insurance companies can all provide the necessary
forms and materials for investing in an IRA.
The available investment vehicles include Certificates of Deposits
(CDs), money market accounts, stocks, bonds, U.S. government
securities, mutual funds, annuities, and limited partnerships in real
estate. There are some investments restricted from usage in an
IRA including precious metals, life insurance, collectibles, antiques
and directly owned real estate.
As with any investment, consider your goals, objectives, needs,
time horizon and tolerance for risk. Your IRA investments should
complement the rest of your portfolio, and be structured to allow for
changing needs in retirement. Although most people prefer to be
somewhat conservative in retirement, recognize that growth is still
necessary, especially to counteract the long-term effects of inflation.
Inflation is a problem because people who retire in their 60s still
have a life expectancy of over 20 years, and will need increasing
income to maintain their purchasing power.
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Withdrawals from an IRA
Any withdrawals from an IRA created before 1987 are treated and
taxed as ordinary income in the year received. If you have made
both non-deductible and deductible IRA contributions, the portion
attributable to your non-deductible contributions is income tax free.
You must file IRS Form 8606 annually to determine the taxable and
non-taxable portions of the withdrawal.
If you have more than one IRA, you will need to calculate required
minimum distributions at age 70 ½ for each account, but the current
law allows you to take the combined minimum distributions from
any one or more accounts. Remember that minimum distributions
are not required for Roth IRAs.
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•
Minimum Distributions
Distributions from an IRA may begin at any time, subject to the
premature distribution penalty previously described. Federal
guidelines stipulate that distributions from traditional IRAs must
begin by April 1st following the year you reach age 70 ½, whether
you have retired or not. The amount of the distribution must be
calculated according to IRS tables, and must, at a minimum, be
distributed over one of the following periods:
•
For most retirees, a uniform table is now used to calculate
minimum required distributions. The percentage to be
distributed increases every year, providing a built-in inflation
protection feature.
•
If your designated beneficiary is your spouse and is more
than 10 years younger than you, a different IRS table may be
used to reduce the required distribution even further if
desired.
The distribution required by April 1st is actually the distribution
required for the year in which the owner attains age 70 ½.
Distributions for each calendar year after the year the owner
becomes age 70 ½ must be made by December 31st of that year.
Therefore, if the first required distribution is delayed, as permitted,
until April 1st of the year after attainment of age 70 ½, there will be
another distribution required that same year by December 31st.
This strategy has the advantage of tax deferral, but the possible
disadvantage of a higher tax rate that may apply to some or all of
the second distribution in that year. For example, a person turning
70 ½ on July 15, 2009 wouldn’t have to take a distribution until April 1,
2010, but must take another distribution by December 31, 2010 to
avoid penalties.
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If the required minimum distribution is not taken in any particular
year, the owner will be assessed a 50% penalty tax on the
difference between what should have been taken out and what was
actually distributed.
•
Excess Contributions
If you contribute more than the allowable limit to an IRA, you are
subject to an excess contribution penalty of 6%, whether the
contribution was deductible or non-deductible. The penalty is
cumulative: if the excess amount is not withdrawn, you will be
subject to the same penalty the following tax year. The excess
contribution may be withdrawn without penalty if done by the due
date of your federal return. However, any earnings on the excess
contribution will also be returned to you, and will be subject to
income tax and the 10% penalty tax on premature distributions prior
to age 59 ½. The 6% excise tax is not income tax deductible.
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41
ANNUITIES
In addition to qualified retirement plans and IRAs, other investment
opportunities are available. Regular non-taxed-deferred savings
and investments may consist of stocks, bonds, mutual funds, bank
deposits and other vehicles.
Annuities may also be used to provide additional retirement income
security. There are two basic types of annuity from an investment
standpoint: Fixed and Variable.
A Fixed Annuity is a relatively conservative investment based on
fixed income investments like bills, notes and bonds.
A Variable Annuity may be somewhat riskier because funds are
usually invested in separate accounts, which are similar to mutual
funds. Separate accounts generally hold equity investments like
common stocks and real estate, or fixed-income investment like
corporate bonds.
