LifeFocus.com T. Young info@lifefocus.com www.LifeFocus.com
Nearing Retirement and Retirement
March 28, 2010
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Table of Contents The Transition into Retirement ..........................................................................................................................11 What is it? ................................................................................................................................................ 11 Early retirement ........................................................................................................................................11 Delayed retirement ...................................................................................................................................11 Retirement ........................................................................................................................................................ 12 What is it? ................................................................................................................................................ 12 Retirement earnings and Social Security ................................................................................................. 12 Required minimum distributions (the age 70½ rule) ................................................................................ 13 Social Security .................................................................................................................................................. 14 What is it? ................................................................................................................................................ 14 How does it work? ....................................................................................................................................14 Social Security benefits ............................................................................................................................14 How much will you receive from Social Security? ....................................................................................16 Getting the most from the Social Security system ................................................................................... 17 Distributions from Employer-Sponsored Retirement Plans ...............................................................................19 Introduction .............................................................................................................................................. 19 When can you take distributions from your retirement plan? ................................................................... 19 Distribution options while still employed by the plan employer ("in-service" distributions) .......................20 Pension plans--annuities as a standard form of benefit ........................................................................... 21 In general: distribution options upon separation from service, retirement, or disability ............................22 Distributions from Traditional IRAs: Between Ages 59½ and 70½ ................................................................... 24 What is an IRA distribution? .....................................................................................................................24 IRA distributions subject to income tax .................................................................................................... 24 Premature distribution tax does not apply ................................................................................................24 Withholding from IRA distributions ........................................................................................................... 24 Rollovers .................................................................................................................................................. 24 Other types of distributions ...................................................................................................................... 26
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Should you withdraw money from your IRA between ages 59½ and 70½? .............................................27 Required Minimum Distributions ....................................................................................................................... 28 What are required minimum distributions (RMDs)? ................................................................................. 28 Which retirement savings vehicles are subject to the RMD rules? .......................................................... 28 When must RMDs be taken? ................................................................................................................... 28 How are RMDs calculated? ......................................................................................................................29 Should you delay your first RMD? ............................................................................................................30 What if you fail to take RMDs as required? ..............................................................................................30 Can you satisfy the RMD rules with the purchase of an annuity contract? .............................................. 31 Tax considerations ................................................................................................................................... 31 Inherited IRAs and retirement plans .........................................................................................................31 Special RMD rules for 2009 ..................................................................................................................... 32 Annuity Distributions ......................................................................................................................................... 33 What are annuity distributions? ................................................................................................................33 How are annuity distributions made? ....................................................................................................... 33 How are your annuity payouts computed if you elect to annuitize? ......................................................... 34 Who are the parties to an annuity contract? ............................................................................................ 34 How are annuity benefits paid out? ..........................................................................................................35 When are annuity benefits paid out? ........................................................................................................35 What payout methods are available? .......................................................................................................36 Options after death .................................................................................................................................. 37 What is the tax treatment of annuity payouts in the annuitization phase? ............................................... 38 Beneficiary Designations for Traditional IRAs and Retirement Plans ............................................................... 39 What is it? ................................................................................................................................................ 39 The law may limit your choices ................................................................................................................ 39 Your choice of beneficiary usually will not affect required minimum distributions during your lifetime .... 40 Your choice of beneficiary will affect required distributions after your death ........................................... 40 Other considerations when choosing beneficiaries ..................................................................................41 Designated beneficiaries vs. named beneficiaries ................................................................................... 41
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Primary and secondary beneficiaries ....................................................................................................... 42 Having multiple beneficiaries ................................................................................................................... 42 When do you have to choose your beneficiaries? ................................................................................... 42 Paying death taxes on IRA and plan benefits .......................................................................................... 43 Your options when choosing your beneficiaries .......................................................................................43 Investment Planning throughout Retirement .....................................................................................................44 Introduction .............................................................................................................................................. 44 Choosing a sustainable withdrawal rate ...................................................................................................44 Withdrawing first from taxable, tax-deferred, or tax-free accounts ...........................................................45 Balancing safety and growth .................................................................................................................... 46 Healthcare in Retirement .................................................................................................................................. 48 What health care benefits are available in retirement? ............................................................................ 48 Medicare .................................................................................................................................................. 48 Medigap ................................................................................................................................................... 49 Medicaid ...................................................................................................................................................49 Military benefits ........................................................................................................................................ 51 Choosing a continuing care retirement community .................................................................................. 51 Choosing a nursing home ........................................................................................................................ 51 Personal Residence Issues in Retirement ........................................................................................................ 52 What is it? ................................................................................................................................................ 52 Getting the most out of your current home ...............................................................................................52 Other residence options ........................................................................................................................... 52 Choosing a continuing care retirement community .................................................................................. 52 Choosing and paying for a nursing home ................................................................................................ 52 How Earnings Affect Social Security .................................................................................................................54 Retirement Planning: The Basics ......................................................................................................................55 Determine your retirement income needs ................................................................................................ 55 Calculate the gap ..................................................................................................................................... 55 Figure out how much you'll need to save .................................................................................................55
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Build your retirement fund: Save, save, save ...........................................................................................56 Understand your investment options ........................................................................................................56 Use the right savings tools ....................................................................................................................... 56 Estimating Your Retirement Income Needs ...................................................................................................... 57 Use your current income as a starting point .............................................................................................57 Project your retirement expenses ............................................................................................................ 57 Decide when you'll retire .......................................................................................................................... 58 Estimate your life expectancy .................................................................................................................. 58 Identify your sources of retirement income .............................................................................................. 58 Make up any income shortfall .................................................................................................................. 58 Evaluating an Early Retirement Offer ................................................................................................................60 What's the severance package? .............................................................................................................. 60 How does all of this affect your pension? .................................................................................................60 Does the offer include health insurance? .................................................................................................60 What other benefits are available? ...........................................................................................................60 Can you afford to retire early? ..................................................................................................................61 What if you can't afford to retire? Finding a new job ............................................................................... 61 What will happen if you say no? ...............................................................................................................61 Taking Advantage of Employer-Sponsored Retirement Plans ..........................................................................62 Understand your employer-sponsored plan ............................................................................................. 62 Contribute as much as possible ............................................................................................................... 62 Capture the full employer match .............................................................................................................. 63 Evaluate your investment choices carefully ............................................................................................. 63 Know your options when you leave your employer ..................................................................................63 Understanding IRAs .......................................................................................................................................... 65 What types of IRAs are available? ........................................................................................................... 65 Learn the rules for traditional IRAs ...........................................................................................................65 Learn the rules for Roth IRAs ...................................................................................................................66 Choose the right IRA for you ....................................................................................................................67
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Know your options for transferring your funds ......................................................................................... 67 Annuities and Retirement Planning ...................................................................................................................68 Get the lay of the land .............................................................................................................................. 68 Understand your payout options .............................................................................................................. 68 Consider the pros and cons ..................................................................................................................... 68 Choose the right type of annuity .............................................................................................................. 69 Shop around ............................................................................................................................................ 70 Choosing a Beneficiary for Your IRA or 401(k) ................................................................................................. 71 Paying income tax on most retirement distributions .................................................................................71 Naming or changing beneficiaries ............................................................................................................71 Designating primary and secondary beneficiaries ................................................................................... 71 Having multiple beneficiaries ................................................................................................................... 71 Avoiding gaps or naming your estate as a beneficiary .............................................................................72 Naming your spouse as a beneficiary ...................................................................................................... 72 Naming other individuals as beneficiaries ................................................................................................72 Naming a trust as a beneficiary ................................................................................................................73 Naming a charity as a beneficiary ............................................................................................................ 73 Your Home as a Source of Dollars in Retirement ............................................................................................. 74 How do you tap your home equity? ..........................................................................................................74 Trading down can give you increased income ......................................................................................... 74 Trading down can reduce your housing costs ..........................................................................................74 But trading down may have disadvantages ............................................................................................. 74 A reverse mortgage can also give you increased income ........................................................................75 A reverse mortgage lets you keep your present home for life ..................................................................75 But a reverse mortgage is not without drawbacks ................................................................................... 75 Understanding Defined Benefit Plans ............................................................................................................... 77 What are defined benefit plans? .............................................................................................................. 77 How do defined benefit plans work? ........................................................................................................ 77 How are retirement benefits calculated? .................................................................................................77
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How will retirement benefits be paid? ...................................................................................................... 77 What are some advantages offered by defined benefit plans? ................................................................ 78 How do defined benefit plans differ from defined contribution plans? ......................................................78 What are cash balance plans? .................................................................................................................78 What you should do now .........................................................................................................................78 Closing a Retirement Income Gap .................................................................................................................... 80 Delay retirement: 65 is just a number ...................................................................................................... 80 Spend less, save more .............................................................................................................................80 Reallocate your assets: consider investing more aggressively ................................................................81 Accept reality: lower your standard of living .............................................................................................81 Understanding Social Security .......................................................................................................................... 82 How does Social Security work? ..............................................................................................................82 Social Security eligibility ...........................................................................................................................82 Your retirement benefits ...........................................................................................................................82 Disability benefits ..................................................................................................................................... 83 Family benefits ......................................................................................................................................... 83 Survivor's benefits ....................................................................................................................................83 Applying for Social Security benefits ........................................................................................................83 Social Security Retirement Benefits ..................................................................................................................85 How do you qualify for retirement benefits? .............................................................................................85 How much will your retirement benefit be? .............................................................................................. 85 Retiring at full retirement age ................................................................................................................... 85 Retiring early will reduce your benefit ...................................................................................................... 86 Delaying retirement will increase your benefit ..........................................................................................86 Working may affect your retirement benefit ............................................................................................. 86 Retirement benefits for qualified family members .................................................................................... 86 How do you sign up for Social Security? ..................................................................................................87 Tax-Deferred Annuities: Are They Right for You? .............................................................................................88 Five questions to consider ....................................................................................................................... 88
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Annuity Basics .................................................................................................................................................. 89 Four parties to an annuity contract ...........................................................................................................89 Two distinct phases to an annuity ............................................................................................................ 89 When is an annuity appropriate? ............................................................................................................. 90 Health Insurance in Retirement .........................................................................................................................91 Retirement--your changing health insurance needs ................................................................................ 91 More about Medicare ............................................................................................................................... 91 What is Medigap? .................................................................................................................................... 91 Thinking about the future--long-term care insurance and Medicaid .........................................................92 Insurance Needs in Retirement .........................................................................................................................93 Stay well with good health insurance ....................................................................................................... 93 Don't overlook long-term care insurance ................................................................................................. 93 Weigh your need for life insurance ...........................................................................................................94 Take a look at your auto and homeowners policies ................................................................................. 94 Medicare ........................................................................................................................................................... 95 What does Medicare cover? .................................................................................................................... 95 Medicare Part A (hospital insurance) ....................................................................................................... 95 Medicare Part B (medical insurance) ....................................................................................................... 95 Medicare Part C (Medicare Advantage) ...................................................................................................95 Medicare Part D (prescription drug coverage) ......................................................................................... 95 What is not covered by Medicare Parts A and B? ....................................................................................95 Are you eligible for Medicare? ..................................................................................................................96 How much does Medicare cost? .............................................................................................................. 96 Who administers the Medicare program? ................................................................................................ 97 How do you sign up for Medicare? ...........................................................................................................97 Buying Supplemental Health Insurance: Medigap ............................................................................................ 98 When's the best time to buy a Medigap policy? .......................................................................................98 What's covered in a Medigap policy? .......................................................................................................98 Are all Medigap policies created equal? .................................................................................................. 98
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Does everyone need Medigap? ............................................................................................................... 98 Understanding Long-Term Care Insurance .......................................................................................................100 What is long-term care? ........................................................................................................................... 100 Why you need long-term care insurance (LTCI) ...................................................................................... 100 How does LTCI work? ..............................................................................................................................100 Comparing LTCI policies ..........................................................................................................................100 What's it going to cost? ............................................................................................................................ 101 Life Insurance at Various Life Stages ............................................................................................................... 102 Footloose and fancy-free ......................................................................................................................... 102 Going to the chapel .................................................................................................................................. 102 Your growing family ..................................................................................................................................102 Moving up the ladder ................................................................................................................................103 Single again ............................................................................................................................................. 103 Your retirement years ...............................................................................................................................103 I'm having a hard time selling my home. Should I take out a reverse mortgage? .............................................104 Should I retire now at age 62 and collect Social Security benefits? ..................................................................105 What happens if I start collecting Social Security after full retirement age? ..................................................... 106 How do I enroll in Medicare? .............................................................................................................................107 Will my children receive money from Social Security when I die? .................................................................... 108 If I'm covered by Medicare, should I have additional health insurance? ...........................................................109 Are my Social Security benefits subject to income tax? ....................................................................................110 I'm traveling to Europe and won't need my car. Can I get my auto insurance suspended to save money? ..... 111 I'm confused--is an annuity an investment vehicle or an insurance policy? ......................................................112 I can choose a single life annuity for my pension or a joint and survivor annuity. Which is better? ..................113 Will Medicare alone be enough to cover my health-care needs in retirement? ................................................ 114 What happens if my Medicare HMO goes out of business? ............................................................................. 115 I'm planning on living in Europe for several months. Do I need special health insurance? .............................. 116 What is an annuity? .......................................................................................................................................... 117 What is Medigap? ............................................................................................................................................. 118
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Should I accept my employer's early retirement offer? ..................................................................................... 120 What if my income during retirement won't be enough to meet my retirement expenses? ...............................121 What are required minimum distributions and how are they calculated? ..........................................................122 I'm retired now and own my home outright. How can I use it to raise money without selling it? .......................123
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The Transition into Retirement What is it? The transition into retirement is when you are changing from your full-time working years to your retirement years. If retirement is approaching, you may have to make numerous decisions. Can you afford to retire? What about early retirement--is it a possibility? If you want to continue working, are there other considerations? Your first step is to review your sources of retirement income and estimate your retirement needs. See our topic discussion, Determining Retirement Income Needs: Preretirement. The closer you are to retirement, the more accurate a picture you should be able to get. Even more, you should consider the timing of your retirement.
Early retirement Your company is offering an early retirement package, and you're considering taking it. Maybe you've always dreamed of retiring early and enjoying yourself while you're still young, and now you want to make that dream a reality. Whatever your situation, you need to understand the consequences of retiring early. If you're evaluating an early retirement offer from your employer, you should understand the basic components of early retirement offers and how they affect you. Even if there isn't a special offer on the table, you've got to understand the downside of early retirement, specifically with respect to Social Security benefits. See our topic discussion, Early Retirement Considerations.
Delayed retirement Delaying retirement is usually considered for one of two reasons. Either you can't afford to retire or you enjoy working too much to stop. Regardless of why you're considering the delay, the consequences are the same. Aside from the obvious benefits of delaying retirement (you can save more, you don't have to start consuming retirement funds, etc.), you should also consider the effect that your decision will have on the Social Security benefits that will be available to you and how the timing of your retirement could affect your IRAs and employer-sponsored retirement plans. See our topic discussion, Delayed Retirement Considerations.
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Retirement What is it? You have finally reached your long-awaited retirement. If you have saved and planned properly, this will be a time of financial independence for you. There are some other considerations that you should keep in mind when you retire. If you choose to work after retirement, you should be aware of the effect it will have on your Social Security benefits. You should also keep abreast of the required minimum distribution rules and their effect on your retirement investments.
Retirement earnings and Social Security Reduction of Social Security benefits based on earnings If you need extra income during retirement or if you find that a retiree's life is boring, you may want to consider working. However, be aware of the effect that working during retirement has on your Social Security benefits. The Social Security Administration gives you the opportunity to work and receive retirement benefits so long as your earnings do not exceed the annual earnings limit, a limit that applies only if you are under normal retirement age. After you reach your normal retirement age, you can earn as much as you want without affecting your Social Security retirement benefit. In 2010 (and 2009), you can earn up to $14,160 if you have not yet reached normal retirement age. If you earn more, $1 in benefits will be withheld for every $2 you earn over that amount. However, a special limit applies during the year in which you reach normal retirement age (up to, but not including, the month you reach normal retirement age). In 2010 (and 2009), this limit is $37,680. If you earn more, $1 in benefits will be withheld for every $3 you earn over that amount. Evaluate pros and cons of exceeding earnings limit It might seem like a good idea to always keep your earnings below the Social Security Administration's limits. However, there may be times when you might want to consider taking a job where your earnings exceed those limits. While you are subject to withholding for your higher earnings, your overall income may be greater because of those same higher earnings. Furthermore, because you pay Social Security taxes when you work, Social Security reconfigures your benefits to take into account the extra earnings. Example(s): Phillip, age 63, receives $1,000 in monthly Social Security benefits for a total of $12,000 per year. In 2010, Phillip takes a job that pays $26,160 per year, $12,000 over the annual earnings limit of $14,160. Social Security withholds $1 for every $2 that Phillip earns over the limit or $6,000. Phillip still receives $6,000 from Social Security ($12,000 - $6,000 = $6,000). He has a total income of $32,160 ($26,160 in earnings + $6,000 in Social Security). Although he has lower monthly Social Security benefits, Phillip's overall income is greater than it would be without the job because of his higher earnings. Tip: If you earn other income during the year, then you might have to pay income tax on part of your Social Security benefits if your total income exceeds a certain base amount. Other facts regarding Social Security • There is a special rule regarding the annual earnings limit during your first year of retirement. If you retire midyear, you may find that you have already earned more than the annual earnings limit. The rule allows you to receive full Social Security benefits for any whole month that you are retired despite the fact that you exceed the annual earnings limit. • You will be subject to penalties if you fail to report retirement earnings. •
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For a more in-depth discussion on working after retirement, see our separate topic discussion, Planning for Earned Income in Retirement.
Required minimum distributions (the age 70½ rule) If you are retired, you might still be enjoying the tax-deferred status of your investments held in retirement plans. However, if you have a traditional IRA, you are required to begin taking required minimum distributions for the year in which you reach age 70½. If you fail to take the minimum distribution, you are subject to a 50 percent penalty on the amount that should have been distributed. Required minimum distributions generally must be made from employer-sponsored retirement plans after age 70½. However, if you retire from your employer after age 70½, you may be able to delay taking required minimum distributions from that employer's plan until after you've retired. Caution: The Worker, Retiree, and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year.
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Social Security What is it? Social Security is a federal system of programs designed to protect individuals and families against economic hardship. Most Americans work in occupations covered by the Social Security system, and they will at some point in their lives receive Social Security benefits. The system is administered by the Social Security Administration and financed mainly by Social Security tax (FICA) withholding on wages and by taxes on self-employment income.