In either case, an annuity is a financial product sold by insurance
companies, providing tax-deferred accumulation and ultimate
distribution during life or at death. In a regular personal account,
the annuity purchase price is non-deductible and the funds grow on
a tax-deferred basis. Distributions will be taxable depending on a
number of considerations.
If the distributions from the annuity are simply occasional
withdrawals, all amounts are taxable as ordinary income until the
earnings on the annuity have been paid out. Then, further
withdrawals will be considered a tax-free return of non-deductible
principal contributions. Note: for annuities purchased prior to
August 14, 1982, distributions are considered a tax-free return of
principal first, until contributions are fully recovered.
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On the other hand, if the annuitant takes distributions based on
insurance company payout options like Single Life Annuity
payments, each annuity payment consists of a partial return of
purchase payments and a partial return of the earnings of the
annuity. The percentage of each payment that is taxable remains
constant during the lifetime payments, until all the purchase
payments have been recovered. Then, all future payments to the
annuitant will be fully taxable.
At the death of the annuitant, any earnings still remaining in the
contract would be taxable to the beneficiary.
One final comment is in order here. Permanent, cash value life
insurance can also be used to generate additional retirement
income, just like annuities. The accumulated cash value is applied
to one of the various options in the policy, providing a stream of
income to the payee.
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RETIREMENT FUNDING
PREFERENCE
Participants in retirement plans are often confronted with having to
make a choice: Which plan or plans should I participate in? What
funding level is appropriate? Should I fund one before the other?
Generally, we suggest that participants in retirement plans like a
401(k) or 403(b) should first maximize their contributions to those
plans on a pre-tax basis. You saw earlier that the maximum pretax amount in 2009 is $16,500 to these types of plans. If the
participant will be age 50 or older by the end of the year, an additional
$5,500 is allowed as a catch-up contribution.
The rationale for this recommendation is that the participant is
shielding income from taxation during years when the tax bracket is
probably relatively high, and deferring receipt of the funds until
retirement when the tax bracket will likely be lower. Meanwhile, the
funds grow on a tax-deferred basis.
Assuming that the maximum pre-tax amount has been reached and
the person has capacity to save even more for retirement, we
usually recommend contributing the maximum $5,000 in 2009 to a
tax-deductible IRA, if eligible, for the same reasons as above. If the
person is not eligible for a deductible IRA, then the Roth IRA should be
considered. Roth IRAs grow tax-deferred, and qualifying distributions
are totally income tax free.
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If the taxpayer is not eligible for a Roth IRA due to excessive income,
then either a non-deductible IRA or a regular non-qualified annuity
would be suitable for tax-deferred growth. Another alternative is to go
back into the retirement plan and make after-tax contributions.
In any case, always make sure that you maximize the amount of
your employer’s matching contributions.
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SOCIAL SECURITY
The Social Security System provides us with a supplement to our
retirement income. If you depended solely on Social Security
payments in your retirement years, it is unlikely you could meet
everyday living expenses. A. Haeworth Robertson, Chief Actuary of
U.S. Social Security, 1975-1978 stated: “Social Security is merely a
floor of protection upon which we build through supplemental
private savings, insurance and retirement programs.” The idea
behind Social Security is to provide you the minimum standard of
living during retirement.
Social Security
In order to find out whether you’re covered by Social Security
benefits, you need to determine the periods of time during which
you paid Social Security taxes. These periods of time are referred
to as “quarters of coverage.” A quarter of coverage is a calendar
quarter (a 3 month period ending March 31, June 30, September
30, or December 31) of any year. An individual earns a quarter of
coverage if he or she has a specified amount of earnings during a
calendar quarter.
Your quarters of coverage determine whether you are “fully insured”
or “currently insured,” which in turn determines what benefit you will
receive.
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Fully Insured Status
A person must be fully insured in order to collect retirement
benefits.
You may use one of two tests in order to determine whether you are
fully insured:
1. You must have at least 40 quarters (10 years) of coverage
since 1936, or
2. You must have at least 1 quarter of coverage for each year
after 1950 (or after the year in which you became 21, if later)
and before the year of your disability, death or year of
attaining age 62. In any case, you must have at least 6
quarters of coverage.
Example: Miss Jones applied for retirement benefits in 1989, the
year she attained age 65. She needed 35 quarters of coverage to
be fully insured (there are 35 years between 1950 and 1986, the
year she attained age 62.)
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Estimating Your Social Security
Retirement Benefit
In order to determine your Social Security benefit you must first
calculate your AIME (Average Indexed Monthly Earnings). The AIME
is based on Social Security earnings for years after 1950.
Calculating Your Average Indexed Monthly
Earnings (AIME)
Rather than performing the laborious calculations yourself, you may
want to ask Social Security for an estimate of your benefits. You can
call (800) 772-1213 for this purpose, or go to the web site
www.ssa.gov. As of October 1, 1999, the earnings and benefit
estimates statement has been automatically provided on an annual
basis to all persons age 25 or over who are not yet receiving
benefits.
Your AIME ultimately determines your Primary Insurance Amount
(PIA) for all subsequent calculations of benefits to which you and
family members are entitled. The PIA is the amount you would
receive if you retired at your full retirement age (FRA).
Social Security bases your benefits on your earnings, up to the
maximum wage base, adjusted yearly as shown. The Social
Security portion of the FICA* tax is 6.2% on earnings up to the
taxable maximum amount. The employer pays a matching amount
each year. The Medicare tax of 1.45% is payable on all earned
income, without limit and is also matched by the employer.
*
FICA is the Federal Insurance Contributions Act, which authorizes the
funding of Social Security and Medicare.
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Maximum Social Security Wage Base
$106,800 for 2009
$102,000 for 2008
$97,500 for 2007
$94,200 for 2006
$90,000 for 2005
$87,900 for 2004
$87,000 for 2003
$84,900 for 2002
$80,400 for 2001
$76,200 for 2000
$72,600 for 1999
$68,400 for 1998
$65,400 for 1997
$62,700 for 1996
$61,200 for 1995
$60,600 for 1994
$57,600 for 1993
$55,500 for 1992
$53,400 for 1991
$51,300 for 1990
$48,000 for 1989
$45,000 for 1988
Retirement Planning
49
$43,800 for 1987
$42,000 for 1986
$39,600 for 1985
$37,800 for 1984
$35,700 for 1983
$32,400 for 1982
$29,700 for 1981
$25,900 for 1980
$22,900 for 1979
$17,700 for 1978
$16,500 for 1977
$15,300 for 1976
$14,100 for 1975
$13,200 for 1974
$10,800 for 1973
$9,000 for 1972
$7,800 for years 1968 - 1971
$6,600 for years 1966 - 1967
$4,800 for years 1959 - 1965
$4,200 for years 1955 - 1958
$3,600 for years 1951 - 1954
$3,000 for years 1937 - 1950
Cost-Of-Living Increases and Social
Security Benefits
Social Security benefits are adjusted upward for inflation. The
percentage increase is published in the Federal Register every
November. The increase is automatically effective beginning with the
January payment after the increase is published in the Registry.
This chart shows the Maximum Retirement Benefits and Cost-ofLiving increases each year since 1988. The annual increase is the
announced rate that applies to benefits in the following year.
Maximum Retirement Benefits
Retirement Planning
50
Year
Maximum
Benefit
Annual
Increase
2009
$2,323
2008
$2,185
5.8%
2007
$2,116
2.3%
2006
$2,053
3.3%
2005
$1,939
4.1%
2004
$1,825
2.7%
2003
$1,741
2.1%
2002
$1,660
1.4%
2001
$1,536
2.6%
2000
$1,433
3.5%
1999
$1,373
2.5%
1998
$1,342
1.3%
1997
$1,326
2.1%
1996
$1,248
2.9%
1995
$1,199
2.6%
1994
$1,147
2.8%
1993
$1,128
2.6%
1992
$1,088
3.0%
1991
$1,022
3.7%
1990
$975
5.4%
1989
$899
4.7%
1988
$838
4.0%
Full Retirement Age
The current Full Retirement Age necessary to collect 100% of your
Social Security benefit is 65, and applies only to those individuals
who were born 1937 or before. Because of longer life expectancies,
the full retirement age will be increased in gradual steps until it
reaches age 67. For individuals born 1938 and later, Full Retirement
Age will increase as follows:
Year of Birth
Before 1938
1938
1939
1940
1941
1942
1943 - 54
1955
1956
1957
1958
1959
1960 or later
Retirement Planning
51
Full Retirement Age
65
65 and 2 months
65 and 4 months
65 and 6 months
65 and 8 months
65 and 10 months
66
66 and 2 months
66 and 4 months
66 and 6 months
66 and 8 months
66 and 10 months
67
Early Retirement
You may elect to take your Social Security benefit as early as age 62.