How does it work? Social Security is a compulsory system Social Security is a compulsory system. Employers, employees, and self-employed individuals are required to participate and pay taxes that finance Social Security benefits. As an employee, you pay a Social Security tax of 6.2 percent of your pay (matched by your employer) each pay period and you pay a Medicare tax of 1.45 percent of your pay (matched by your employer). If you are self-employed, you pay a 12.4 percent self-employment tax on your earnings to finance Social Security programs and you pay a 2.9 percent tax to finance Medicare. Tip: The Social Security tax on your earnings applies only to earnings under the maximum earnings limit (currently $106,800). No limit applies, however, to the Medicare tax on your earnings. Your earnings are tracked by the Social Security Administration Your employer reports your annual Social Security earnings to the Social Security Administration. If you are self-employed, the IRS reports your earnings. They are compiled on a record known as a Social Security earnings record, which is identified by your nine-digit Social Security number. This earnings record is eventually used to calculate the amount of your Social Security benefit. You receive benefits after meeting certain eligibility criteria To be eligible to receive Social Security benefits, you must be insured under the system. To become insured, you have to work for a certain amount of time in an occupation covered under Social Security or be the spouse, ex-spouse, widow or widower, or parent of someone who has. You also have to meet the eligibility requirements specific to the benefit.
Social Security benefits Retirement benefits Providing retirement benefits was a key provision of the Social Security Act of 1935. Older Americans were especially financially vulnerable during the Great Depression, and Social Security was enacted partly to provide them with some continuing income after retirement. Today, although the scope of the program has been widened through amendments to include survivor, disability, and medical insurance benefits, Social Security remains synonymous with retirement benefits. When planning for retirement, you should neither overlook nor overstate the value of your Social Security benefits. Despite the anxiety some baby boomers feel over the future of Social Security, funds in the trust that pays benefits will rapidly increase in the short term (10 to 15 years). Predicting the future of Social Security is difficult, however, because to keep the system solvent, some changes must be made to it. The younger and wealthier you are, the more likely that these changes will affect you. But even if you retire in the next few years, remember that Social Security was never meant to be the sole source of income for retirees. As President Dwight D. Eisenhower said: "The system is not intended as a substitute for private savings, pension plans, and insurance
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protection. It is, rather, intended as the foundation upon which these other forms of protection can be soundly built." Normal retirement age is the age at which you can retire and receive full (unreduced) Social Security benefits. However, many people choose to receive Social Security retirement benefits early at age 62 (early retirement age). You can also retire and begin receiving benefits after normal retirement age. If so, you are considered to be electing delayed retirement benefits. Electing early retirement benefits means that you will receive a reduced benefit, while electing delayed retirement benefits means that you will receive a delayed retirement credit and thus a higher benefit. Disability benefits Most people don't expect to become disabled and are unprepared when they are unable to work due to illness or injury. The fact is that you are much more likely to become disabled than to die during your earning years. Because eligibility standards are strict, Social Security disability benefits may not offer the comprehensive protection you need. However, these benefits can help protect you and your family from financial devastation when you can't work for a year or more. In general, to receive Social Security disability benefits, you must be unable to engage in any substantial gainful activity by reason of a medically determinable physical or mental impairment that can be expected to last for at least 12 months or result in your death. Benefits for family members Some of your family members may be eligible for benefits based on your earnings record if you are receiving Social Security retirement or disability benefits. Benefits are generally paid to family members who relied upon your income for support. Benefits paid to family members are based upon your primary insurance amount (PIA) and are paid in addition to the benefit you receive. The following chart outlines who these family members might be, what benefits they may be entitled to receive, and the basic conditions they must meet to be eligible for those benefits: Beneficiary
Minimum Age
Insured Status
Conditions
Amount of Benefit
Spouse of retired worker
62 or earlier if caring for a dependent child (under 16 or disabled) who is eligible for child's benefits
Worker must be fully insured. Spouse does not have to be insured
Worker must be receiving retirement benefits before spouse is eligible
50% of the worker's PIA, subject to early retirement reduction, if applicable
Divorced spouse of worker
62 or earlier if caring for a dependent child (under 16 or disabled) who is eligible for child's benefits
Marriage must have lasted at least ten years before final divorce date. Remarriage may affect benefit
Worker does not have to be receiving retirement benefits but must be 62 or older
Usually 50% of the worker's PIA, subject to early retirement reduction, if applicable
Child of retired worker
No minimum age but must be under 18 or under 19 (in school). Disabled child can be over 18 if disability began before 22
Worker must be fully Worker must be insured receiving retirement benefits before child is eligible. Child in school must be a full-time student and unmarried
Each child receives 50% of worker's PIA. Family maximum, however, may limit this benefit
Tip: Family benefits end when the retired worker dies. However, at that time, family members may be eligible to receive Social Security survivor's benefits.
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Survivor's benefits If you die and you were currently or fully insured under Social Security, your surviving spouse, ex-spouse, children, or dependent parents may be eligible to receive Social Security benefits based on your earnings record. The following chart outlines those who may be eligible for benefits and under what conditions. Beneficiary
Age
Insured Status of Worker Conditions
Spouse of worker (no dependent child)
60 or over (or if disabled, 50 or over)
Fully insured
Must have been married to the worker for nine months before worker died (unless death was accidental or military-related) or be parent of worker's natural or adopted child
Spouse of worker with dependent child
Any age
Fully or currently insured
Must be unmarried and not already eligible for widow(er)'s benefits
Divorced spouse of worker Age 60 or over (if (no dependent child) disabled, age 50-59)
Fully insured
Must have been married to the worker for at least ten years
Divorced spouse of worker Any age with dependent child
Fully or currently insured
Must be unmarried and not already eligible for widow(ER)'s benefits as a divorced spouse
Dependent child of worker
Age 18 or under, or 19 if full-time elementary or secondary school student. If child is disabled, can be over 18 if disability began before age 22
Fully or currently insured
Must be unmarried
Dependent parent(s) of worker
Age 62 or above
Fully insured
50% or more of the parent's support must have been furnished by worker
How much will you receive from Social Security? The amount of Social Security benefit you receive is based on your Social Security earnings record. Your earnings are averaged according to a formula and then indexed. The resulting figure is called your primary insurance amount (PIA). Once your PIA has been calculated, all your benefits (and those of your family members who are dependent upon your Social Security record) will be based on this figure. Your PIA is the maximum benefit that you could receive once you become eligible. Your maximum benefit may be payable if: • You retire at normal retirement age • Your widow or widower is normal retirement age • You are disabled
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In other circumstances, the benefits that you receive will be a certain percentage of your maximum benefit. For example, if you retire early, your maximum benefit will be reduced by a certain percentage for each month of early retirement. If you or your family members are eligible for reduced benefits, the reduction will be expressed as a percentage of your PIA. Example(s): Mr. Jones retired at his normal retirement age after working for many years. His PIA is determined to be $1,176. He will receive the maximum retirement benefit (100 percent of his PIA) so his monthly benefit check will be $1,176. His wife also plans on retiring when she reaches her normal retirement age. Since her own PIA is less, she decides to base her retirement income on her husband's PIA. She is entitled to 50 percent of his PIA, so when she retires, her monthly benefit check will be $588. The following chart summarizes the relationship between your PIA and your eventual benefits: Benefit
Requirements
Amount
Retirement
Normal retirement age
100% of PIA
62 or above, but less than normal retirement age
PIA reduced by 5/9 of 1% for each month under age 65, and by 5/12 of 1% thereafter
Disability
None
100% of PIA
Spouse's Benefit
Caring for dependent child
50% of PIA
Normal retirement age
50% of PIA
Age 62 or above, but less than normal retirement age
50% of PIA further reduced by 25/36 of 1% for each of the first 36 months under normal retirement age
Child of retired or disabled worker
50% of PIA
Child of deceased worker
75% of PIA
Mother's or Father's Benefit
Child must be under 16 or disabled
75% of PIA
Widow(er)'s Benefit
Normal retirement age
100% of PIA
Age 60 or above, but less than normal retirement age
Reduced; 71½% of PIA or more
Child's Benefit
Disabled Widow(er)'s Benefit Starting at age 50-60
71½% of PIA
Parent's Benefit
82½% of PIA; 75% of PIA (each)
One dependent parent; two dependent parents
Getting the most from the Social Security system You should do several things to ensure that you receive the most protection from Social Security that the system offers. Check your Social Security earnings record You should periodically (every couple of years) check your Social Security earnings record to make sure that your earnings have been properly credited. To do this, you can request a Social Security Statementfrom the Social Security Administration. At your request, this statement will be mailed to you. You can review it to check that all your annual earnings from employment or self-employment have been properly credited to your account. This statement will also estimate the amount of Social Security benefits you will be eligible to receive in the future (based on your actual earnings and projections of future earnings). You can request this statement through your
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local Social Security Administration office or by calling (800) 772-1213. You may also request one on-line through the Social Security website ( www.ssa.gov). Optimize your Social Security benefits To get the most out of Social Security, you have to make some decisions. Deciding when to retire and begin receiving benefits is important because the age at which you elect to begin receiving benefits can greatly affect the amount of monthly benefit you receive and your overall lifetime benefit. You'll also need to decide whether you want to work after you begin receiving benefits, and if so, determine how your wages will affect your benefit. Finally, if you are a business owner or a self-employed individual, you need to consider how you can minimize your Social Security payroll taxes.
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Distributions from Employer-Sponsored Retirement Plans Introduction A withdrawal of money from an employer-sponsored retirement plan is generally referred to as a distribution. When you have money in a plan maintained by your current or former employer, you need to be aware of your distribution options for several reasons. First, not every option may be available to you. Your distribution options may differ depending on the type of employer-sponsored plan, the specific provisions of the plan, the type of contributions (employer, employee, pre-tax, Roth, after-tax, etc.), and whether you are still working for the employer at the time of the distribution. Second, your choices may result in different tax consequences for you--one choice may lead to immediate taxation or taxation at a higher rate, while another choice may allow continued tax-deferred growth of your retirement money. Third, your payout choices may determine how long your retirement plan funds last. When dealing with retirement money, you need to be extra careful about the amount and timing of your distributions. One or more bad decisions now could have a significant impact later in your retirement. Finally, different choices may result in different payouts and tax consequences for your beneficiaries. This can be an important concern if providing for your beneficiaries and minimizing their taxes is one of your main goals. Caution: The tax laws governing distributions from employer-sponsored retirement plans are complex. Consult a tax professional for guidance. Caution: Special rules apply to qualified individuals impacted by certain presidentially-declared national disasters.
When can you take distributions from your retirement plan? In general, you can take distributions from your retirement plan upon some specified events. For example, you may be entitled to take distributions when you retire or when you reach the plan's normal retirement age. You may also be entitled to take a distribution upon job termination, disability, plan termination, or financial hardship. Depending upon the type of retirement plan and the provisions of the plan, you may be eligible to receive certain distributions while you are still working for your employer as well as after your employment has ended. However, some plans may only allow distributions after your employment has ended. Caution: Distributions made prior to age 59½ may be subject to the federal 10 percent premature distribution tax unless an exception applies. When you must start taking distributions--required minimum distributions You cannot leave your money in an employer-sponsored retirement plan indefinitely. The federal government requires you to take annual distributions ( required minimum distributions, or RMDs) over your life expectancy. Your required beginning date for taking your first distribution from a qualified retirement plan is usually April 1 of the calendar year following the calendar year in which you (the plan participant) reach age 70½. Caution: The Worker, Retiree, and Employer Recovery Act of 2008 waives required minimum distributions from IRAs and employer defined contribution (but not defined benefit) plans for the 2009 calendar year.
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There is one situation where your required beginning date can be later than described above. If you work past age 70½, your required beginning date as a plan participant under the plan of your current employer can be as late as April 1 of the calendar year following the calendar year in which you retire when both of the following apply: • Your employer's retirement plan allows you to delay your required beginning date in this manner • You (the plan participant) own 5 percent or less of the employer's company Example(s): You own more than 5 percent of your employer's company and you are still working at the company. Your 70th birthday is on December 2, 2009. This means that you will reach age 70½ in 2010. So, you must take your first RMD from your retirement plan by April 1, 2011--even if you are still working for the company at that time. Example(s): You have money in two plans--one with your current employer and one with a former employer. You own less than 5 percent of each company. Your 70th birthday is on December 2, 2009 (and you will reach 70½ on June 2, 2010), but you'll keep working until you turn 73 on December 2, 2012. You can delay your first RMD from your current employer's plan until April 1, 2013--the April 1 following the calendar year in which you retire. However, as to your former employer's plan, you must take your first distribution by the April 1 following the calendar year you reached age 70½--April 1, 2011. Regardless of your required beginning date, subsequent distributions are due on or by December 31 of each calendar year. Caution: This means that if you delay your first required distribution (as described above), you will have to take both your first and second required distributions in the same calendar year. When your plan must make distributions available Although you may decide to postpone distributions from your retirement plan until age 70½ or later (in some cases), your plan has to make distributions available to you on a different schedule. A plan must allow you to receive distributions no later than 60 days after the latest of: • The end of the plan year in which you no longer work for the employer's company • The end of the plan year in which you reach age 65 or whatever age is normal retirement age under the plan, whichever occurs first • The end of the plan year in which the 10th anniversary of your participation in the plan occurs Tip: A plan year is not necessarily the same as the calendar year. Check with your plan administrator to find out the plan year for your plan. Normal retirement age is the earlier of: • The age specified in your plan as the normal retirement age • The later of the date you reach age 65 or the fifth anniversary of your participation in the plan occurs Generally, distributions are made to you once you reach age 65 or leave the employer's company. It depends upon how the plan document is written. The plan may even provide for early retirement benefits.
Distribution options while still employed by the plan employer ("in-service" distributions) Depending upon the type of retirement plan and the provisions of the plan, one or more of the following
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distribution options may be available to you while you are still working for the employer maintaining the plan. However, plans differ in the distribution options allowed to employees. You may need to look at the plan's summary plan description and/or consult the plan administrator to find out the details of your employer's plan. Plan loans You may be able to borrow against your vested benefits in your employer's retirement plan, if the plan allows participants to take loans. If the loan meets IRS guidelines, the loan will not be treated as a taxable distribution. In most cases, a plan loan must be repaid within five years from the date you borrowed the funds (the repayment period can be longer if the funds are used to purchase a primary residence). The interest rate on plan loans is generally very reasonable compared to other loans. Hardship distribution Some plans allow you to take hardship withdrawals while you are still working for your employer. If your plan permits this type of withdrawal, you need to demonstrate financial hardship to justify the withdrawal. Hardship withdrawals are generally subject to income tax, and perhaps a 10 percent premature distribution tax if you are under age 59½. Caution: 401(k) plans typically allow you to withdraw your own elective deferrals (pre-tax and Roth), and pre-1989 earnings, if you can demonstrate financial hardship. However, your participation in the plan may be suspended for six months or more if you make a hardship withdrawal. This could result in you losing employer matching contributions for a significant period of time. Caution: Hardship withdrawals generally may not be rolled over into an IRA or other employer retirement plan. Profit-sharing plans Some profit-sharing plans (including 401(k) plans) allow you to withdraw employer contributions (e.g., matching contributions or discretionary profit-sharing contributions) after the contributions have been in the trust for a specified period of time (at least two years), after you have been a plan participant for at least five years, or after you've attained a certain age. Tip: 401(k) plans can also let you withdraw your own elective deferrals (pre-tax and Roth) when you reach age 59½. Pension plans In general, defined benefit and money purchase pension plans can't allow any distributions until you terminate your employment or reach the plan's normal retirement age. Tip: The Pension Protection Act of 2006 encourages "phased retirement" programs by permitting the distribution of pension benefits to employees who have attained age 62, but haven't yet separated from service or reached the plan's normal retirement age.
Pension plans--annuities as a standard form of benefit A defined benefit pension plan and a money purchase pension plan are required to offer a certain type of annuity retirement benefit. In some cases, profit-sharing plans and stock bonus plans must also follow these rules. A defined benefit plan normally pays benefits in some form of periodic payment for life. If you participate in a defined benefit plan, your options may be relatively limited. A defined benefit plan as a starting point must provide a qualified joint and survivor annuity (QJSA) to married participants. Keep in mind that you are not required to accept this annuity form of benefit--you and your spouse may elect to change this default form of payout. In this case, your plan will spell out alternate forms of payout that are available, such as a single-life annuity.
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Married persons Generally, if you have been married for at least a year on the annuity starting date, these pension plans must offer you and your spouse a QJSA. A QJSA provides an annuity payment during retirement as long as either you or your spouse is alive. The annuity is for your life with a survivor annuity for the life of your spouse. The annuity for your spouse's life must not be less than 50 percent (or greater than 100 percent) of the annuity payable during the time you are both alive. Tip: If you obtain the written consent of your spouse, you may elect against the QJSA. You can then choose another form of payout allowed under the plan. For example, you may be able to choose a single-life annuity based only on your lifetime. A single-life annuity provides a higher monthly benefit because the same amount of money is designed to last for one lifetime rather than two. The risk is that if your spouse outlives you, the annuity payments stop upon your death. If you die before your spouse, your spouse will stop receiving pension payments with a single-life annuity. To protect your spouse after your death, consider using a portion of the single-life annuity payments to purchase life insurance on your life (if you are insurable at an affordable cost). This option is often referred to as "maximizing your pension with life insurance". Single persons If you are unmarried, these pension plans generally must offer you the option of a single-life annuity payout. However, you may generally elect against the single-life annuity and choose an alternate form of payout allowed under the plan. Consult your plan administrator regarding the distribution options available to you as a single individual.