If you decide to take your benefit prior to your Full Retirement Age,
your benefit will be reduced to compensate for receiving benefits over
a longer period. The following illustrates the amount of Social
Security benefit you will receive, if your full retirement age is 66:
Age
Reduced Amount
62
75%
63
80%
64
86.7%
65
93.3%
66
100%
A retirement benefit that starts at your Full Retirement Age is equal
to 100% of your Primary Insurance Amount (PIA). When your
benefit is taken before your Full Retirement Age, your benefit is
equal to a percentage of your PIA. Your benefit will be reduced by
5/9 of 1% for each of the first 36 months you retire before your Full
Retirement Age and 5/12 of 1% for each month in excess of 36
months.
Delayed Retirement
Retirement Planning
52
If you elect to work full-time beyond your Full Retirement Age, you
may increase your benefit two ways:
1. When you elect to delay your retirement beyond your Full
Retirement Age by working full-time, you will be adding a
year of high earnings to your record. This will result in higher
benefits.
2. Your benefit may also be increased a certain percentage
based on the year you were born, if you delay retirement.
The increases will be added in automatically from the time
you reach your full retirement age until you start taking your
benefits, or you reach age 70. The increases are called
Delayed Retirement Credits.
Increases for Delayed Retirement
Year of Birth
Yearly Percentage Increase
1931 - 1932
1933 - 1934
1935 - 1936
1937 - 1938
1939 - 1940
1941 - 1942
1943 or later
5.0%
5.5%
6.0%
6.5%
7.0%
7.5%
8.0%
For example, if you were born in 1943 or later, Social Security will add
Retirement Planning
53
8% to your benefit for each and every year you delay signing up for
Social Security beyond your full retirement age, up to age 70.
Delayed Retirement Credits (DRCs) increase the benefit for a
retired worker, but not for the spouse. However, DRCs do increase
the benefit payable to the widow(er).
When to Take Your Benefit?
Evaluating the following considerations may help you decide
whether to take a reduced benefit before your Full Retirement Age,
or wait until your Full Retirement Age in order to collect 100% of
your benefit.
•
Financial Considerations
•
Will the reduced benefit plus any other retirement income be
enough to maintain the desired lifestyle of the retiree?
•
How will early retirement affect the individual’s pension?
•
Non-Financial Considerations
•
How will early retirement affect the individual, his/her
spouse, and/or other dependents?
•
Will the individual find a psychological substitute for the job
satisfaction received when working – through part-time
employment, hobbies, volunteer activities or travel?
•
How is the individual’s health?
If you fare well in the non-financial considerations and can meet
Retirement Planning
54
anticipated expenditures, it may be more advantageous to retire at
62. The reason is that if you wait until age 65, you must collect 12
years worth of Social Security before you equal the amount
collected by someone who started at 62. However, if you continue
to work until 65, you are still adding to your earnings record and you
may have a higher benefit. This would shorten the 12-year breakeven point by a few years.
Social Security Earnings Test
Retirement Planning
55
If you continue to work after you begin receiving a Social Security
benefit, your benefit could be reduced depending on your age and
earnings. Each dollar earned in excess of a specified amount will
reduce your Social Security benefit. Note below the age and
earnings limitations for 2007.
Earnings Limitation
(Threshold)
Benefit Lost
$14,160
$1 for Each $2
over Threshold
Year In Which
FRA Is Reached
$37,680 for Period
Before the Month That
Age 65 Is Attained
$1 for Each $3
over Threshold
Month In Which
FRA Is Reached
And Beyond
No Limi t
None
Age
Before Year In
Which FRA* Is
R each ed
*FRA = Full Age Retirement
Example #1: Mrs. Anita Knapp is age 64 and receives a benefit
amount of $975 per month ($11,700 per year). She will not reach
her Full Retirement Age until sometime in 2009. In addition to
receiving her Social Security retirement benefit, she also will earn
$22,000 in 2009.