In general: distribution options upon separation from service, retirement, or disability After you leave your employer whether due to a separation from service (voluntarily or involuntarily), retirement, or disability, you may be able to choose from up to four methods of taking a distribution from your retirement plan. Tip: In general, a plan cannot force you to take a distribution from your account until you reach the plan's normal retirement age. Caution: However, a plan may "cash out" your benefit without your consent if the value is $5,000 or less. (In general, if the distribution exceeds $1,000, payment must be made to an IRA established on your behalf unless you elect to receive the payment in cash, or to roll it over into a different IRA or employer retirement plan.) Rollover A rollover is a direct (from one plan trustee to an IRA or second plan trustee) or indirect (from a plan trustee to you, and then to an IRA or second plan trustee) tax-free transfer of assets from a retirement plan to another plan (at a new employer) or to an IRA. If you cannot roll over your funds directly to another plan, you can generally roll over your funds first to an IRA and then later (if you choose) from the IRA to a new employer's plan. Rollovers encourage retirement savings by allowing your money to continue growing tax deferred in the IRA or new plan. With an indirect rollover, your old plan administrator must withhold 20 percent of the distribution to you for federal income tax. (You can claim the amount withheld as a credit on your federal income tax return.) Lump-sum distribution A lump-sum distribution is the withdrawal of your entire balance in an employer-sponsored retirement plan in one taxable year. The income tax consequences of a large lump-sum distribution are often considerable, and in some cases, you may have to pay the 10 percent premature distribution tax if you are under age 59½ (and perhaps a state penalty, too). In addition, after you take a lump-sum distribution, your plan funds are no longer in a tax-deferred retirement account. A lump-sum distribution is usually not a preferred option unless you urgently
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need money and have no other recourse. But note, however, that there are special tax-averaging and capital gains provisions that may make a lump-sum distribution a less taxing experience. Tip: An important exception from the 10 percent premature distribution tax applies to distributions from qualified retirement plans after you separate from service with the employer maintaining the plan, if your separation occurs during or after the calendar year in which you reach age 55 (age 50 for governmental defined benefit plan distributions to qualified public safety employees). Periodic payments You may be able to receive periodic payments from your employer-sponsored retirement plan in the form of an annuity, installment payments, or payments spread over your life expectancy. Some of these options are described above (see Defined benefit plans--annuities as a standard form of benefit). Consult your plan administrator to determine the specific types of annuities and periodic payments allowed under your plan. Discretionary distributions A discretionary distribution is any withdrawal from your retirement plan that is not a lump sum, loan, or annuity payout. It may be structured (you withdraw a set amount at set times) or unstructured (you withdraw what you need as you need it). Not all plans allow this option. The advantage is that you take only what you need, letting the balance of the funds continue to grow tax deferred. However, these distributions are generally subject to income tax, and the 10 percent premature distribution tax if you are under age 59½ (unless an exception applies).
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Distributions from Traditional IRAs: Between Ages 59½ and 70½ What is an IRA distribution? A withdrawal from an IRA is referred to as a distribution. Distributions can come in the form of several payment patterns, from a one-time (lump-sum) payment to a series of distributions over a number of years. Depending on how old you are at the time of the distribution, the payment may be classified as a premature distribution (made prior to age 59½), a normal distribution (between ages 59½ and 70½), or a required minimum distribution (after age 70½). There are tax consequences to any type of traditional IRA distribution. Caution: This discussion pertains primarily to distributions from traditional IRAs. Qualified distributions from Roth IRAs are tax-free. Even Roth IRA distributions that don't qualify for tax-free treatment are tax free to the extent of your own contributions to the Roth IRA. Only after you've recovered all of your contributions are distributions considered to consist of taxable earnings. Further, special rules apply to distributions taken from Roth IRAs that have funds rolled over or converted from traditional IRAs.
IRA distributions subject to income tax When you receive a distribution from your traditional IRA, the amount you receive is generally subject to income tax. If you have made nondeductible contributions to your traditional IRA, part of any distribution will be considered nontaxable. Caution: Taxable income from an IRA is taxed at ordinary income tax rates even if the funds represent long-term capital gains or qualifying dividends from stock held within the IRA.
Premature distribution tax does not apply Once you reach the age of 59½, you are allowed (but not required) to take distributions from your IRA without being subject to the 10 percent premature distribution tax. You may choose to take distributions sporadically, as you need the money, or you may request an automatic distribution from your account according to a prearranged schedule you establish with your IRA administrator.
Withholding from IRA distributions Federal income tax is withheld from distributions from traditional IRAs unless you choose not to have tax withheld. Generally, tax is withheld at a 10 percent rate. If you receive an annuity or similar periodic payment, tax withheld is based on your marital status and the number of withholding allowances you claim on your withholding certificate (Form W-4P). No withholding or waiver is needed when the distribution is a trustee-to-trustee rollover from one IRA to another. See the following section.
Rollovers In general A rollover is the reinvestment of a distribution from one retirement plan to another. A rollover must be completed within 60 days of the date the funds are released from the distributing account. If your rollover isn't completed in this time frame, the entire distribution is treated as having been distributed to you for tax purposes. Rollovers are treated separately from contributions. You are still allowed to make your regular IRA contribution in a year when you have a rollover transaction.
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Tip: You can roll over funds from a traditional IRA to another traditional IRA or you can roll over funds from a Roth IRA to another Roth IRA. Special rules apply to converting or rolling over funds from a traditional IRA to a Roth IRA. See "Converting traditional IRAs to Roth IRAs" below. You may also be able to roll over taxable funds from an IRA to an employer-sponsored retirement plan. You receive the funds and reinvest them With this method, you receive a distribution from your IRA. To complete the rollover transaction, you make a deposit into the IRA plan receiving the funds, and you must deposit the full amount distributed within the allowable 60-day time period. Example(s): On January 2, you withdraw your IRA funds from a maturing bank CD and choose to have no income tax withheld. The bank cuts a check payable to you for the full balance of the account. You plan to move the money into a higher-rate CD at a competing bank. Fifteen days later, you go to the new bank and deposit the full amount of your IRA distribution into your new rollover IRA CD. Your rollover is complete. If you don't complete the rollover transaction or miss the 60-day deadline, your distribution is treated as taxable. However, the IRS is able to extend the 60-day period, in limited circumstances, when the failure to timely complete the rollover is not the taxpayer's fault. Example(s): Assume the same scenario as the first example, except that when you receive your check from the first bank, you cash the check and loan the money to your brother-in-law, who promises to repay you in 30 days. As it turns out, he doesn't pay back the loan until March 5 (the 62nd day after your withdrawal). You deposit the full sum into the higher-rate CD at the new bank. Because you didn't complete your rollover within the 60-day time period, the January 2 withdrawal is treated as a distribution of your IRA funds for income tax purposes. Caution: You are allowed to make a rollover from a particular IRA only once in a 12-month period. If you receive a second distribution from the same IRA within a 12-month period, you cannot roll it over (you also can't make a rollover from the IRA you roll the funds into for 12 months). Tip: If federal income tax is withheld from a distribution and you wish to roll over the entire amount of the distribution, you have to make up the amount of withholding out of pocket. Example(s): You take a $1,000 distribution (all of which would be taxable) from your IRA that you want to roll over into a new IRA, and $100 is withheld for federal income taxes, so you actually receive $900. If you roll over only the $900, you are treated as having received a $100 taxable distribution. To roll over the entire $1,000, you will have to deposit in the new IRA the $900 that you actually received, plus an additional $100. (The $100 withheld will be claimed as part of your credit for federal income tax withheld on your federal income tax return.) Trustee-to-trustee rollover The second type of rollover transaction occurs directly between the trustees of your old and new IRA plans. You never have control of the funds, so the trustee-to-trustee rollover is not subject to withholding taxes or penalties, and is not subject to the "once per 12-month" limitation. Example(s): You have an IRA invested in a bank CD with a maturity date of January 2. In December, you provide your bank with instructions to close your CD on the maturity date and transfer the funds to the bank across town paying a higher CD rate. On January 2, your bank issues a check payable to the new bank as trustee for your IRA and sends it to the new bank. The new bank deposits the IRA check into your new CD account, and your trustee-to-trustee rollover is complete. Trustee-to-trustee rollovers avoid the danger of missing the 60-day deadline. Converting traditional IRAs to Roth IRAs You may be able to convert your traditional IRA to a Roth IRA, but you will have to pay income taxes on the amount of the traditional IRA contributions you previously deducted and any earnings you withdraw. Generally, if
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you're over age 59½, withdrawals from your Roth IRA are considered to be qualified tax-free distributions once you satisfy a five-year holding period.
Other types of distributions Lump-sum distributions A lump-sum distribution is one whereby you receive the entire balance of your account in one payment. The trustee or custodian of your IRA will withhold 10 percent of your balance for taxes unless you choose not to have taxes withheld. You must report your distribution for income tax purposes and are subject to regular income taxes on the distribution. Caution: The amount of your distribution is included in your income in the year received. A large enough lump-sum distribution could have the effect of causing a portion of your income to be taxed at a higher marginal tax rate (i.e., "pushing you into a higher tax bracket"). Discretionary distributions Discretionary distributions do not follow a payment schedule and are considered nonperiodic payments. Under this withdrawal scheme, you take distributions as the need arises. The IRA custodian or trustee will withhold 10 percent of your withdrawals for federal income tax unless you choose not to have tax withheld. Example(s): You have $55,000 in your IRA. You are age 60. You decide to take a distribution from your account to celebrate your 25th wedding anniversary with a cruise. You withdraw $10,000. You are subject to federal and state income taxes on the amount of the distribution. If you have made only deductible contributions to the IRA, the entire amount of the distribution is subject to tax. If you have made nondeductible contributions, a portion of the distribution will not be subject to tax. Caution: The amount of your distribution is included in your income in the year received. Substantially equal periodic payments You may have begun taking substantially equal periodic payments from your IRA before reaching age 59½ to avoid the 10 percent premature distribution tax (refer to Internal Revenue Code Sec. 72(t)). The rules for substantially equal payments require that you receive payments over your life expectancy (or the joint life expectancy of you and your designated beneficiary). The payments must occur at least annually. If you started taking substantially equal payments before age 59½, you can't modify the payments before five years from the payment start date or upon reaching age 59½, whichever is later. If you began receiving payments under this guideline and you increase or decrease the payment amounts before this period of time ends, the premature distribution tax generally applies retroactively to all distributions before age 59½. Example(s): Billy Bob, at age 57, needed some cash from his IRA and didn't want to pay the premature distribution tax, so he began receiving substantially equal payments from his IRA. The balance in his IRA at the time was $60,000, and according to the charts accepted by the IRS at the time, his life expectancy was 27.9 years. Based on this life expectancy and the IRA balance, and applying the level payment amount amortization method, the amount allowed each year under substantially equal payments was $5,435 (derived by amortizing $60,000 at 8 percent interest in level payments over 27.9 years). Three years later, on his 60th birthday, Billy Bob increases the distribution amount to $7,000. Because the substantially equal payments did not run for 5 years before the change, Billy Bob must pay the premature distribution tax on the full amount received from age 57 until age 59½. Tip: One of the methods that can be used to calculate substantially equal periodic payments is effectively the same as that used to calculate required minimum distributions. In April 2002, the IRS issued final regulations relating to required minimum distribution rules and provided new distribution tables. Substantially equal periodic payments that were calculated using the required distribution method will not be considered to have been modified merely because the new tables are used in the future to determine annual periodic payments. Consult a tax professional.
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Should you withdraw money from your IRA between ages 59½ and 70½? It depends on your circumstances. If you really need the money for income or unforeseen expenses, it may very well be advisable to draw on your IRA. However, if you have other sources of income and don't need the IRA funds, you may want to think twice about withdrawing funds. Even though you will be free of the premature distribution tax once you've reached age 59½, you still may have to pay income taxes on all or part of any IRA withdrawals (depending on whether or not the contributions you made were tax deductible). If the amount of a taxable distribution is substantial, it may even push you into a higher tax bracket for that year. This could increase your annual tax liability significantly. In addition, if you take a number of large IRA distributions after reaching 59½, your IRA could be depleted (or at least reduced in size) more quickly than you had planned. This could mean a smaller nest egg for your later retirement years when you may need income the most, and a much smaller balance available to leave to your beneficiaries when you die. And, of course, the longer you leave funds in an IRA, the greater the opportunity for compounded, tax-deferred growth of earnings. The point is that it's often not wise or appropriate to take distributions from an IRA between ages 59½ and 70½.
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Required Minimum Distributions What are required minimum distributions (RMDs)? Required minimum distributions, often referred to as RMDs or minimum required distributions, are amounts that the federal government requires you to withdraw annually from traditional IRAs and employer-sponsored retirement plans after you reach age 70½ (or, in some cases, after you retire). You can always withdraw more than the minimum amount from your IRA or plan in any year, but if you withdraw less than the required minimum, you will be subject to a federal penalty. The RMD rules are designed to spread out the distribution of your entire interest in an IRA or plan account over your lifetime. The purpose of the RMD rules is to ensure that people don't just accumulate retirement accounts, defer taxation, and leave these retirement funds as an inheritance. Instead, required minimum distributions generally have the effect of producing taxable income during your lifetime. Caution: The Worker, Retiree, and Employer Recovery Act of 2008 waives certain required minimum distributions for the 2009 calendar year. See "Special RMD rules for 2009," below.
Which retirement savings vehicles are subject to the RMD rules? In addition to traditional IRAs, simplified employee pension (SEP) IRAs and SIMPLE IRAs are subject to the RMD rules. Roth IRAs, however, are not subject to these rules while you are alive. Although you are not required to take any distributions from your Roth IRAs during your lifetime, your beneficiary will generally be required to take distributions from the Roth IRA after your death. Employer-sponsored retirement plans that are subject to the RMD rules include qualified pension plans, qualified stock bonus plans, qualified profit-sharing plans, including 401(k) plans. Section 457(b) plans and Section 403(b) plans are also subject to these rules. If you are uncertain whether the RMD rules apply to your employer-sponsored plan, you should consult your plan administrator or a tax professional.
When must RMDs be taken? Your first required distribution from an IRA or retirement plan is for the year you reach age 70½. However, you have some flexibility as to when you actually have to take this first-year distribution. You can take it during the year you reach age 70½, or you can delay it until April 1 of the following year. Since this first distribution generally must be taken no later than April 1 following the year you reach age 70½, this April 1 date is known as your required beginning date. Required distributions for subsequent years must be taken no later than December 31 of each calendar year until you die or your balance is reduced to zero. This means that if you opt to delay your first distribution until April 1 of the following year, you will be required to take two distributions during that year--your first year's required distribution and your second year's required distribution. Example(s): You have a traditional IRA. Your 70th birthday was December 2, 2009, so you will reach age 70½ in 2010. You can take your first RMD during 2010, or you can delay it until April 1, 2011. If you choose to delay your first distribution until 2011, you will have to take two required distributions during 2011--one for 2010 and one for 2011. This is because your required distribution for 2011 cannot be delayed until the following year. There is one situation in which your required beginning date can be later than described above. If you continue working past age 70½ and are still participating in your employer's retirement plan, your required beginning date under the plan of your current employer can be as late as April 1 following the calendar year in which you retire (if the retirement plan allows this and you own five percent or less of the company). Again, subsequent distributions must be taken no later than December 31 of each calendar year.
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Example(s): You own more than five percent of your employer's company and you are still working at the company. Your 70th birthday is on December 2, 2009, meaning that you will reach age 70½ in 2010. So you must take your first RMD from your current employer's plan by April 1, 2011--even if you're still working for the company at that time. Example(s): You participate in two plans--one with your current employer and one with your former employer. You own less than five percent of each company. Your 70th birthday is on December 2, 2009 (so you'll reach 70½ on June 2, 2010), but you'll keep working until you turn 73 on December 2, 2012. You can delay your first RMD from your current employer's plan until April 1, 2013--the April 1 following the calendar year in which you retire. However, as to your former employer's plan, you must take your first distribution (for 2010) no later than April 1, 2011--the April 1 after reaching age 70½.
How are RMDs calculated? RMDs are calculated by dividing your traditional IRA or retirement plan account balance by a life expectancy factor specified in IRS tables. Your account balance is usually calculated as of December 31 of the year preceding the calendar year for which the distribution is required to be made. Example(s): You have a traditional IRA. Your 70th birthday is November 1 of year one, and you therefore reach age 70½ in year two. Because you turn 70½ in year two, you must take an RMD for year two from your IRA. This distribution (your first RMD) must be taken no later than April 1 of year three. In calculating this RMD, you must use the total value of your IRA as of December 31 of year one. Caution: When calculating the RMD amount for your second distribution year, you base the calculation on the IRA or plan balance as of December 31 of the first distribution year (the year you reached age 70½) regardless of whether or not you waited until April 1 of the following year to take your first required distribution. For most taxpayers, calculating RMDs is straightforward. For each calendar year, simply divide your account balance as of December 31 of the prior year by your distribution period, determined under the Uniform Lifetime Table using your attained age in that calendar year. This life expectancy table is based on the assumption that you have designated a beneficiary who is exactly 10 years younger than you are. Every IRA owner's and plan participant's calculation is based on the same assumption. There is one exception to the procedure described above. If your sole designated beneficiary is your spouse, and he or she is more than 10 years younger than you, the calculation of your RMDs may be based on the longer joint and survivor life expectancy of you and your spouse. (These life expectancy factors can be found in IRS Publication 590.) Consequently, if your spouse is your designated beneficiary and is more than 10 years younger than you, you can take your RMDs over a longer payout period than under the Uniform Lifetime Table. If your beneficiary is a nonspouse or a spouse who is not more than 10 years younger than you, you are subject to the shorter payout period under the simplified general rule. Tip: In order for the younger spouse rule to apply, your spouse must be your sole beneficiary for the entire distribution year. The final regulations specify that your spouse will be considered your sole beneficiary for the entire year if he or she is your sole beneficiary on January 1 of the year, and you do not change your beneficiary during the year. In other words, even if your spouse dies, or you get divorced after January 1, you can use the younger spouse rule for that distribution year (but not for distribution years that follow). In the case of divorce, however, if you designate a new beneficiary prior to the end of the distribution year, you cannot use the younger spouse rule (since your former spouse will not be considered your sole beneficiary for the entire year). If you have multiple IRAs, an RMD is calculated separately for each IRA. However, you can withdraw the required amount from any one or more IRAs. Inherited IRAs are not included with your own for this purpose. (Similar rules apply to Section 403(b) accounts.) If you participate in more than one employer retirement plan, your RMD is calculated separately for each plan and must be paid from that plan.