2009 Earnings:
Minus earnings limit:
Difference:
$22,000
- 14,960
$7,840 divided by 2 = $3,920
$3,920 of Benefits Lost in 2009
Retirement Planning
56
Ms. Knapp will receive a reduced annual Social Security benefit of
$7,780 ($11,700 minus the $3,920 reduction) or $648.33 monthly.
She is not pleased with such a heavy penalty in 2009, but will not
suffer a loss of benefits in 2010, unless she earns over $37,680
before the month in which she reaches Full Retirement Age. Once
she reaches Full Retirement Age, she can earn an unlimited amount
without a reduction in her benefits.
Example #2: Mr. Jerry Attrick reaches Full Retirement Age on July
1, 2009. His annual earned income is $85,000, spread evenly
throughout the year. He also is receiving Social Security
Retirement benefits.
2009 Earnings Before reaching FRA:
$42,500
Minus earnings limit:
- 37,680
Difference:
$4,820 divided by 3 = $1,607
$1,607 of Benefits Lost in 2009
Starting July 1, 2009, Jerry Attrick will not suffer a loss of benefits due
to excess earned income, because he will have attained his Full
Retirement Age. However, remember that he must still pay Federal
and State income tax, as well as FICA tax, on his earned income.
Moreover, some of his benefits from Social Security may be subject to
income tax, as discussed in the next session.
Retirement Planning
57
Taxation of Benefits
Taxpayers who are receiving Social Security benefits may be
surprised to learn that some of their benefits may be subject to
federal income tax. The calculation is somewhat complex, and the
amount taxable depends on your Modified Adjusted Gross Income,
as discussed below.
The maximum amount of your benefits subject to taxation is 85%.
Up to 50% of benefits are taxable when income amounts exceed
$25,000 for a single taxpayer, $32,000 for married taxpayers filing
jointly and zero for married taxpayers filing separately. Up to 85%
of benefits are taxable when income is over $34,000 for a single
taxpayer and $44,000 for married taxpayers filing jointly.
The formula to determine whether a portion of your Social Security
benefit will be taxable is as follows:
A.
Determine Modified Adjusted Gross Income
1. Adjusted Gross Income
2. Deduction for exclusion for foreign
earned income taken for the year.
3. All Tax-exempt interest received or
accrued (e.g. municipal bond interest)
4. MODIFIED ADJUSTED GROSS INCOME
(Add items 1, 2 & 3)
Retirement Planning
58
0
$________
0
$________
0
$________
0
$________
B.
½ of Social Security Benefit Received
0
$________
C.
Line A4 plus line B
0
$________
D.
Base Amount
Single–$25,000
Married/jointly–$32,000
Married/separately–zero
0
$________
If the base amount (line D) EXCEEDS the Modified Adjusted Gross
Income (line A-4) PLUS one-half of the Social Security Benefit (line
B), your benefit is NOT taxable.
If the base amount (line D) is LESS THAN the Modified Adjusted
Gross Income (line A-4) PLUS one-half of the Social Security
Benefit (line B), your benefit IS taxable.
•
What Portion of the Benefit is Taxed?
The Lesser Of:
A.
0
$___________
One-half of the Social Security benefit (line B)
OR
B.
One-half of the excess of combined income (lines
A4 and B) less the base amount (line D).
0
0
0
0
($_________
+ $_________
) – $_________
= $___________
(line A4)
(line B)
(line D)
0
$___________
x .5
=
0
$___________
If your Modified Adjusted Gross Income exceeds $34,000 for a
single taxpayer and $44,000 for married taxpayers filing jointly, use
these figures for your base amount and use 85% for the amount
taxable.
Retirement Planning
59
Additional Benefits
•
Disability
The disability benefit provides security to an individual who has
become severely disabled before the age of 65. A person is
considered disabled if his/her impairment:
•
•
Prevents the individual from doing any substantial gainful
work.
•
Is expected to last, or has lasted, for at least one year or is
expected to result in death.