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Should you delay your first RMD? Your first decision is when to take your first RMD. Remember, you have the option of delaying your first distribution until April 1 following the calendar year in which you reach age 70½ (or April 1 following the calendar year in which you retire, in some cases). You might delay taking your first distribution if you expect to be in a lower income tax bracket in the following year, perhaps because you're no longer working or will have less income from other sources. However, if you wait until the following year to take your first distribution, your second distribution must be made on or by December 31 of that same year. Receiving your first and second RMDs in the same year may not be in your best interest. Since this "double" distribution will increase your taxable income for the year, it will probably cause you to pay more in federal and state income taxes. It could even push you into a higher federal income tax bracket for the year. In addition, the increased income may cause you to lose the benefit of certain tax exemptions and deductions that might otherwise be available to you. So the decision of whether to delay your first required distribution can be important, and should be based on your personal tax situation. Example(s): You are unmarried and reached age 70½ in 2007. You had taxable income of $25,000 in 2007 and expect to have $25,000 in taxable income in 2008. You have money in a traditional IRA and determined that your RMD from the IRA for 2007 was $50,000, and that your RMD for 2008 is $50,000 as well. You took your first RMD in 2007. The $50,000 was included in your income for 2007, which increased your taxable income to $75,000. At a marginal tax rate of 25 percent, federal income tax was approximately $15,174 for 2007 (assuming no other variables). In 2008, you take your second RMD. The $50,000 will be included in your income for 2008, increasing your taxable income to $75,000 and resulting in federal income tax of approximately $15,094. Total federal income tax for 2007 and 2008 will be $30,268. Example(s): Now suppose you did not take your first RMD in 2007 but waited until 2008. In 2007, your taxable income was $25,000. At a marginal tax rate of 15 percent, your federal income tax was $3,359 for 2007. In 2008, you take both your first RMD ($50,000) and your second RMD ($50,000). These two $50,000 distributions will increase your taxable income in 2008 to $125,000, taxable at a marginal rate of 28 percent,resulting in federal income tax of approximately $28,978. Total federal income tax for 2007 and 2008 will be $32,337--almost $2,069 more than if you had taken your first RMD in 2007.
What if you fail to take RMDs as required? You can always withdraw more than you are required to from your IRAs and retirement plans. However, if you fail to take at least the RMD for any year (or if you take it too late), you will be subject to a federal penalty. The penalty is a 50 percent excise tax on the amount by which the RMD exceeds the distributions actually made to you during the taxable year. Example(s): You own one traditional IRA and compute your RMD for year one to be $7,000. You take only $2,000 as a year-one distribution from the IRA by the date required. Since you are required to take at least $7,000 as a distribution but have only taken $2,000, your RMD exceeds the amount of your actual distribution by $5,000 ($7,000 minus $2,000). You are therefore subject to an excise tax of $2,500 (50 percent of $5,000). Technical Note: You report and pay the 50 percent tax on your federal income tax return for the calendar year in which the distribution shortfall occurs. You should complete and attach IRS Form 5329, "Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts." The tax can be waived if you can demonstrate that your failure to take adequate distributions was due to "reasonable error" and that steps have been taken to correct the insufficient distribution. You must file Form 5329 with your individual income tax return, and attach a letter of explanation. The IRS will review the information you provide and decide whether to grant your request for a waiver.
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Can you satisfy the RMD rules with the purchase of an annuity contract? Your purchase of an annuity contract with the funds in your IRA or retirement plan satisfies the RMD rules if all of the following are true: • Payments are made at least yearly • The annuity is purchased on or before the date that distributions are required to begin • The annuity is calculated and paid over a time period that does not exceed those permitted under the RMD rules • Payments, with certain exceptions, are nonincreasing
Tax considerations Income tax Like all distributions from traditional IRAs and retirement plans, RMDs are generally subject to federal (and possibly state) income tax for the year in which you receive the distribution. However, a portion of the funds distributed to you may not be subject to tax if you have ever made after-tax contributions to your IRA or plan. For example, if some of your traditional IRA contributions were not tax deductible, those contribution amounts will be income tax free when you withdraw them from the IRA. This is simply because those dollars were already taxed once. You should consult a tax professional if your IRA or plan contains any after-tax contributions. (Special tax rules apply to Roth IRAs and Roth 401(k)/403(b) contributions.) Caution: Taxable income from an IRA or retirement plan is taxed at ordinary income tax rates even if the funds represent long-term capital gain or qualifying dividends from stock held within the plan. There are special rules for capital gain treatment in some cases on distributions from retirement plans. Estate tax You first need to determine whether or not the federal estate tax will apply to you. If you do not expect the value of your taxable estate to exceed the federal applicable exclusion amount ($3.5 million for 2009, $2 million for 2008), then federal estate tax may not be a concern for you. However, state death (or inheritance) tax may be a concern. In some cases, your assets may be subject to more than one type of death tax--for example, the generation-skipping transfer tax may also apply. Consider getting professional advice to establish appropriate strategies to minimize your future estate tax liability. For example, you might reduce the value of your taxable estate by gifting all or part of your required distribution to your spouse or others. Making gifts to your spouse can sometimes work well if your taxable estate is larger than your spouse's, and one or both of you will leave an estate larger than the applicable exclusion amount. This strategy can provide your spouse with additional assets to better utilize his or her applicable exclusion amount, thereby minimizing the combined estate tax liability of you and your spouse. Be sure to consult an estate planning attorney, however, about this and other possible strategies. Caution: In addition to federal estate tax, your state may impose its own estate or death tax. Consult an estate planning attorney for details.
Inherited IRAs and retirement plans Your RMDs from your IRA or plan will cease after your death, but your designated beneficiary (or beneficiaries) will then typically be required to take minimum required distributions from the account. A spouse beneficiary may
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generally roll over an inherited IRA or plan account into an IRA in the spouse's own name, allowing the spouse to delay taking additional required distributions until he or she turns 70½. As with required lifetime distributions, proper planning for required post-death distributions is essential. You should consult an estate planning attorney and/or a tax professional.
Special RMD rules for 2009 The Worker, Retiree, and Employer Recovery Act of 2008 suspends RMDs for 2009. That is, no minimum distribution will be required from IRAs and employer-sponsored defined contribution retirement plans (i.e., qualified stock bonus plans, qualified profit-sharing plans, 401(k) plans, 457(b) plans, and 403(b) plans) for the 2009 calendar year. This applies to both RMDs during a plan participant's or IRA owner's lifetime as well as after-death RMDs to beneficiaries. (The Act does not suspend 2009 RMDs from defined benefit plans.) An individual who reached age 70½ prior to 2009 would normally be required to take his or her 2009 RMD no later than December 31, 2009. As a result of this legislation, that RMD will not have to be made. An individual who reaches age 70½ in 2009 would normally be required to take his or her first RMD on or before April 1, 2010. As a result of this legislation, no distribution is required for 2009, and thus there is no requirement that a distribution be made by April 1, 2010. However, in both cases, the individual will still be responsible for taking an RMD for the 2010 calendar year on or by December 31, 2010. • Individuals are still required to take an RMD for 2008. Normal RMD rules apply: For individuals who reached age 70½ prior to 2008, 2008 RMDs must generally be made no later than December 31, 2008. An individual who reached age 70½ in 2008 is generally required to take his or her 2008 RMD on or before April 1, 2009. The legislation does not affect this requirement. • If an individual who reaches age 70½ in 2009 dies on or after April 1, 2010, the RMD for the individual’s beneficiary will be determined using the rules that apply on or after the individual’s required beginning date (generally, based on the beneficiary’s life expectancy). • For beneficiaries receiving RMDs from a decedent’s account under the "five-year rule," the five-year period is determined without regard to calendar year 2009. For example, for an account with respect to an individual who died in 2007, under the provision, the five-year period ends in 2013 instead of 2012. • Distributions made during 2009 that would have been considered RMDs but for this legislation will not be treated as eligible rollover distributions for purposes of an employer’s requirement to offer a direct rollover (and related notification obligations) and mandatory withholding requirements for non-direct rollovers. Therefore employers may, but do not have to, offer a direct rollover and provide related documentation, and the distribution isn’t subject to mandatory 20 percent withholding. Even if an employer does not offer a direct rollover, employees may roll over the distribution into another eligible plan within 60 days.
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Annuity Distributions What are annuity distributions? The second phase of an annuity contract, called the distribution phase, begins when you start receiving payments from the annuity. These payments are called annuity distributions. Distributions typically consist of principal and earnings. Caution: The examples used throughout this discussion are hypothetical. They do not reflect the actual performance of an annuity or the fees and charges associated with an annuity.
How are annuity distributions made? Withdrawal option You can choose to simply withdraw earnings (or earnings and principal) from the annuity. There are several ways of doing this. You can withdraw all of the money in the annuity (both the principal and earnings) in one lump sum. You can also withdraw the money over a period of time through regular or irregular withdrawals. By choosing to make withdrawals from your annuity, you continue to have control over money you have invested in the annuity. In a sense, it is similar to a savings account at a bank. You can withdraw only earnings (interest) from the account, or you can withdraw both the principal and the interest. However, if you systematically withdraw the principal and the earnings from the annuity, there is obviously no guarantee that the funds in the annuity will last for your entire lifetime. Caution: Withdrawals made prior to age 59½ may be subject to a 10 percent federal penalty tax. Guaranteed income (annuitization) option A second distribution option is called the guaranteed income (or annuitization) option. If you select this option, your annuity will be "annuitized," which means that the current value of your annuity is converted into a stream of payments. This allows you to receive a guaranteed income stream from the annuity. The annuity issuer promises to pay you an amount of money on a periodic basis (e.g., monthly, quarterly, yearly, etc.). If you elect to annuitize, the periodic payments you receive are called annuity payouts. You can elect to receive either a fixed amount for each payment period or a variable amount for each period. You can receive the income stream for your entire lifetime (no matter how long you live), or you can receive the income stream for a specific time period (10 years, for example). You can also elect to receive annuity payouts over your lifetime and the lifetime of another person (called a "joint and survivor annuity"). The amount you receive for each payment period will depend on the cash value of the annuity, how earnings are credited to your account (whether fixed or variable), and the age at which you begin receiving annuity payments. The length of the distribution period will also affect how much you receive. If you are 65 years old and elect to receive annuity payments over your entire lifetime, the amount you will receive with each payment will be less than if you had elected to receive annuity payouts over 5 years. Caution: Annuity guarantees are subject to the claims-paying ability of the annuity issuer. Example(s): Over the course of 10 years, you accumulated $300,000 in an annuity. When you reach 65 and begin your retirement, you annuitize the annuity (i.e., elect to begin receiving distributions from the annuity). You elect to receive the annuity payments over your entire lifetime--called a single life annuity. You also elect to receive a variable annuity payout whereby the annuity issuer will invest the amount of money in your annuity in a variety of equity portfolios. The amount you will then receive with each annuity payment will vary, depending in part on the performance of the portfolios.
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Example(s): In the alternative, you could have elected to receive payments for a specific term of years. You could have also elected to receive a fixed annuity payout whereby you would receive an equal amount with each payment. Example(s): Sally is 43 and is planning to retire when she turns 65. She purchases an annuity and makes annual premium payments of $3,000. For the next 22 years, the annuity accumulates tax-deferred income. When Sally turns 65, she chooses to annuitize. Sally stops making premium payments and starts receiving an annual payment of $8,000, which she will receive for the rest of her life.
How are your annuity payouts computed if you elect to annuitize? Annuitization is computed using actuarial tables. These tables take into account the annuitant's life expectancy and interest earned. It's the annuitant whose life is of primary importance in determining the timing and amount of the payout. Thus, the annuitant's life is the "measuring life." The tables are gender based because women generally live longer. However, some states in which annuities are sold, use tables which are gender neutral. In the case of joint and survivor annuity options, an actuarial table containing both the annuitant's age and the designated survivor's age must be used to calculate the amount of the periodic payments. Example(s): Mr. Smith bought an annuity that now has an accumulation value of $50,000. He is now 65 and decides to begin receiving annuity payouts under a life-only settlement option. Using the actuarial tables, Mr. Smith receives a monthly payment in the amount of $334. Example(s): Mr. Jones, on the other hand, bought an annuity that now has an accumulation value of $50,000. He is now 75 and decides to begin receiving annuity payments under a life-only settlement option. Using the actuarial tables, Mr. Jones receives a monthly payment in the amount of $471. Example(s): Mr. Lucky bought an annuity that now has an accumulation value of $50,000. He is only 55 when he decides to take early retirement, after which he begins receiving annuity payments under a life-only settlement option. Using the actuarial tables issued, Mr. Lucky receives a monthly payment in the amount of only $265.
Who are the parties to an annuity contract? There are generally four parties to an annuity: the issuer, the owner, the annuitant, and the beneficiary. The issuer is the issuing insurance company and is the party that accepts the premiums and promises to pay the benefits under the annuity contract. The owner is generally the purchaser of the annuity, the party who pays the premiums, and, usually, the party that receives the annuity payouts during the distribution phase. The annuitant provides the measuring life for the determination of the annuity payments to be paid. The beneficiary receives the remaining benefits, if any, at the death of the owner. Typically, the owner and the annuitant are the same person. Can there be more than one annuitant? Yes. Commonly referred to as a joint and survivor annuity, the payments are based on the combined life expectancies of both annuitants and generally continue until both annuitants are deceased. Technical Note: We are discussing commercial annuities here. Commercial annuities differ from private annuities, which are contractual arrangements between private parties.
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How are annuity benefits paid out? Fixed payout If the annuity is a fixed annuity (sometimes referred to as an ordinary annuity), the payout is a fixed dollar amount that remains the same throughout the contract period. The fixed payments may be made monthly, yearly, or in some other periodic manner. The cash value accumulation is "annuitized" (i.e., it is converted into a stream of payments). Thus, the payout is guaranteed. This annuitization is computed using actuarial tables that take into account the annuitant's life expectancy and interest earned, as discussed above. Example(s): John buys a fixed annuity from Annuities Unlimited Life Insurance Company. John pays Annuities Unlimited a lump-sum premium of $80,000. Annuities Unlimited agrees to pay John $800 a month for life. Caution: If the insurance company fails, you may lose your investment. Therefore, be sure to check the financial strength of the insurance company before purchasing any annuity policies. Variable payout An annuity payout from a variable annuity fluctuates with the market value of the assets in the account (separate accounts are kept for each contract owner). The amount of the payments is determined by the performance of the investment portfolio. Thus, while the number of variable payments can be determined, the amount is not. Example(s): You have accumulated $300,000 in a variable annuity. When the annuitization phase begins, you elect to receive a variable payout. In the first year, you receive $15,000. In the second year, however, you receive only $13,000 because of the poor performance of your investments in the variable annuity. In the third year, after the investment performance improves, you receive $16,000. The remainder of the payments continues in this fashion. Caution: Variable annuities are sold by prospectus. You should consider the investment objectives, risk, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity, can be obtained from the insurance company issuing the variable annuity or from your financial professional. You should read the prospectus carefully before you invest.
When are annuity benefits paid out? Immediate As the name implies, an immediate annuity is one that has no accumulation period (i.e., it is annuitized and the distribution period begins within 12 months after the purchase). Immediate annuities may be appropriate for people who have an immediate income need. Immediate annuities provide those who have accumulated money in other types of investments an opportunity to still enjoy the benefits of an annuity payout. For instance, an individual who has sold his or her business for a substantial amount of money and would then like to immediately retire may want to purchase an immediate annuity. Immediate annuities are typically purchased upon retirement or sometime thereafter through payment of a single large premium. They appeal to those who prefer the security of a fixed income and who are uncomfortable managing their own investments. Example(s): Steve has just retired as warehouse manager from Glide-Lite, one of the nation's leading running-shoe manufacturers. Glide-Lite has no pension plan, but Steve has built up a retirement nest egg through the company's 401(k) plan and an individual retirement account he funded while previously self-employed. Never a whiz with finances, Steve has opted to use part of his retirement savings to purchase an immediate annuity that will guarantee him a monthly income for life. The remainder of his savings will be used to supplement his annuity payout income as needed.
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Caution: Because immediate annuities are annuitized almost immediately, they are usually irrevocable. Some immediate annuities offer riders allowing access to remaining cash values or increased annuity payments such as commuted payout rider or a refund rider. Nevertheless, the purchase of an immediate annuity calls for thoughtful consideration and planning. Tip: When a person is less than seven years from retirement, planning to purchase an immediate annuity upon or after retirement may be preferable to buying a deferred annuity. Investment earnings within a deferred annuity need to accumulate for about this long to offset the annuity's management fees. Deferred A deferred annuity is one in which the distribution period will begin at some point in the future (usually more than one year after the purchase of an annuity). Deferred annuities delay the payment of benefits until some future date. A deferred annuity grows through a combination of premiums paid and investment earnings that occur during an accumulation period. The earnings portion grows tax deferred during this time and is taxed upon withdrawal, when your tax bracket is typically lower, especially if withdrawals are made during retirement. Deferred annuities may be appropriate for those who find annuities generally preferable to other retirement savings alternatives. Tip: A single payment annuity may be a deferred annuity. For example, you purchase an annuity for a lump sum of $100,000 and then let the earnings accrue for 10 years before the distribution period begins. Tip: An accumulation period of seven years is generally required to break even on the management and other fees typically charged by companies offering deferred annuities. For shorter accumulation periods, mutual funds may provide better growth for a given investment amount. The investor can then still enjoy annuity payout benefits by purchasing an immediate annuity. Combination A combination annuity is, in reality, two annuities--one immediate and the other deferred. The immediate annuity is typically designed to distribute all of its proceeds within a fixed number of years, while the deferred portion accumulates earnings tax deferred. After the fixed number of years has passed and when the immediate annuity's proceeds have been exhausted, the deferred portion begins to pay.
What payout methods are available? Payments for life This method provides the owner with payments for life only, and then they end. Payments can be made monthly, quarterly, semi-annually, or annually. There is no designated beneficiary with this type of policy because the policy terminates at the owner's death. Payments for life with term certain This method provides the owner with payments for life, and, after the owner's death, the payments continue to a named beneficiary for the remainder of the original specified period of time (generally 5, 10, 15, or 20 years). Payments for a specified period This method provides the owner with payments for a specified period of time (generally 5, 10, 15, or 20 years). If the owner dies before the specified time period has elapsed, the remaining payments are received by a named beneficiary.
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Refund life This method provides the annuitant with income for life, but if the owner dies before the total amount of the annuity is received, the balance is paid to a named beneficiary. The named beneficiary may receive the balance in a lump sum or in installments. Joint and survivor life This method provides two persons with income for life (first one, then the other--but not both at the same time). When one dies, the other continues to receive the payment (or some portion of it) for life. This may be advantageous if you want to provide for yourself and then someone else (e.g., your spouse) or if you want to provide for others (e.g., your children). Also, because a survivor annuity may pay until the death of the designated survivor, it generally pays for a longer period of time than a single policy. However, because the benefits are expected to pay longer, monthly payments are lower. Typically, spouses purchase joint and survivor annuities, although nonspouses (e.g., elderly siblings) may purchase them as well. A joint and survivor annuity can end at the death of the last person or after a certain number of payouts. Some policies continue to pay the full income to the survivor (this is called a "joint and full to the survivor" policy). Some insurers offer policies that provide one-half or two-thirds of the income to the survivor after the first owner dies (these are called a "joint and one-half" policy or a "joint and two-thirds" policy, respectively). Tip: Joint and survivor annuity may be subject to estate tax. Joint and survivor annuities are included in the first owner's gross estate to the extent of the fair market value of the survivor's interest in the annuity. Caution: The purchase of a joint and survivor annuity for annuitants who are not spouses may result in a taxable gift.
Options after death In addition to different distribution options while the annuitant is alive, many annuities offer different options after the annuitant dies. If the annuitant dies before annuitization begins, typically the funds in the annuity will be distributed to the named beneficiary. If the annuitant dies after annuitization has begun, then, with some annuities (e.g., single life annuities), the periodic payments stop. With a single life annuity, if the annuitant has not completely depleted the money invested in the annuity, then the annuity issuer keeps the difference. However, many annuities also offer distribution options whereby if you die within a certain time period after annuitization begins, your named beneficiary will receive a certain amount from your annuity account. Example(s): You have accumulated $300,000 in a fixed annuity. When the time comes to start receiving payments, you elect to receive payments over your entire lifetime. However, you select a further option offered by the issuer whereby if you die within the first five years of the payout period, the annuity issuer will pay 75 percent of the monies in your annuity account at the time of your death to your named beneficiary. Of course, if you select this option, the annuity issuer pays you a lower amount per year than if you had not elected this option. But now you know that if you die within a short time after annuitization begins, 75 percent of your remaining investment will go to your named beneficiary. Cannot outlive payments to you if you elect to annuitize over your entire lifetime One of the unique features to an annuity is that you cannot outlive the payments from the annuity issuer to you if you elect to receive payments over your entire lifetime. If you elect to receive payments over your entire lifetime, the annuity issuer must make the payments to you no matter how long you live. Even if you begin receiving payments when you are 65 years old and then live to the age of 100, the annuity issuer must make the payments to you for your entire lifetime. The downside to this ability to receive payments for your entire life is that if you die after receiving just one payment, no more payments will be made to your beneficiaries. You have essentially given up control and ownership of the principal and earnings in the annuity.
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What is the tax treatment of annuity payouts in the annuitization phase? Each annuity payment is part nontaxable return of investment in the contract and part payment of accumulated earnings (until the investment in the contract is exhausted). Generally, only the portion of the payment that represents payments of accumulated earnings is subject to income tax. To determine the amount of each annuity payment treated as a nontaxable return of investment in the contract, divide the investment in the contract (i.e., premiums paid) by the expected return (i.e., premiums paid plus investment income) and multiply this amount by the amount of the annuity payment. For annuity contracts where the annuity starting date is after December 31, 1986, after the investment in the contract is fully recovered, all subsequent annuity payments are treated as coming entirely from taxable earnings.
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Beneficiary Designations for Traditional IRAs and Retirement Plans What is it? If you have a traditional IRA or participate in an employer-sponsored retirement plan such as a 401(k) plan, you are generally required to complete a beneficiary designation form with the IRA custodian or plan administrator. As you may know, the beneficiary or beneficiaries you name (you can generally name more than one) will receive the remaining funds in your IRA or plan account after you die. What you may not realize is that your choice of beneficiary may have implications in other important areas, including: • The size of the annual required minimum distributions (RMDs) that you must take from the IRA or plan during your lifetime • The rate at which the funds must be distributed from the IRA or plan after your death • The combined federal estate tax liability of you and your spouse (assuming you are married and expect estate tax to be an issue for one or both of you) Because of these and other issues, choosing beneficiaries for your IRA or plan is often a significant financial decision. This is particularly true if your financial situation is complicated, and if your retirement accounts make up a substantial portion of your total assets. It is in your best interest to select proper beneficiaries with the help of a tax advisor and/or other qualified professionals. Your financial and personal circumstances will likely evolve over time, and you are often free to add or remove beneficiaries whenever you want (though certain restrictions may apply, as discussed below). You should periodically review your beneficiary choices to make sure they are still the right choices. Tip: Employer-sponsored retirement plans include qualified stock bonus, pension, or profit-sharing plans. A 401(k) plan is a type of employer-sponsored retirement plan. If you are unsure if you participate in an employer-sponsored retirement plan, ask your employer. This discussion also applies to you if you are a schoolteacher or an employee of a tax-exempt organization or state or municipal government and participate in an eligible Section 457 plan or a Section 403(b) plan. Caution: This discussion does not apply to Roth IRAs. Roth IRAs have their own special beneficiary designation considerations.
The law may limit your choices You are often free to name any beneficiaries you choose for your IRA or plan, but there are exceptions. If you are married and want to name a primary beneficiary other than your spouse, there may be restrictions on your ability to do so. No matter which state you live in, federal law may require that your surviving spouse be the primary beneficiary of your interest in some employer-sponsored retirement plans (such as 401(k) plans), unless your spouse signs a timely, effective written waiver allowing you to name a different primary beneficiary. You should consult your plan administrator for further details. IRAs are not subject to this federal law, although your state may impose its own requirements. For example, if you live in one of the community property states, your spouse may have legal rights in your IRA regardless of whether he or she is named as the primary beneficiary. In addition, if your roles are reversed (your spouse is the IRA owner or plan participant, and you the primary beneficiary) and you die first, state law may prevent your surviving spouse from changing the beneficiary designation after your death (unless you grant your spouse the power to make these changes in a will or other document). You should consult an estate planning attorney for details regarding these and other state issues.
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Your choice of beneficiary usually will not affect required minimum distributions during your lifetime Under federal law, you must begin taking annual RMDs from your traditional IRA and most employer-sponsored retirement plans (including 401(k)s, 403(b)s, 457(b)s, SEPs, and SIMPLE plans) by April 1 of the calendar year following the calendar year in which you reach age 70½ (your "required beginning date"). With employer-sponsored retirement plans, you can delay your first distribution from your current employer's plan until April 1 of the calendar year following the calendar year in which you retire if (1) you retire after age 70½, (2) you are still participating in the employer's plan, and (3) you own five percent or less of the employer. Your choice of beneficiary will not have an impact on the calculation of RMDs during your lifetime in most cases. An exception exists if your spouse is your sole designated beneficiary for the entire distribution year, and he or she is more than 10 years younger than you. Also, your choice of beneficiary can impact the tax deferral and other consequences for your beneficiaries. Caution: The calculation of RMDs is complex, as are the related tax and estate planning issues. Consult a tax professional. Caution: The Worker, Retiree, and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year.
Your choice of beneficiary will affect required distributions after your death After your death, your IRA or plan beneficiary (or beneficiaries) will generally have to receive the inherited retirement funds at some point. Distributions from an inherited IRA or retirement plan are referred to as required post-death distributions. With some exceptions, these distributions must begin by the end of the year following the year of your death. Caution: The Worker, Retiree, and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year. For federal income tax purposes, post-death distributions are treated the same as distributions you take during your lifetime. (State income tax may also apply.) The portion of a distribution that represents pretax or tax deductible contributions and investment earnings will be subject to tax, while the portion that represents after-tax contributions will not be. Your beneficiary's income tax bracket will determine how heavily the funds are taxed after your death. This may be something to consider when choosing your beneficiaries. In addition, different types of beneficiaries will have different post-death options and be subject to different payout periods. The payout period is important because the longer the funds can remain in the IRA or plan, the more time they have to benefit from tax-deferred growth. Also, a longer payout period spreads out the income tax liability on the funds over more years. In most cases, an individual designated as a beneficiary can take post-death distributions over his or her remaining life expectancy. The younger the individual, the longer the payout period. A surviving spouse can generally use this method, but often has other options as well (such as the ability to roll over the inherited funds to the spouse's own IRA or plan). Special post-death rules apply if you name a trust, a charity, or your estate as beneficiary. Caution: Nonspouse beneficiaries cannot roll over inherited funds to their own IRA or plan. However, the Pension Protection Act of 2006 lets a nonspouse beneficiary make a direct rollover of certain death benefits from an employer-sponsored retirement plan to an inherited IRA (traditional or Roth), effective for distributions received after 2006. However, employer plans aren't required to offer this rollover option to nonspouse beneficiaries until 2010. Be aware that your beneficiaries will be subject to a federal penalty tax if required post-death distributions are not taken, or not taken in a timely manner. The penalty tax is equal to 50 percent of the undistributed required amount for a given year. This is the same penalty tax that applies when lifetime RMDs (see above) are not taken by the applicable deadline.
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Finally, the important point is that who or what you name as your beneficiary is crucial because it will ultimately determine how the funds are paid out after you die, and what portion is lost to taxes. Estate taxes may also be a factor to consider if you expect the value of your estate and/or your spouse's estate to exceed the federal applicable exclusion amount ($3.5 million for 2009, $2 million for 2008). Caution: In the case of a retirement plan account, the plan may be able to specify the post-death distribution options available to your beneficiaries. Those options may or may not be identical to the allowable options set forth in the IRS distribution rules. You should consult your plan administrator for details, as this could have an impact on your choice of beneficiaries.
Other considerations when choosing beneficiaries Income and estate taxes are very important considerations when choosing IRA and plan beneficiaries, but they are not the only factors that should enter into your decision. Never forget that, ultimately, you are deciding who will receive your IRA or retirement plan benefits after you die. Think carefully about who you want to provide for, and about how this decision fits into your overall estate plan. Consider the value of your IRA or retirement plan in relation to the value of all of your other assets. Designating the beneficiary of a $20,000 IRA that makes up five percent of your total assets is very different from designating the beneficiary of an $800,000 retirement plan that makes up 80 percent of your total assets. In the first situation, your decision impacts only a small portion of your total estate. In the second situation, your retirement plan is the bulk of your estate.
Designated beneficiaries vs. named beneficiaries Designated beneficiaries get preferential income tax treatment after your death. Being a "designated" beneficiary is not necessarily the same as being named as a beneficiary on a beneficiary designation form. IRAs and retirement plan accounts may have beneficiaries, but no designated beneficiaries. Designated beneficiaries are individuals (human beings) who are named as beneficiaries, do not share the IRA or plan account with nonindividuals, and are named in a timely manner. Charities and/or your estate can be named as beneficiaries, but they are not designated beneficiaries. A trust named as a beneficiary is not a designated beneficiary either, although the underlying beneficiaries of the trust can be designated beneficiaries under certain conditions. The distinction between a designated beneficiary and a named beneficiary is important because designated beneficiaries generally have more flexible post-death distribution options, often resulting in more favorable income tax treatment. For example, only a designated beneficiary can use the life expectancy payout method for post-death distributions. What happens if you have named both an individual and a non-individual (for example, a charity) as beneficiaries of your IRA or plan? Is the individual beneficiary allowed to use the life expectancy method to distribute his or her share? The answer is maybe. It depends on whether certain rules are followed. If you have left your IRA or plan to the beneficiaries in fractional amounts (as opposed to dollar amounts), the account may be divided into separate accounts up until December 31 of the calendar year following the year of your death. Then, the individual beneficiary can use his or her own life expectancy for his or her separate account. Or, the benefits due to the non-individual beneficiary can simply be paid out before September 30 of the calendar year following the year of your death. If the non-individual beneficiary has been fully paid off by the date indicated above, it is no longer considered a beneficiary for distribution purposes. (This approach can be used whether the non-individual beneficiary's share is expressed as a fractional amount or a dollar amount, but the separate accounts rules generally won't apply to pecuniary (specific dollar amount) bequests.) Caution: If separate accounts are not established by December 31 of the year following the year of your death, or benefits are not paid to the non-individual before September 30 of the year following the year of your death, then your entire account will generally be treated as if there were no designated beneficiary. Caution: The rules regarding separate accounts are complex. Consult a tax professional.
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Primary and secondary beneficiaries When it comes to beneficiary designation forms, your goal should be to avoid gaps. If you do not have a named beneficiary who survives you, your estate may end up as the "default" beneficiary of your IRA or plan. That typically produces the worst possible result in terms of estate and income taxes and other issues. Your primary beneficiary is your first choice to receive your retirement assets after you die. You can name more than one person or entity as your primary beneficiary (see below--Having multiple beneficiaries). If your primary beneficiary does not survive you or decides to decline the inherited funds (the tax term for this is a "disclaimer"), then your secondary beneficiaries (also called "contingent" beneficiaries) receive the assets. Typically, the beneficiary designation form that you complete will have separate sections for the different levels of beneficiaries.
Having multiple beneficiaries You may generally name more than one primary beneficiary to share in the IRA or retirement plan proceeds. You just need to specify (on the beneficiary designation form) the portion of the funds that you want each beneficiary to receive. This can be expressed as fractional amounts (i.e., percentages) or as fixed dollar amounts. Fractional or percentage amounts usually make more sense, since the dollar value of the account usually fluctuates with the underlying investments and the separate account rules (discussed below) generally won't apply to pecuniary (specific dollar amount) bequests. The account does not have to be divided equally among multiple beneficiaries. For example, you can leave 60 percent to one of your primary beneficiaries, and 20 percent each to your other two primary beneficiaries. In addition, you can designate multiple beneficiaries by name or by a grouping. For example, you might want to name your spouse as your primary beneficiary and your children as the secondary beneficiaries. You can do this by providing the full name of each person, or by listing them simply as "my spouse who survives me" and "my children who survive me." In some cases, you may want to designate a different beneficiary for each of your retirement accounts (assuming you have more than one), or divide an account into separate subaccounts (with a separate beneficiary for each subaccount). This could potentially allow each beneficiary to use his or her own life expectancy to calculate required post-death distributions, providing greater income tax deferral for your beneficiaries in many cases. If you do this, however, you should try to plan withdrawals from the different accounts accordingly. Taking most of your distributions from one IRA or plan account could leave the beneficiary of that account with less money than you had intended. If you have more than one beneficiary you want to provide for, the advantage of having one retirement account (or as few as possible) with multiple primary beneficiaries is reduced paperwork and record keeping. Account consolidation may also save you money in annual fees and other expenses. The drawback is that this may limit post-death options. For example, say your children are all named as primary beneficiaries of your one IRA, and they want to use the life expectancy method for post-death distributions. The calculation would generally have to be based on the age of the oldest child, subjecting the other children to a shorter payout period than they could otherwise have. This outcome can be avoided, however, if separate accounts are established for the children at some point. An IRA or plan account with multiple designated beneficiaries can generally be split into separate accounts at any time up until December 31 of the year following the year of your death (but note that designated beneficiaries are determined by September 30). Each account and its beneficiary might then be treated separately for purposes of determining required post-death distributions. Caution: The rules regarding "separate accounts" are complicated. Consult a tax professional.
When do you have to choose your beneficiaries? In the past, you typically had to choose a beneficiary for your IRA or retirement plan by your required beginning
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date for lifetime RMDs. Your choice was then "locked in" (at least for certain purposes) on the earlier of that date or the date of your death. The final IRS regulations issued in 2002 extend the deadline for finalizing your beneficiary choices for purposes of post-death distributions until September 30 of the year following your death. This gives you greater flexibility because you are now free to change beneficiaries any time during your life. Changes made after your required beginning date usually will not affect the distributions you are taking (since your choice of beneficiary, unless it is a more than 10 years younger spouse, now has no bearing on the calculation of your RMDs during your lifetime). The final regulation distribution rules also create significant opportunities for post-death planning. Since your IRA or plan beneficiaries are not finalized until September 30 of the year following your death, a beneficiary could either disclaim (refuse to accept) or cash out (withdraw) his or her share of the inherited funds by this deadline. That beneficiary would then be removed from the list of designated beneficiaries. Only those beneficiaries remaining as of the September 30 deadline would be considered when determining required post-death distributions from the account. Caution: Although the date for finalizing beneficiaries for distribution purposes is September 30 of the year following your death, an IRA or plan account can be split into separate accounts up until December 31 of that same year. Again, consult a tax professional regarding the rules for separate accounts.
Paying death taxes on IRA and plan benefits Consult your estate planner as to the source to pay any death taxes due on your IRA and retirement plan benefits. Depending on the death tax payment clause in your will and/or trust and state law, it could be that other assets are used to pay death taxes, or it might be that the benefits will be diminished by the payment of death taxes. An important part of completing your beneficiary designations is making sure that the source of payment of death taxes does not conflict with your overall estate plan.
Your options when choosing your beneficiaries The terms of your IRA or retirement plan may govern your beneficiary designations. As discussed, many qualified retirement plans require you to designate your spouse as beneficiary or, alternatively, that you have your spouse sign a consent and waiver. Some states (particularly community property states) may require similar spousal consent for IRAs. Assuming you have a choice, you should carefully consider your options and seek qualified professional advice. The designation of a beneficiary can involve income taxes, estate tax, and other important non-tax issues. Often it will make sense to name your spouse as beneficiary of your IRA or retirement plan benefits. In other cases, it may make sense to name a child, grandchild, or other individual, a trust, a charity, or in rare cases, your estate, as beneficiary. Make sure you understand the advantages and disadvantages of each particular beneficiary choice.
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Investment Planning throughout Retirement Introduction Investment planning during retirement is not the same as investing for retirement and, in many ways, is more complicated. Your working years are your saving years. With luck, your income increases from year to year as you receive promotions and/or pay raises; those increases offer some protection against rising costs caused by inflation. While you're working, your retirement objective generally is to grow retirement savings as much as possible, and investments that offer higher potential reward in exchange for greater potential for volatility and/or loss are often the focus for those retirement savings. When you retire, on the other hand, spending rather than saving becomes your focus. Your sources of income may include Social Security, employer pensions, personal savings and assets, and perhaps some income from working part-time. Typically, a retiree's objective is to derive sufficient income to maintain a chosen lifestyle and to make assets last as long as necessary. This can be a tricky balancing act. Uncertainty abounds--you don't know how long you'll live or whether rates of return will meet your expectations. If your income is fixed, inflation could erode its purchasing power over time, which may cause you to invade principal to meet day-to-day expenses. Or, your retirement plan may require that you make minimum withdrawals in excess of your needs, depleting your resources and triggering taxes unnecessarily. Further, your ability to tolerate risk is lessened--you have less time to recover from losses, and you may feel less secure about your finances in general. How, then, should you manage your investments during retirement given the above complications? The answer is different for everyone. You should tailor your plans to your own unique circumstances, and you may want to consult a financial planning professional for advice. The following discusses two important factors you should consider: (1) withdrawing income from retirement assets, and (2) balancing safety with growth.