Survivor
Survivor benefits provide security to the family of a deceased
worker to help ease the financial burden which sometimes follows a
death.
Survivor benefits are based upon the earnings record of a
deceased worker and may be provided to:
•
A widow or widower
•
Unmarried children
•
Divorced or widowed children
•
Grandchildren
•
Great grandchildren
Limitations may apply for the above.
Retirement Planning
60
Applying for Social Security
You should apply for Social Security benefits three to six months
before you would like your benefits to begin and no later than the
last day of the month you are eligible. You can apply on-line at
https://s044a90.ssa.gov/apps6z/ISBA/main.html. The following
checklist may help you be better prepared, and save some time,
when you make your appointment:
•
Social Security Administration Telephone Number
•
Social Security card or record of your number
•
Copy of W-2 federal income tax forms for two years prior to
year of filing
•
Birth certificate or other evidence of age
•
Marriage certificate (only for spouse’s or survivor benefit)
Generally, original documents are required.
Retirement Planning
61
APPENDIX
Time Value of Money
The time value of money is the concept of giving up $1 today to
receive more than $1 tomorrow. Knowledge of this concept can aid
those planning for retirement in predicting potential retirement
income from investments. When you invest your money, whether in
a savings account, money market fund, CD or other investment
vehicle, you are expecting to get out more than you put in.
In order to make a clear comparison of your future income and
expenses, you have to determine your future income. As long as
you know the average rate of investment return and the number of
years your money will be invested, you can get a fairly accurate
picture of your future income.
Using the tables provided, you can determine:
1. Present value of a future amount,
2. Future value of a lump sum,
3. Future value of an equal stream of payments (an annuity),
4. Sinking Fund factors, an equal stream of payments (an
annuity) providing for a specific future amount,
5. Present value of an equal stream of payments (an annuity).
Retirement Planning
62
Present Value of a Future Amount
There are times you are fairly certain you will need a specific
amount of money at a specific future date. Using the Present Value
of One Dollar table, you can determine how much to invest today to
meet that future requirement. To help you grasp the different
concepts of time value of money, we will follow the needs and
wants of Mr. Cappi Chino.
Present Value of One Dollar
(What a Dollar Later is Worth Now )
Rate of Return (% )
Years
3%
5%
7%
8%
9%
10%
12%
14%
16%
18%
1
.9709
.9524
.9346
.9259
.9174
.9091
.8929
.8772
.8621
.8475
2
.9426
.9070
.8734
.8573
.8417
.8264
.7972
.7695
.7432
.7182
3
.9151
.8638
.8163
.7938
.7722
.7513
.7118
.6750
.6407
.6086
4
.8885
.8227
.7629
.7350
.7084
.6830
.6355
.5921
.5523
.5158
5
.8626
.7835
.7130
.6806
.6499
.6209
.5674
.5194
.4761
.4371
6
.8375
.7462
.6663
.6302
.5963
.5645
.5066
.4556
.4104
.3704
7
.8131
.7107
.6227
.5835
.5470
.5132
.4523
.3996
.3538
.3139
8
.7894
.6768
.5820
.5403
.5019
.4665
.4039
.3506
.3050
.2660
9
.7664
.6446
.5439
.5002
.4604
.4241
.3606
.3075
.2630
.2255
10
.7441
.6139
.5083
.4632
.4224
.3855
.3220
.2697
.2267
.1911
15
.6419
.4810
.3624
.3152
.2745
.2394
.1827
.1401
.1079
.0835
20
.5537
.3769
.2584
.2145
.1784
.1486
.1037
.0728
.0514
.0365
25
.4776
.2953
.1842
.1460
.1160
.0923
.0588
.0378
.0245
.0160
30
.4120
.2314
.1314
.0994
.0754
.0573
.0334
.0196
.0116
.0070
40
.3066
.1420
.0668
.0460
.0318
.0221
.0107
.0053
.0026
.0013
Retirement Planning
63
Let’s say that Mr. Cappi Chino determines that he will require
$100,000 when he reaches retirement in 10 years. Mr. Chino also
knows that he can get an average return of 10% on an investment
over the next 10 years. Using the Present Value of One Dollar
Table, find the column marked 10% and follow it down until you get
to the 10-year row. There you will find the factor .3855. To use the
table, multiply the factor .3855 by $100,000 to arrive at the present
value. The answer is $38,550. In other words, if you invested
$38,550 dollars today at 10% for 10 years, you will have $100,000
at the end of ten years.