Choosing a sustainable withdrawal rate A key factor that determines whether your assets will last for your entire lifetime is the rate at which you withdraw funds. The more you withdraw, the greater the likelihood you'll exhaust your resources too soon. On the other hand, if you withdraw too little, you may have to struggle to meet expenses; also, you could end up with assets in your estate, part of which may go to the government in taxes. It is vital that you estimate an appropriate withdrawal rate for your circumstances, and determine whether you should adjust your lifestyle and/or estate plan. Your withdrawal rate is typically expressed as a percentage of your overall assets, even though withdrawals may represent earnings, principal, or some combination of the two. For example, if you have $700,000 in assets and decide a 4 percent withdrawal rate is appropriate, the portfolio would need to earn $28,000 a year if you intend to withdraw only earnings; alternatively, you might set it up to earn $14,000 in interest and take the remaining $14,000 from the principal. An appropriate and sustainable withdrawal rate depends on many factors including the value of your current assets, your expected rate of return, your life expectancy, your risk tolerance, whether you adjust for inflation, how much your expenses are expected to be, and whether you want some assets left over for your heirs. Fortunately, you don't have to make a wild guess. Studies have tackled this issue, resulting in the creation of tables and calculators that can provide you with a range of rates that have some probability of success. However, you'll probably need some expert help to ensure that this important decision is made carefully.
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Withdrawing first from taxable, tax-deferred, or tax-free accounts Many retirees have assets in various types of accounts--taxable, tax-deferred (e.g., traditional IRAs), and tax-free (e.g., Roth IRAs). Given a choice, which type of account should you withdraw from first? The answer--it depends. Caution: Roth IRA earnings are generally free from federal income tax if certain conditions are met, but may not be free from state income tax. Retirees who will not have an estate For retirees who do not intend to leave assets to beneficiaries, the answer is simple in theory: Withdraw money from a taxable account first, then a tax-deferred account, and lastly, a tax-free account. This will provide for the greatest growth potential due to the power of compounding. In practice, however, your choices, to some extent, may be directed by tax rules. Retirement accounts, other than Roth IRAs, have minimum withdrawal requirements. In general, you must begin withdrawing from these accounts by April 1 of the year following the year you turn age 70½. Failure to do so can result in a 50 percent excise tax imposed on the amount by which the required minimum distribution exceeds the distribution you actually take. Retirees who will have an estate For retirees who intend to leave assets to beneficiaries, the analysis is more complicated. You need to coordinate your retirement plan with your estate plan. If you have appreciated or rapidly appreciating assets, it may be more advantageous for you to withdraw from tax-deferred and tax-free accounts first. This is because these accounts will not receive a step-up in basis at your death, as many of your other assets will, and your heirs could face a larger than necessary tax liability. Example(s): John is a widower with two children who retires at age 65. He has a tax-deferred pension plan valued at $200,000 and an investment portfolio holding appreciated shares of stock and bonds with a current value of $500,000 and a basis of $250,000. John's investment portfolio has been held long-term. Assume John is in the 15 percent tax bracket and his children are in the 33 percent tax bracket. Assume John's investment portfolio earns $25,000 each year, and assume no other variables. Say John dies four years later having made withdrawals totaling $100,000. Example(s): If John had withdrawn from his investment portfolio first, he would have paid $15,000 in federal ordinary income tax. His children would receive the $200,000 pension, on which they will have to pay federal ordinary income tax of $66,000. They would also receive the investment portfolio, which would receive a step-up in basis. Say the children sell the investment portfolio for $500,000 and owed no capital gains tax. In this scenario, the family (John and his children combined) pays $81,000 in federal taxes. Example(s): If John had withdrawn from his tax-deferred pension first, he would have paid $15,000 in federal ordinary income tax. His children would receive the $100,000 balance of the pension on which they would have to pay federal ordinary income tax of $33,000. They would also receive the $500,000 investment portfolio, which would receive a step-up in basis. Say the children sell the investment portfolio for $500,000 and owed no capital gains tax. In this scenario, the family (John and his children combined) pays $48,000 in federal taxes, $33,000 less than in the first scenario. Caution: The example above is for illustrative purposes only and does not represent the performance of any investment. However, this may not always be the best strategy. For example, if you intend to leave your entire estate to your spouse, it may be better to withdraw from taxable accounts first. This is because spouses are given preferential tax treatment with regard to retirement plans. As a beneficiary of a traditional IRA or retirement plan, a surviving spouse can roll over retirement plan funds to his or her own IRA or retirement plan, or, in some cases, may
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continue the deceased spouse's plan as his or her own. The funds in the plan continue to grow tax deferred, and distributions need not begin until the spouse's own required beginning date. For retirees who have a "stretch" IRA, you may want to take advantage of your ability to defer taxes over a number of generations. Tip: Retirees in this situation should consult a qualified estate planning attorney who has some expertise with regard to retirement plan assets.
Balancing safety and growth When you retire, you generally stop receiving income from wages, a salary, or other work-related activity and start relying on your assets for income. To ensure a consistent and reliable flow of income for your lifetime, you must provide some safety for your principal. This is why retirees typically shift at least a portion of their investment portfolio to more secure income-producing investments, and this makes a great deal of sense. Unfortunately, safety comes with a price--reduced growth potential and erosion of value due to inflation. Safety at the expense of growth can be a critical mistake for some retirees. On the other hand, if you invest too heavily in growth investments, your risk is heightened, and you may be forced to sell during a downturn in the market should you need more income. Retirees must find a way to strike a reasonable balance between safety and growth. One solution may be the "two bucket" approach. To implement this, you would determine your sustainable withdrawal rate (see above), and then reallocate a portion of your portfolio to fixed income investments (e.g., certificates of deposit and bonds) that will provide you with sufficient income for a predetermined number of years. You would then reallocate the balance of your portfolio to growth investments (e.g., stocks) that you can use to replenish that income "bucket" over time. The fixed income portion of your portfolio should be able to provide you with enough income (together with any other income you may receive, such as Social Security and required minimum distributions from retirement plans) to meet your expenses so you won't have to liquidate investments in the growth portion of your portfolio at a time when they may be down. This can help you ride out fluctuations in the market, and sell only when you think a sale is advantageous. Be sure that your fixed income investments will provide you with income when you'll need it. One way to accomplish this is by laddering. For example, if you're investing in bonds, instead of investing the entire amount in one issue that matures on a certain date, spread your investment over several issues with staggered maturity dates (e.g., one year, two years, three years). As each bond matures, reinvest the principal to maintain the pattern. As for the growth portion of your investment portfolio, common investing principles still apply: • Diversify your holdings • Invest on a tax-deferred or tax-free basis if possible • Monitor your portfolio and reallocate assets when appropriate Caution: For retirees investing in bonds, don't assume that individual bonds and bond funds are the same type of investment. Bond funds do not offer the two key characteristics offered by bonds: (1) income from bond funds is not fixed--dividends change depending on the bonds the funds has bought and sold as well as the prevailing interest rate, and (2) a bond fund does not have an obligation to return principal to you when bonds within the fund mature. Additionally, the risk associated with bond funds varies depending on the bonds held within the fund at any given time, whereas the risk associated with individual bonds generally decreases over time as a bond nears its maturity date (assuming the issuer's financial situation doesn't deteriorate). Finally, fees and charges associated with bond funds reduce returns. Even so, you may still find bond funds attractive because of their convenience. Just be sure you understand the differences between bond
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funds and individual bonds before you invest.
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Healthcare in Retirement What health care benefits are available in retirement? Health care in retirement is available from many sources. Government programs (such as Medicaid and Medicare) offer numerous health care benefits. However, you may need to purchase supplemental health insurance or Medigap, as well. Most Americans are eligible to begin receiving Medicare benefits at age 65, but qualifying for Medicaid may require some planning on your part. In addition to these resources, you may also be entitled to military health care benefits if you are a veteran, retired servicemember, or the spouse or widow of a veteran or retired servicemember. Continuing care retirement communities and nursing homes also offer health care services for older individuals. Depending on your specific needs and circumstances, you may use any number of these resources during your retirement years.
Medicare In general Medicare is a federal health insurance program created in 1965. Medicare primarily assists those who are 65 or older, but if you are disabled or have kidney disease, you may be eligible for Medicare coverage no matter what your age. Medicare currently consists of Part A (hospital insurance), Part B (medical insurance), Part C (which allows private insurance companies to offer Medicare benefits), and Part D (which covers the costs of prescription drugs), with each part having its own eligibility requirements. You may qualify for one or more parts, or you may choose to accept or decline coverage if you are eligible. Many health policies limit coverage for Medicare-eligible individuals regardless of whether they have accepted Medicare coverage. Medicare benefits for disabled individuals Under certain conditions, the disabled are eligible to enroll in Medicare before age 65. If you have been receiving (or have been entitled to receive) Social Security disability benefits for at least 24 months (not necessarily consecutively), you may be eligible to enroll in Medicare. To enroll, you must be entitled to benefits in one of the following categories: • A disabled individual of any age receiving worker's disability benefits • A disabled widow or widower age 50 or older • A disabled beneficiary who is older than age 18 and receives benefits based on a disability that occurred before age 22 In addition, Medicare may be available at any age if you are disabled as a result of chronic kidney failure requiring dialysis or a kidney transplant. For more information, see Medicare Benefits for Disabled Individuals. Qualified Medicare Beneficiary program If you have limited means, you may be eligible for the Qualified Medicare Beneficiary (QMB) program. Here, your state's Medicaid program may pay for your Medicare Part B premium, Part A and Part B deductibles, and coinsurance requirements. Eligibility rules may vary from state to state, but in general, you must meet the following three criteria: • You must be entitled to Medicare Part A • Your income must be at or below the national poverty level • The value of your assets must be below a certain level
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There are also other related programs that have somewhat less restrictive eligibility requirements. For more information, see Qualified Medicare Beneficiary Program.
Medigap In general Medigap is supplemental insurance specifically designed to cover some of the gaps in Medicare coverage. Although the name might lead you to believe otherwise, Medigap is provided by private health insurance companies, not the government. However, Medigap is strictly regulated by the federal government. Every Medigap policy offers certain basic core benefits, and various additional benefits may be included as well. The basic benefits and the optional benefits can only be combined in certain ways, creating 12 standard Medigap policy types. Basic Medigap will cover most of your Medicare co-payments, while optional benefits may cover your Medicare deductibles, prescription drugs, skilled nursing facility care, preventative care, and charges that result when a provider bills more than the Medicare-approved amount for a service. Caution: No new Medigap policies with drug coverage (plans H, I, and J) are currently being sold, although two new types of Medigap benefits packages are available (plans K and L).
Medicaid In general Medicaid provides medical assistance to aged, disabled, or blind individuals, or to needy, dependent children who could not otherwise afford the necessary medical care. Medicaid pays for a number of medical costs, including hospital bills, physician services, home health care, and long-term nursing home care. Each state administers its own Medicaid programs based on broad federal guidelines and regulations. Within these guidelines, each state performs the following: (1) determines its own eligibility requirements; (2) prescribes the amount, duration, and types of services; (3) chooses the rate of reimbursement for services; and (4) oversees its own program. Applying for benefits To apply for Medicaid, you must use a written application on a form prescribed by your state and signed under penalties of perjury. Give the application to your state Medicaid office. Typically, you will need to provide proof of age, marital status, residence, and citizenship, along with your Social Security number, verification of receipt of government benefits, and verification of your income and assets. A responsible individual can complete the application on behalf of an incompetent or incapacitated individual. For more information, see Applying for Benefits. Eligibility To qualify for Medicaid, you must meet two basic eligibility requirements. First, you must be considered categorically needy because of blindness, disability, old age, or by virtue of being the parent of a minor child. Next, you must be financially needy, which is determined by income and asset limitation tests. States have much discretion in determining which groups their Medicaid programs will cover, but as participants in Medicaid, they must provide coverage for all residents who are considered categorically needy. Caution: State and federal rules regarding Medicaid eligibility change frequently. For further information, see Eligibility for Medicaid. Transfer of assets Because Medicaid eligibility is based on your income and other resources, state Medicaid authorities are interested in knowing whether you have tried to transfer assets out of your name in order to qualify for Medicaid. When you apply for Medicaid, the state has the right to examine your finances and those of your spouse as far
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back as 60 months before the date you applied for Medicaid. Only certain transfers are prohibited. Fair market transactions will typically be considered legitimate, but if you transfer assets for less than fair market value around the time you apply for Medicaid, the state will presume that the transfer was made solely to help you qualify for Medicaid. For further information, see Transfer of Assets. Planning goals and strategies As mentioned earlier, the state has the right to look into your financial transactions to determine whether you have transferred assets solely to qualify for Medicaid. However, the state may count only the income and assets that are legally available to you for paying your bills. Consequently, several methods have been developed to help you shelter your assets from the state and facilitate Medicaid qualification. Proper planning can help you to qualify for Medicaid, shelter "countable" assets, preserve assets (including the family home) for loved ones, and protect the healthy spouse (if any). For more information, see Planning Goals and Strategies. Medicaid qualifying trusts To qualify for Medicaid, both your income and the value of your other assets must fall below certain limits (which vary from state to state). A trust helps you to qualify for Medicaid because it can shelter your income and assets, making them unavailable to you. The state Medicaid authorities cannot consider assets that are truly inaccessible to the Medicaid applicant. Therefore, anything that stays in an irrevocable trust will lie outside of your financial picture for Medicaid eligibility purposes. If you are looking for a strategy to shelter your resources, one of the following may be appropriate: (1) an irrevocable income-only trust, (2) an irrevocable trust in which the creator of the trust is not a beneficiary, (3) a Miller trust, or (4) a special needs trust. For further information, see Medicaid Qualifying Trusts. Protection of principal residence In certain cases, the state may be entitled to seek reimbursement for Medicaid payments by forcing the sale of your principal residence if you are a Medicaid recipient. Medicaid planning tools have been devised to protect your home, but their effectiveness varies. Therefore, it is important to weigh the costs and benefits of each device carefully. If you are looking for a strategy to preserve your home for loved ones, one of the following four methods may be appropriate: (1) an outright transfer or gift of the home, (2) a transfer subject to life estate, (3) a transfer subject to special power of appointment, or (4) a transfer in trust. For more information, see Protection of Principal Residence. Medicaid and long-term care insurance Long-term care (LTC) insurance can be useful as part of your Medicaid planning strategy. Your LTC policy can subsidize your nursing home bills during the Medicaid ineligibility period caused by your transfer of assets to third parties. Thus, it may be possible for you to give your assets away to loved ones, have the security of paid nursing home bills during the ineligibility period, and qualify for Medicaid when the LTC policy runs out. For further information, see Medicaid and Long-Term Care Insurance. Medicaid liens and estate recoveries Federal law requires states to seek reimbursement from Medicaid recipients for Medicaid payments made on their behalf. Cost-recovery actions against the assets of Medicaid recipients may come in two forms: (1) real or personal property liens and (2) recovery from decedents' estates. A Medicaid lien makes it impossible for you to sell or refinance your house without the state's knowledge and ability to collect what it is owed. As for recovery from decedents' estates, states also can seek reimbursement from your probate estate after you die. States have the option to expand the definition of estate to include all nonprobate assets as well. For more information, see Medicaid Liens and Estate Recoveries.
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Divorce and Medicaid From a purely financial perspective, divorce can be a practical move and may actually be used as a Medicaid planning tool. When a spouse enters a nursing home and applies for Medicaid, the couple's assets must be pooled together and totaled to determine what portion the healthy spouse may keep. After this Spousal Resource Allowance has been determined, the Medicaid applicant must transfer assets representing the amount of the allowance to the healthy spouse. The remaining assets must be spent on the institutionalized partner's medical care. A divorce court order can supersede the normal Spousal Resource Allowance rules prescribed under state Medicaid regulations. You should consult your legal advisor for further information. For more information, see Divorce and Medicaid.
Military benefits Disability benefits, health-care benefits, and long-term care benefits are available through various military programs sponsored by the Department of Defense and the Department of Veterans Affairs (VA), formerly known as the Veterans Administration. Health care for veterans is typically available at VA hospitals and health-care facilities. In general, active service members, retirees, and veterans other than those who were dishonorably discharged are eligible for military benefits. Survivors of servicemembers and veterans are also generally eligible for some of the same benefits. However, the rules surrounding these benefits can be complex and may change frequently. It is best to check with your military personnel office or local VA office if you have questions about any of these benefits. For further information on military health care benefits and eligibility requirements, see Military Benefits.
Choosing a continuing care retirement community Continuing care retirement communities (CCRCs) are retirement facilities that offer housing, meals, activities, and health care to their residents. These communities appeal to people who are currently in good health but who worry that they may need nursing care later on. The CCRC and the resident sign a contract guaranteeing that the CCRC will provide housing and nursing home care throughout the resident's life and that, in return, the resident pays an entrance fee and a monthly fee. In choosing a CCRC, you should consider factors such as the entrance fee and monthly fees, insurance requirements, the financial stability of the CCRC, its facilities and activities, and the quality of medical care provided to residents. For more information, see Choosing a Continuing Care Retirement Community.
Choosing a nursing home A nursing home is a licensed facility that provides skilled nursing care, intermediate care, and custodial care. Although you may prefer in-home care, you may have to enter a nursing home if you need round-the-clock care, especially if you can't get help from family or an in-home caregiver. When choosing a nursing home, you should consider factors such as the cost of the home, the quality of medical care provided, the appearance and the safety of the facilities, the ratio of staff to residents, and recreational opportunities. For further information, see Choosing a Nursing Home. Paying for nursing home care Nursing home care can be extremely expensive, and paying for this care is a problem that weighs heavily on the minds of older Americans and their families. There are several resources you can use in planning for this expense, including self-insurance, long-term care insurance, Medicare (limited benefits), Medicaid, and military benefits. For more information, see Paying for Nursing Home Care.
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Personal Residence Issues in Retirement What is it? As you grow older, housing issues become an integral part of your retirement plans. You may be living on a fixed income and want to get additional cash by borrowing against the equity in your home. You may feel isolated in that big house you bought 30 years ago when your children were young. Perhaps your health isn't what it used be, and you may desire more convenient access to medical services or may need around-the-clock care. Maybe you want to leave your home to your children and avoid estate taxes if possible. These are just a few of the personal residence issues you may be facing in retirement. It is important to make a timely examination of the primary residence issues in your life. Financial, emotional, and physical considerations will drive your decisions. Careful planning may allow you to enrich the quality of your retirement years, get the health care and services you need, and maximize the financial benefits of homeownership for you and your family.
Getting the most out of your current home If you are living on a fixed income, you may want to use the equity in your home to obtain additional cash. One way in which you can tap the equity in your home is by obtaining a reverse mortgage. One advantage of a reverse mortgage is that repayment is deferred until a later time. A home equity loan or second mortgage may also provide you with cash, but repayment is not deferred. Renting your home may provide you with additional cash flow and tax benefits, and seeking relief from real estate taxes may allow you to lower the expense of maintaining your home. If you plan to leave your home to your family, you may be able to avoid estate taxes and continue using the home as your principal residence. A qualified personal residence trust allows you to transfer the home to your intended heirs now and retain the right to use the home for a number of years. A gift- or sale-leaseback transaction also involves a current transfer of your home but requires you to rent the home thereafter. If instead you decide to sell the house and move to a more agreeable climate or closer to the grandchildren, you should know that under the current tax laws, you may be able to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain.
Other residence options You should carefully consider your housing options before pulling up stakes and moving out. There may be advantages to staying where you are and financial products to help you do so. You may also be able to take advantage of in-home care programs if you need in-home healthcare services, household help, or personal care assistance. However, if you decide to move on, you also have choices. Moving in with (or near) your children often seems the obvious choice, but be aware of your emotional and physical needs before taking over the spare room in your child's house. If you need independence but don't want to buy another house, consider an independent living community (retirement community) where you can rent or own a condominium or townhouse. Someone else will mow the lawn and shovel the sidewalk, but you can enjoy the privacy of your own living space. If you are faced with physical or medical limitations, assisted living options may be your best bet. Typical assisted living arrangements provide you with a room or apartment, housekeeping services, meals, transportation, and, in some cases, nursing services. When you need more care, your last resort may be a quality nursing home.
Choosing a continuing care retirement community Choosing and paying for a nursing home The prospect of entering a nursing home can be a frightening one. However, there are good facilities that provide
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care and services not available elsewhere. You must choose carefully. Examine the quality of medical care and the cost of the care. Look at the appearance of the facility and grounds. Find out about safety and security. Ask about recreational activities and staff-to-resident ratios. There are a number of ways to pay for nursing home care. You may have sufficient savings, or you may have long-term care insurance. Long-term care (LTC) insurance premiums may be tax deductible, and you may be able to exclude LTC insurance reimbursements from income. Government benefits may also pay for a portion of your nursing home costs.
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How Earnings Affect Social Security If you begin to receive Social Security retirement (or survivor's) benefits before you reach full retirement age, money you earn over a certain limit will reduce the amount of your Social Security benefit. In 2010, your benefit will be reduced by $1 for every $2 of earnings in excess of $14,160.* The chart below shows the effect of annual earnings of $10,000, $20,000 and $30,000 on a $12,000 annual Social Security benefit ($1,000 monthly) for someone who hasn't yet reached full retirement age.
Source: Social Security Administration, 2010
*Special rules apply in both the year you reach full retirement age and the year you retire if you have not reached full retirement age.
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Retirement Planning: The Basics You may have a very idealistic vision of retirement--doing all of the things that you never seem to have time to do now. But how do you pursue that vision? Social Security may be around when you retire, but the benefit that you get from Uncle Sam may not provide enough income for your retirement years. To make matters worse, few employers today offer a traditional company pension plan that guarantees you a specific income at retirement. On top of that, people are living longer and must find ways to fund those additional years of retirement. Such eye-opening facts mean that today, sound retirement planning is critical. But there's good news: Retirement planning is easier than it used to be, thanks to the many tools and resources available. Here are some basic steps to get you started.
Determine your retirement income needs It's common to discuss desired annual retirement income as a percentage of your current income. Depending on who you're talking to, that percentage could be anywhere from 60 to 90 percent, or even more. The appeal of this approach lies in its simplicity. The problem, however, is that it doesn't account for your specific situation. To determine your specific needs, you may want to estimate your annual retirement expenses. Use your current expenses as a starting point, but note that your expenses may change dramatically by the time you retire. If you're nearing retirement, the gap between your current expenses and your retirement expenses may be small. If retirement is many years away, the gap may be significant, and projecting your future expenses may be more difficult. Remember to take inflation into account. The average annual rate of inflation over the past 20 years has been approximately 3 percent. (Source: Consumer price index (CPI-U) data published annually by the U.S. Department of Labor, 2009.) And keep in mind that your annual expenses may fluctuate throughout retirement. For instance, if you own a home and are paying a mortgage, your expenses will drop if the mortgage is paid off by the time you retire. Other expenses, such as health-related expenses, may increase in your later retirement years. A realistic estimate of your expenses will tell you about how much yearly income you'll need to live comfortably.
Calculate the gap Once you have estimated your retirement income needs, take stock of your estimated future assets and income. These may come from Social Security, a retirement plan at work, a part-time job, and other sources. If estimates show that your future assets and income will fall short of what you need, the rest will have to come from additional personal retirement savings.
Figure out how much you'll need to save By the time you retire, you'll need a nest egg that will provide you with enough income to fill the gap left by your other income sources. But exactly how much is enough? The following questions may help you find the answer: • At what age do you plan to retire? The younger you retire, the longer your retirement will be, and the more money you'll need to carry you through it. • What is your life expectancy? The longer you live, the more years of retirement you'll have to fund. • What rate of growth can you expect from your savings now and during retirement? Be conservative when projecting rates of return. • Do you expect to dip into your principal? If so, you may deplete your savings faster than if you just live off investment earnings. Build in a cushion to guard against these risks.
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Build your retirement fund: Save, save, save When you know roughly how much money you'll need, your next goal is to save that amount. First, you'll have to map out a savings plan that works for you. Assume a conservative rate of return (e.g., 5 to 6 percent), and then determine approximately how much you'll need to save every year between now and your retirement to reach your goal. The next step is to put your savings plan into action. It's never too early to get started (ideally, begin saving in your 20s). To the extent possible, you may want to arrange to have certain amounts taken directly from your paycheck and automatically invested in accounts of your choice (e.g., 401(k) plans, payroll deduction savings). This arrangement reduces the risk of impulsive or unwise spending that will threaten your savings plan--out of sight, out of mind. If possible, save more than you think you'll need to provide a cushion.
Understand your investment options You need to understand the types of investments that are available, and decide which ones are right for you. If you don't have the time, energy, or inclination to do this yourself, hire a financial professional. He or she will explain the options that are available to you, and will assist you in selecting investments that are appropriate for your goals, risk tolerance, and time horizon.
Use the right savings tools The following are among the most common retirement savings tools, but others are also available. Employer-sponsored retirement plans that allow employee deferrals (like 401(k), 403(b), SIMPLE, and 457(b) plans) are powerful savings tools. Your contributions come out of your salary as pretax contributions (reducing your current taxable income) and any investment earnings are tax deferred until withdrawn. These plans often include employer-matching contributions and should be your first choice when it comes to saving for retirement. Both 401(k) and 403(b) plans can also allow after-tax Roth contributions. While Roth contributions don’t offer an immediate tax benefit, qualified distributions from your Roth account are federal income tax free. IRAs, like employer-sponsored retirement plans, feature tax deferral of earnings. If you are eligible, traditional IRAs may enable you to lower your current taxable income through deductible contributions. Withdrawals, however, are taxable as ordinary income (unless you've made nondeductible contributions, in which case a portion of the withdrawals will not be taxable). Roth IRAs don't permit tax-deductible contributions but allow you to make completely tax-free withdrawals under certain conditions. With both types, you can typically choose from a wide range of investments to fund your IRA. Annuities are generally funded with after-tax dollars, but their earnings are tax deferred (you pay tax on the portion of distributions that represents earnings). There is generally no annual limit on contributions to an annuity. A typical annuity provides income payments beginning at some future time, usually retirement. The payments may last for your life, for the joint life of you and a beneficiary, or for a specified number of years (guarantees are subject to the claims-paying ability of the issuing insurance company). Note: In addition to any income taxes owed, a 10 percent premature distribution penalty tax may apply to distributions made from employer-sponsored retirement plans, IRAs, and annuities prior to age 59½ (prior to age 55 for employer-sponsored retirement plans in some circumstances).
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Estimating Your Retirement Income Needs You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you'll need to fund your retirement. That's not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.
Use your current income as a starting point It's common to discuss desired annual retirement income as a percentage of your current income. Depending on who you're talking to, that percentage could be anywhere from 60 to 90 percent, or even more. The appeal of this approach lies in its simplicity, and the fact that there's a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you'll no longer be liable for (e.g., payroll taxes) will, theoretically, allow you to sustain your current lifestyle. The problem with this approach is that it doesn't account for your specific situation. If you intend to travel extensively in retirement, for example, you might easily need 100 percent (or more) of your current income to get by. It's fine to use a percentage of your current income as a benchmark, but it's worth going through all of your current expenses in detail, and really thinking about how those expenses will change over time as you transition into retirement.
Project your retirement expenses Your annual income during retirement should be enough (or more than enough) to meet your retirement expenses. That's why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all of your expenses and projecting how much you'll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses: • Food and clothing • Housing: Rent or mortgage payments, property taxes, homeowners insurance, property upkeep and repairs • Utilities: Gas, electric, water, telephone, cable TV • Transportation: Car payments, auto insurance, gas, maintenance and repairs, public transportation • Insurance: Medical, dental, life, disability, long-term care • Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs • Taxes: Federal and state income tax, capital gains tax • Debts: Personal loans, business loans, credit card payments • Education: Children's or grandchildren's college expenses • Gifts: Charitable and personal • Savings and investments: Contributions to IRAs, annuities, and other investment accounts • Recreation: Travel, dining out, hobbies, leisure activities • Care for yourself, your parents, or others: Costs for a nursing home, home health aide, or other type of
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assisted living • Miscellaneous: Personal grooming, pets, club memberships Don't forget that the cost of living will go up over time. The average annual rate of inflation over the past 20 years has been approximately 3 percent. (Source: Consumer price index (CPI-U) data published annually by the U.S. Department of Labor, 2009.) And keep in mind that your retirement expenses may change from year to year. For example, you may pay off your home mortgage or your children's education early in retirement. Other expenses, such as health care and insurance, may increase as you age. To protect against these variables, build a comfortable cushion into your estimates (it's always best to be conservative). Finally, have a financial professional help you with your estimates to make sure they're as accurate and realistic as possible.
Decide when you'll retire To determine your total retirement needs, you can't just estimate how much annual income you need. You also have to estimate how long you'll be retired. Why? The longer your retirement, the more years of income you'll need to fund it. The length of your retirement will depend partly on when you plan to retire. This important decision typically revolves around your personal goals and financial situation. For example, you may see yourself retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement package will make that possible. Although it's great to have the flexibility to choose when you'll retire, it's important to remember that retiring at 50 will end up costing you a lot more than retiring at 65.
Estimate your life expectancy The age at which you retire isn't the only factor that determines how long you'll be retired. The other important factor is your lifespan. We all hope to live to an old age, but a longer life means that you'll have even more years of retirement to fund. You may even run the risk of outliving your savings and other income sources. To guard against that risk, you'll need to estimate your life expectancy. You can use government statistics, life insurance tables, or a life expectancy calculator to get a reasonable estimate of how long you'll live. Experts base these estimates on your age, gender, race, health, lifestyle, occupation, and family history. But remember, these are just estimates. There's no way to predict how long you'll actually live, but with life expectancies on the rise, it's probably best to assume you'll live longer than you expect.
Identify your sources of retirement income Once you have an idea of your retirement income needs, your next step is to assess how prepared you are to meet those needs. In other words, what sources of retirement income will be available to you? Your employer may offer a traditional pension that will pay you monthly benefits. In addition, you can likely count on Social Security to provide a portion of your retirement income. To get an estimate of your Social Security benefits, visit the Social Security Administration website (www.ssa.gov) and order a copy of your statement. Additional sources of retirement income may include a 401(k) or other retirement plan, IRAs, annuities, and other investments. The amount of income you receive from those sources will depend on the amount you invest, the rate of investment return, and other factors. Finally, if you plan to work during retirement, your job earnings will be another source of income.
Make up any income shortfall If you're lucky, your expected income sources will be more than enough to fund even a lengthy retirement. But what if it looks like you'll come up short? Don't panic--there are probably steps that you can take to bridge the gap. A financial professional can help you figure out the best ways to do that, but here are a few suggestions: • Try to cut current expenses so you'll have more money to save for retirement • Shift your assets to investments that have the potential to substantially outpace inflation (but keep in mind that investments that offer higher potential returns may involve greater risk of loss)
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• Lower your expectations for retirement so you won't need as much money (no beach house on the Riviera, for example) • Work part-time during retirement for extra income • Consider delaying your retirement for a few years (or longer)
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Evaluating an Early Retirement Offer In today's corporate environment, cost cutting, restructuring, and downsizing are the norm, and many employers are offering their employees early retirement packages. But how do you know if the seemingly attractive offer you've received is a good one? By evaluating it carefully to make sure that the offer fits your needs.
What's the severance package? Most early retirement offers include a severance package that is based on your annual salary and years of service at the company. For example, your employer might offer you one or two weeks' salary (or even a month's salary) for each year of service. Make sure that the severance package will be enough for you to make the transition to the next phase of your life. Also, make sure that you understand the payout options available to you. You may be able to take a lump-sum severance payment and then invest the money to provide income, or use it to meet large expenses. Or, you may be able to take deferred payments over several years to spread out your income tax bill on the money.
How does all of this affect your pension? If your employer has a traditional pension plan, the retirement benefits you receive from the plan are based on your age, years of service, and annual salary. You typically must work until your company's normal retirement age (usually 65) to receive the maximum benefits. This means that you may receive smaller benefits if you accept an offer to retire early. The difference between this reduced pension and a full pension could be large, because pension benefits typically accrue faster as you near retirement. However, your employer may provide you with larger pension benefits until you can start collecting Social Security at age 62. Or, your employer might boost your pension benefits by adding years to your age, length of service, or both. These types of pension sweeteners are key features to look for in your employer's offer--especially if a reduced pension won't give you enough income.
Does the offer include health insurance? Does your employer's early retirement offer include medical coverage for you and your family? If not, look at your other health insurance options, such as COBRA, a private policy, or dependent coverage through your spouse's employer-sponsored plan. Because your health-care costs will probably increase as you age, an offer with no medical coverage may not be worth taking if these other options are unavailable or too expensive. Even if the offer does include medical coverage, make sure that you understand and evaluate the coverage. Will you be covered for life, or at least until you're eligible for Medicare? Is the coverage adequate and affordable (some employers may cut benefits or raise premiums for early retirees)? If your employer's coverage doesn't meet your health insurance needs, you may be able to fill the gaps with other insurance.
What other benefits are available? Some early retirement offers include employer-sponsored life insurance. This can help you meet your life insurance needs, and the coverage probably won't cost you much (if anything). However, continued employer coverage is usually limited (e.g., one year's coverage equal to your annual salary) or may not be offered at all. This may not be a problem if you already have enough life insurance elsewhere, or if you're financially secure and don't need life insurance. Otherwise, weigh your needs against the cost of buying an individual policy. You may also be able to convert some of your old employer coverage to an individual policy, though your premium will be higher than when you were employed. In addition, a good early retirement offer may include other perks. Your employer may provide you and other early retirees with financial planning assistance. This can come in handy if you feel overwhelmed by all of the financial issues that early retirement brings. Your employer may also offer job placement assistance to help you find other employment. If you have company stock options, your employer may give you more time to exercise
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them. Other benefits, such as educational assistance, may also be available. Check with your employer to find out exactly what its offer includes.
Can you afford to retire early? To decide if you should accept an early retirement offer, you can't just look at the offer itself. You have to consider your total financial picture. Can you afford to retire early? Even if you can, will you still be able to reach all of your retirement goals? These are tough questions that a financial professional should help you sort out, but you can take some basic steps yourself. Identify your sources of retirement income and the yearly amount you can expect from each source. Then, estimate your annual retirement expenses (don't forget taxes and inflation) and make sure your income will be more than enough to meet them. You may find that you can accept your employer's offer and probably still have the retirement lifestyle you want. But remember, these are only estimates. Build in a comfortable cushion in case your expenses increase, your income drops, or you live longer than expected. If you don't think you can afford early retirement, it may be better not to accept your employer's offer. The longer you stay in the workforce, the shorter your retirement will be and the less money you'll need to fund it. Working longer may also allow you to build larger savings in your IRAs, retirement plans, and investments. However, if you really want to retire early, making some smart choices may help you overcome the obstacles. Try to lower or eliminate some of your retirement expenses. Consider a more aggressive approach to investing. Take a part-time job for extra income. Finally, think about electing early Social Security benefits at age 62, but remember that your monthly benefit will be smaller if you do this.
What if you can't afford to retire? Finding a new job You may find yourself having to accept an early retirement offer, even though you can't afford to retire. One way to make up for the difference between what you receive from your early retirement package and your old paycheck is to find a new job, but that doesn't mean that you have to abandon your former line of work for a new career. You can start by finding out if your former employer would hire you as a consultant. Or, you may find that you would like to turn what was once just a hobby into a second career. Then there is always the possibility of finding full-time or part-time employment with a new company. However, for the employee who has 20 years of service with the same company, the prospect of job hunting may be terrifying. If you have been out of the job market for a long time, you might not feel comfortable or have experience marketing yourself for a new job. Some companies provide career counseling to assist employees in re-entering the workforce. If your company does not provide you with this service, you may want to look into corporate outplacement firms and nonprofit organizations in your area that deal with career transition. Note: Many early retirement offers contain noncompetition agreements or offer monetary inducements on the condition that you agree not to work for a competitor. However, you'll generally be able to work for a new employer and still receive your pension and other retirement plan benefits.
What will happen if you say no? If you refuse early retirement, you may continue to thrive with your employer. You could earn promotions and salary raises that boost your pension. You could receive a second early retirement offer that's better than the first one. But, you may not be so lucky. Consider whether your position could be eliminated down the road. If the consequences of saying no are hard to predict, use your best judgment and seek professional advice. But don't take too long. You may have only a short window of time, typically 60 to 90 days, to make your decision.
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Taking Advantage of Employer-Sponsored Retirement Plans Employer-sponsored qualified retirement plans such as 401(k)s are some of the most powerful retirement savings tools available. If your employer offers such a plan and you're not participating in it, you should be. Once you're participating in a plan, try to take full advantage of it.
Understand your employer-sponsored plan Before you can take advantage of your employer's plan, you need to understand how these plans work. Read everything you can about the plan and talk to your employer's benefits officer. You can also talk to a financial planner, a tax advisor, and other professionals. Recognize the key features that many employer-sponsored plans share: • Your employer automatically deducts your contributions from your paycheck. You may never even miss the money--out of sight, out of mind. • You decide what portion of your salary to contribute, up to the legal limit. And you can usually change your contribution amount on certain dates during the year. • With 401(k), 403(b), 457(b), SARSEPs, and SIMPLE plans, you contribute to the plan on a pretax basis. Your contributions come off the top of your salary before your employer withholds income taxes. • • Your 401(k) or 403(b) plan may let you make after-tax Roth contributions--there's no up-front tax benefit but qualified distributions are entirely tax free. • Your employer may match all or part of your contribution up to a certain level. You typically become vested in these employer dollars through years of service with the company. • Your funds grow tax deferred in the plan. You don't pay taxes on investment earnings until you withdraw your money from the plan. • You'll pay income taxes and possibly an early withdrawal penalty if you withdraw your money from the plan. • You may be able to borrow a portion of your vested balance (up to $50,000) at a reasonable interest rate. • Your creditors cannot reach your plan funds to satisfy your debts.