Future Value of a Lump Sum
Suppose, Cappi has $7,000 in his savings that he can invest for ten
years at 10%. Using the Future Value of One Dollar Table, Cappi
can find out how much his $7,000 will be worth in 10 years. Find
the column marked 10% and follow it down to the year row 10.
There you will find the factor 2.5937. Multiply $7,000 by 2.5937 to
come up with $18,156. This is how much Cappi will have in ten
years.
Retirement Planning
64
Future Value of One Dollar
(What a Dollar Today is Worth Later)
Rate of Return (% )
Years
3%
5%
7%
8%
9%
10%
12%
14%
16%
18%
1
1.0300
1.0500
1.0700
1.0800
1.0900
1.1000
1.1200
1.1400
1.1600
1.1800
2
1.0609
1.1025
1.1449
1.1664
1.1881
1.2100
1.2544
1.2996
1.3456
1.3924
3
1.0927
1.1576
1.2250
1.2597
1.2950
1.3310
1.4049
1.4815
1.5609
1.6430
4
1.1255
1.2155
1.3108
1.3605
1.4116
1.4641
1.5735
1.6890
1.8106
1.9388
5
1.1593
1.2763
1.4026
1.4693
1.5386
1.6105
1.7623
1.9254
2.1003
2.2878
6
1.1941
1.3401
1.5007
1.5869
1.6771
1.7716
1.9738
2.1950
2.4364
2.6996
7
1.2299
1.4071
1.6058
1.7138
1.8280
1.9487
2.2107
2.5023
2.8262
3.1855
8
1.2668
1.4775
1.7182
1.8509
1.9926
2.1436
2.4760
2.8526
3.2784
3.7589
9
1.3048
1.5513
1.8385
1.9990
2.1719
2.3579
2.7731
3.2519
3.8030
4.4355
10
1.3439
1.6289
1.9672
2.1589
2.3674
2.5937
3.1058
3.7072
4.4114
5.2338
15
1.5580
2.0789
2.7590
3.1722
3.6425
4.1772
5.4736
7.1379
9.2655
11.974
20
1.8061
2.6533
3.8697
4.6610
5.6044
6.7275
9.6463
13.743
19.461
27.393
25
2.0938
3.3864
5.4274
6.8485
8.6231
10.835
17.000
26.462
40.874
62.669
30
2.4273
4.3219
7.6123
10.063
13.268
17.449
29.960
50.950
85.850
143.37
40
3.2620
7.0400
14.974
21.725
31.409
45.259
93.051
188.88
378.72
750.38
Retirement Planning
65
Future Value of an Annuity
Cappi is also investing in an IRA and puts $4,000 away each year
(stream of payments) in his account. His IRA presently earns a
yearly average of 12%. Cappi can find out how much his yearly
investment (annuity) will be worth in 10 years by using the Future
Value of an Annuity Table. Find the column marked 12% and follow
it down to the 10-year row. There he will find 17.549. Multiply
Cappi’s yearly investment of $4,000 by 17.549 to get $70,196. This
is what Cappi’s IRA will be worth in 10 years.
Future Value of an Annuity
(Annual Savings: One Dollar a Year)
Rate of Return (%)
Years
3%
5%
7%
8%
9%
10%
12%
14%
16%
18%
1
1.0000
1.0000
1.0000
1.0000
1.0000
1.0000
1.0000
1.0000
1.0000
1.0000
2
2.0300
2.0500
2.0700
2.0800
2.0900
2.1000
2.1200
2.1400
2.1600
2.1800
3
3.0909
3.1525
3.2149
3.2464
3.2781
3.3100
3.3744
3.4396
3.5056
3.5724
4
4.1836
4.3101
4.4399
4.5061
4.5731
4.6410
4.7793
4.9211
5.0665
5.2154
5
5.3091
5.5256
5.7507
5.8666
5.9847
6.1051
6.3528
6.6101
6.8771
7.1542
6
6.4684
6.8019
7.1533
7.3359
7.5233
7.7156
8.1152
8.5355
8.9775
9.4420
7
7.6625
8.1420
8.6540
8.9228
9.2004
9.4872
10.089
10.730
11.414
12.142
8
8.8923
9.5491
10.260
10.637
11.028
11.436
12.300
13.233
14.240
15.327
9
10.159
11.027
11.978
12.483
12.488
13.579
14.776
16.085
17.519
19.086
10
11.464
12.578
13.816
14.487
15.193
15.937
17.549
19.337
21.321
23.521
15
18.599
21.579
25.129
27.152
29.361
31.772
37.280
43.842
51.660
60.965
20
26.870
33.066
40.995
45.762
51.160
57.275
72.052
91.025
115.38
146.63
25
36.459
47.727
63.249
73.106
84.701
98.347
133.33
181.87
249.21
342.60
30
47.575
66.439
94.461
113.28
136.31
164.49
241.33
356.79
530.31
790.95
40
75.401
120.80
199.64
259.06
337.88
442.59
767.09
1342.0
2360.8
4163.2
Retirement Planning
66
Present Value of an Annuity
Mr. Chino thinks all this is great, but what he really needs to know is
how much he will need at retirement in order to receive an annual
gross income of $20,000. By using the Present Value of an Annuity
Table on the next page, Cappi can determine the exact amount
needed.
Let’s say that Cappi knows he will be able to get 8% guaranteed on
his money at retirement. The $20,000 per year includes using the
interest plus a portion of the principal. Cappi must decide how long
he wants to be able to receive this income. Cappi decides that
since he will retire at 65, he would like the payments to last 15
years.
Using the table, find the 8% column and follow it down to the year
15 row. There you will find the factor of 8.5595. Multiply 8.5595 by
$20,000 to arrive at the amount needed at retirement. Cappi needs
$171,190 at the time he retires in order to receive $20,000 per year
for 15 years.
Retirement Planning
67
Present Value of an Annuity
(Withdraw al of One Dollar a Year)
Rate of Return (% )
Years
3%
5%
7%
8%
9%
10%
12%
14%
16%
18%
1
0.9709
0.9524
0.9346
0.9259
0.9174
0.9091
0.8929
0.8772
0.8621
0.8475
2
1.9135
1.8594
1.8080
1.7833
1.7591
1.7355
1.6901
1.6467
1.6052
1.5656
3
2.8286
2.7232
2.6243
2.5771
2.5313
2.4869
2.4018
2.3216
2.2459
2.1743
4
3.7171
3.5460
3.3872
3.3121
3.2397
3.1699
3.0373
2.9137
2.7982
2.6901
5
4.5797
4.3295
4.1002
3.9927
3.8897
3.7908
3.6048
3.4331
3.2743
3.1272
6
5.4172
5.0757
4.7665
4.6229
4.4859
4.3553
4.1114
3.8887
3.6847
3.4976
7
6.2303
5.7864
5.3893
5.2064
5.0330
4.8684
4.5638
4.2883
4.0386
3.8115
8
7.0197
6.4632
5.9713
5.7466
5.5348
5.3349
4.9676
4.6389
4.3436
4.0776
9
7.7861
7.1078
6.5152
6.2469
5.9952
5.7590
5.3282
4.9464
4.6065
4.3030
10
8.5302
7.7217
7.0236
6.7101
6.4177
6.1446
5.6502
5.2161
4.8332
4.4941
15
11.9379 10.3797
9.1079
8.5595
8.0607
7.6061
6.8109
6.1422
5.5755
5.0916
20
14.8775 12.4622 10.5940
9.8181
9.1285
8.5136
7.4694
6.6231
5.9288
5.3527
25
17.4131 14.0939 11.6536 10.6748
9.8226
9.0770
7.8431
6.8729
6.0971
5.4669
30
19.6004 15.3725 12.4090 11.2578 10.2737
9.4269
8.0552
7.0027
6.1772
5.5168
40
23.1148
9.7791
8.2438
7.1050
6.2335
5.5482
Retirement Planning
68
17.1591 13.3317 11.9246 10.7574