Contribute as much as possible The more you can save for retirement, the better your chances of retiring comfortably. If you can, max out your contribution up to the legal limit. If you need to free up money to do that, try to cut certain expenses. Why put your retirement dollars in your employer's plan instead of somewhere else? One reason is that your pretax contributions to your employer's plan lower your taxable income for the year. This means you save money in taxes when you contribute to the plan--a big advantage if you're in a high tax bracket. For example, if you earn $100,000 a year and contribute $10,000 to a 401(k) plan, you'll pay income taxes on $90,000 instead of $100,000. (Roth contributions don't lower your current taxable income but qualified distributions of your contributions and earnings--that is, distributions made after you satisfy a five-year holding period and reach age 59½, become disabled, or die--are tax free.)
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Another reason is the power of tax-deferred growth. Your investment earnings compound year after year and aren't taxable as long as they remain in the plan. Over the long term, this gives you the opportunity to build an impressive sum in your employer's plan. You should end up with a much larger balance than somebody who invests the same amount in taxable investments at the same rate of return. For example, you participate in your employer's tax-deferred plan (Account A). You also have a taxable investment account (Account B). Each account earns 8 percent per year. You're in the 28 percent tax bracket and contribute $10,000 to each account at the end of every year. You pay the yearly income taxes on Account B's earnings using funds from that same account. At the end of 30 years, Account A is worth $1,132,832, while Account B is worth only $757,970. That's a difference of over $370,000. (Note: This example is for illustrative purposes only and does not represent a specific investment.)
Capture the full employer match If you can't max out your 401(k) or other plan, you should at least try to contribute up to the limit your employer will match. Employer contributions are basically free money once you're vested in them (check with your employer to find out when vesting happens). By capturing the full benefit of your employer's match, you'll be surprised how much faster your balance grows. If you don't take advantage of your employer's generosity, you could be passing up a significant return on your money. For example, you earn $30,000 a year and work for an employer that has a matching 401(k) plan. The match is 50 cents on the dollar up to 6 percent of your salary. Each year, you contribute 6 percent of your salary ($1,800) to the plan and receive a matching contribution of $900 from your employer.
Evaluate your investment choices carefully Most employer-sponsored plans give you a selection of mutual funds or other investments to choose from. Make your choices carefully. The right investment mix for your employer's plan could be one of your keys to a comfortable retirement. That's because over the long term, varying rates of return can make a big difference in the size of your balance. Research the investments available to you. How have they performed over the long term? Have they held their own during down markets? How much risk will they expose you to? Which ones are best suited for long-term goals like retirement? You may also want to get advice from a financial professional (either your own, or one provided through your plan). He or she can help you pick the right investments based on your personal goals, your attitude toward risk, how long you have until retirement, and other factors. Your financial professional can also help you coordinate your plan investments with your overall investment portfolio. Finally, you may be able to change your investment allocations or move money between the plan's investments on specific dates during the year (e.g., at the start of every month or every quarter).
Know your options when you leave your employer When you leave your job, your vested balance in your former employer's retirement plan is yours to keep. You have several options at that point, including: • Taking a lump-sum distribution. This is often a bad idea, because you'll pay income taxes and possibly a penalty on the amount you withdraw. Plus, you're giving up continued tax-deferred growth. • Leaving your funds in the old plan, growing tax deferred (your old plan may not permit this if your balance is less than $5,000, or if you've reached the plan's normal retirement age--typically age 65). This may be a good idea if you're happy with the plan's investments or you need time to decide what to do with your money. • Rolling your funds over to an IRA or a new employer's plan if the plan accepts rollovers. This is often a smart move because there will be no income taxes or penalties if you do the rollover properly (your old
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plan will withhold 20 percent for income taxes if you receive the funds before rolling them over). Plus, your funds will keep growing tax deferred in the IRA or new plan.
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Understanding IRAs An individual retirement arrangement (IRA) is a personal savings plan that offers specific tax benefits. IRAs are one of the most powerful retirement savings tools available to you. Even if you're contributing to a 401(k) or other plan at work, you should also consider investing in an IRA.
What types of IRAs are available? The two major types of IRAs are traditional IRAs and Roth IRAs. Both allow you to contribute as much as $5,000 in 2009 and 2010. You must have at least as much taxable compensation as the amount of your IRA contribution. But if you are married filing jointly, your spouse can also contribute to an IRA, even if he or she does not have taxable compensation. The law also allows taxpayers age 50 and older to make additional "catch-up" contributions. These folks can contribute up to $6,000 in 2009 and 2010. Both traditional and Roth IRAs feature tax-sheltered growth of earnings. And both give you a wide range of investment choices. However, there are important differences between these two types of IRAs. You must understand these differences before you can choose the type of IRA that's best for you. Note: Special rules apply to qualified individuals impacted by certain natural disasters, taxpayers who receive certain Exxon Valdez settlement payments, certain former Enron employees, certain employees of bankrupt airlines, and certain reservists and national guardsmen called to active duty after September 11, 2001.
Learn the rules for traditional IRAs Practically anyone can open and contribute to a traditional IRA. The only requirements are that you must have taxable compensation and be under age 70½. You can contribute the maximum allowed each year as long as your taxable compensation for the year is at least that amount. If your taxable compensation for the year is below the maximum contribution allowed, you can contribute only up to the amount that you earned. Your contributions to a traditional IRA may be tax deductible on your federal income tax return. This is important because tax-deductible (pretax) contributions lower your taxable income for the year, saving you money in taxes. If neither you nor your spouse is covered by a 401(k) or other employer-sponsored plan, you can generally deduct the full amount of your annual contribution. If one of you is covered by such a plan, your ability to deduct your contributions depends on your annual income (modified adjusted gross income, or MAGI) and your income tax filing status: For 2010, if you are covered by a retirement plan at work, and: • Your filing status is single or head of household, and your MAGI is $56,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $56,000 and less than $66,000, and you can't deduct your contribution at all if your MAGI is $66,000 or more. • Your filing status is married filing jointly or qualifying widow(er), and your MAGI is $89,000 or less, your traditional IRA contribution is fully deductible. Your deduction is reduced if your MAGI is more than $89,000 and less than $109,000, and you can't deduct your contribution at all if your MAGI is $109,000 or more. • Your filing status is married filing separately, your traditional IRA deduction is reduced if your MAGI is less than $10,000, and you can't deduct your contribution at all if your MAGI is $10,000 or more. For 2010, if you are not covered by a retirement plan at work, but your spouse is, and you file a joint tax return, your traditional IRA contribution is fully deductible if your MAGI is $167,000 or less. Your deduction is reduced if your MAGI is more than $167,000 and less than $177,000, and you can't deduct your contribution at all if your MAGI is $177,000 or more.
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What happens when you start taking money from your traditional IRA? Any portion of a distribution that represents deductible contributions is subject to income tax because those contributions were not taxed when you made them. Any portion that represents investment earnings is also subject to income tax because those earnings were not previously taxed either. Only the portion that represents nondeductible, after-tax contributions (if any) is not subject to income tax. In addition to income tax, you may have to pay a 10 percent early withdrawal penalty if you're under age 59½, unless you meet one of the exceptions. If you wish to defer taxes, you can leave your funds in the traditional IRA, but only until April 1 of the year following the year you reach age 70½. That's when you have to take your first required minimum distribution from the IRA. After that, you must take a distribution by the end of every calendar year until you die or your funds are exhausted. The annual distribution amounts are based on a standard life expectancy table. You can always withdraw more than you're required to in any year. However, if you withdraw less, you'll be hit with a 50 percent penalty on the difference between the required minimum and the amount you actually withdrew. (The Worker, Retiree and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year.)
Learn the rules for Roth IRAs Not everyone can set up a Roth IRA. Even if you can, you may not qualify to take full advantage of it. The first requirement is that you must have taxable compensation. If your taxable compensation in 2010 is at least $5,000, you may be able to contribute the full amount. But it gets more complicated. Your ability to contribute to a Roth IRA in any year depends on your MAGI and your income tax filing status: • If your filing status is single or head of household, and your MAGI for 2010 is $105,000 or less, you can make a full contribution to your Roth IRA. Your Roth IRA contribution is reduced if your MAGI is more than $105,000 and less than $120,000, and you can't contribute to a Roth IRA at all if your MAGI is $120,000 or more. • If your filing status is married filing jointly or qualifying widow(er), and your MAGI for 2010 is $167,000 or less, you can make a full contribution to your Roth IRA. Your Roth IRA contribution is reduced if your MAGI is more than $167,000 and less than $177,000, and you can't contribute to a Roth IRA at all if your MAGI is $177,000 or more. • If your filing status is married filing separately, your Roth IRA contribution is reduced if your MAGI is less than $10,000, and you can't contribute to a Roth IRA at all if your MAGI is $10,000 or more. Your contributions to a Roth IRA are not tax deductible. You can invest only after-tax dollars in a Roth IRA. The good news is that if you meet certain conditions, your withdrawals from a Roth IRA will be completely income tax free, including both contributions and investment earnings. To be eligible for these qualifying distributions, you must meet a five-year holding period requirement. In addition, one of the following must apply: • You have reached age 59½ by the time of the withdrawal • The withdrawal is made because of disability • The withdrawal is made to pay first-time home-buyer expenses ($10,000 lifetime limit) • The withdrawal is made by your beneficiary or estate after your death Qualified distributions will also avoid the 10 percent early withdrawal penalty. This ability to withdraw your funds with no taxes or penalties is a key strength of the Roth IRA. And remember, even nonqualified distributions will be taxed (and possibly penalized) only on the investment earnings portion of the distribution, and then only to the extent that your distribution exceeds the total amount of all contributions that you have made. Another advantage of the Roth IRA is that there are no required distributions after age 70½ or at any time during your life. You can put off taking distributions until you really need the income. Or, you can leave the entire balance to your beneficiary without ever taking a single distribution. Also, as long as you have taxable compensation and qualify, you can keep contributing to a Roth IRA after age 70½.
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Choose the right IRA for you Assuming you qualify to use both, which type of IRA is best for you? Sometimes the choice is easy. The Roth IRA will probably be a more effective tool if you don't qualify for tax-deductible contributions to a traditional IRA. However, if you can deduct your traditional IRA contributions, the choice is more difficult. The Roth IRA may very well make more sense if you want to minimize taxes during retirement and preserve assets for your beneficiaries. But a traditional deductible IRA may be a better tool if you want to lower your yearly tax bill while you're still working (and probably in a higher tax bracket than you'll be in after you retire). A financial professional or tax advisor can help you pick the right type of IRA for you. Note: You can have both a traditional IRA and a Roth IRA, but your total annual contribution to all of the IRAs that you own cannot be more than $5,000 for 2010 ($6,000 if you're age 50 or older).
Know your options for transferring your funds You can move funds from an IRA to the same type of IRA with a different institution (e.g., traditional to traditional, Roth to Roth). No taxes or penalty will be imposed if you arrange for the old IRA trustee to transfer your funds directly to the new IRA trustee. The other option is to have your funds distributed to you first and then roll them over to the new IRA trustee yourself. You'll still avoid taxes and penalty as long as you complete the rollover within 60 days from the date you receive the funds. You may also be able to convert funds from a traditional IRA to a Roth IRA. This decision is complicated, however, so be sure to consult a tax advisor. He or she can help you weigh the benefits of shifting funds against the tax consequences and other drawbacks. Note: The IRS has the authority to waive the 60-day rule for rollovers under certain limited circumstances, such as proven hardship.
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Annuities and Retirement Planning You may have heard that IRAs and employer-sponsored plans (e.g., 401(k)s) are the best ways to invest for retirement. That's true for many people, but what if you've maxed out your contributions to those accounts and want to save more? An annuity may be a good investment to look into.
Get the lay of the land An annuity is a tax-deferred investment contract. The details on how it works vary, but here's the general idea. You invest your money (either a lump sum or a series of contributions) with a life insurance company that sells annuities (the annuity issuer). The period when you are funding the annuity is known as the accumulation phase. In exchange for your investment, the annuity issuer promises to make payments to you or a named beneficiary at some point in the future. The period when you are receiving payments from the annuity is known as the distribution phase. Chances are, you'll start receiving payments after you retire.
Understand your payout options Understanding your annuity payout options is very important. Keep in mind that payments are based on the claims-paying ability of the issuer. You want to be sure that the payments you receive will meet your income needs during retirement. Here are some of the most common payout options: • You surrender the annuity and receive a lump-sum payment of all of the money you have accumulated. • You receive payments from the annuity over a specific number of years, typically between 5 and 20. If you die before this "period certain" is up, your beneficiary will receive the remaining payments. • You receive payments from the annuity for your entire lifetime. You can't outlive the payments (no matter how long you live), but there will typically be no survivor payments after you die. • You combine a lifetime annuity with a period certain annuity. This means that you receive payments for the longer of your lifetime or the time period chosen. Again, if you die before the period certain is up, your beneficiary will receive the remaining payments. • You elect a joint and survivor annuity so that payments last for the combined life of you and another person, usually your spouse. When one of you dies, the survivor receives payments for the rest of his or her life. When you surrender the annuity for a lump sum, your tax bill on the investment earnings will be due all in one year. The other options on this list provide you with a guaranteed stream of income (subject to the claims-paying ability of the issuer). They're known as annuitization options because you've elected to spread payments over a period of years. Part of each payment is a return of your principal investment. The other part is taxable investment earnings. You typically receive payments at regular intervals throughout the year (usually monthly, but sometimes quarterly or yearly). The amount of each payment depends on the amount of your principal investment, the particular type of annuity, the length of the payout period, your age if payments for lifetime payments, and other factors.
Consider the pros and cons An annuity can often be a great addition to your retirement portfolio. Here are some reasons to consider investing in an annuity: • Your investment earnings are tax deferred as long as they remain in the annuity. You don't pay income tax on those earnings until they are paid out to you.
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• An annuity may be free from the claims of your creditors in some states. • If you die with an annuity, the annuity's death benefit will pass to your beneficiary without having to go through probate. • Your annuity can be a reliable source of retirement income, and you have some freedom to decide how you'll receive that income. • You don't have to meet income tests or other criteria to invest in an annuity. • You're not subject to an annual contribution limit, unlike IRAs and employer-sponsored plans. You can contribute as much or as little as you like in any given year. • You're not required to start taking distributions from an annuity at age 70½ (the required minimum distribution age for IRAs and employer-sponsored plans). You can typically postpone payments until you need the income. But annuities aren't for everyone. Here are some potential drawbacks: • Contributions to nonqualified annuities are made with after-tax dollars and are not tax deductible. • Once you've elected to annuitize payments, you usually can't change them, but there are some exceptions. • You can take your money from an annuity before you start receiving payments, but your annuity issuer may impose a surrender charge if you withdraw your money within a certain number of years (e.g., seven) after your original investment. • You may have to pay other costs when you invest in an annuity (e.g., annual fees, investment management fees, insurance expenses). • You may be subject to a 10 percent federal penalty tax (in addition to any regular income tax) if you withdraw your money from an annuity before age 59½, unless you meet one of the exceptions to this rule. • Investment gains are taxed at ordinary income tax rates, not at the lower capital gains rate.
Choose the right type of annuity If you think that an annuity is right for you, your next step is to decide which type of annuity. Overwhelmed by all of the annuity products on the market today? Don't be. In fact, most annuities fit into a small handful of categories. Your choices basically revolve around two key questions. First, how soon would you like annuity payments to begin? That probably depends on how close you are to retiring. If you're near retirement or already retired, an immediate annuity may be your best bet. This type of annuity starts making payments to you shortly after you buy the annuity, typically within a year or less. But what if you're younger, and retirement is still a long-term goal? Then you're probably better off with a deferred annuity. As the name suggests, this type of annuity lets you postpone payments until a later time, even if that's many years down the road. Second, how would you like your money invested? With a fixed annuity, the annuity issuer determines an interest rate to credit to your investment account. An immediate fixed annuity guarantees a particular rate, and your payment amount never varies. A deferred fixed annuity guarantees your rate for a certain number of years; your rate then fluctuates from year to year as market interest rates change. A variable annuity, whether immediate or deferred, gives you more control and the chance to earn a better rate of return (although with a greater potential for gain comes a greater potential for loss). You select your own investments from the subaccounts that the annuity issuer offers. Your payment amount will vary based on how your investments perform.
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Note:Variable annuities are sold by prospectus. You should consider the investment objectives, risk, charges and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity, can be obtained from the insurance company issuing the variable annuity or from your financial professional. You should read the prospectus carefully before you invest.
Shop around It pays to shop around for the right annuity. In fact, doing a little homework could save you hundreds of dollars a year or more. Why? Rates of return and costs can vary widely between different annuities. You'll also want to shop around for a reputable, financially sound annuity issuer. There are firms that make a business of rating insurance companies based on their financial strength, investment performance, and other factors. Consider checking out these ratings.
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Choosing a Beneficiary for Your IRA or 401(k) Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for other assets such as life insurance. With retirement benefits, you need to know the impact of income tax and estate tax laws in order to select the right beneficiaries. Although taxes shouldn't be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make an incorrect choice. In addition, if you're married, beneficiary designations may affect the size of minimum required distributions to you from your IRAs and retirement plans while you're alive.
Paying income tax on most retirement distributions Most inherited assets such as bank accounts, stocks, and real estate pass to your beneficiaries without income tax being due. However, that's not usually the case with 401(k) plans and IRAs. Beneficiaries pay ordinary income tax on distributions from 401(k) plans and traditional IRAs. With Roth IRAs and Roth 401(k)s, however, your beneficiaries can receive the benefits free from income tax if all of the tax requirements are met. That means you need to consider the impact of income taxes when designating beneficiaries for your 401(k) and IRA assets. For example, if one of your children inherits $100,000 cash from you and another child receives your 401(k) account worth $100,000, they aren't receiving the same amount. The reason is that all distributions from the 401(k) plan will be subject to income tax at ordinary income tax rates, while the cash isn't subject to income tax when it passes to your child upon your death. Similarly, if one of your children inherits your taxable traditional IRA and another child receives your income-tax-free Roth IRA, the bottom line is different for each of them.
Naming or changing beneficiaries When you open up an IRA or begin participating in a 401(k), you are given a form to complete in order to name your beneficiaries. Changes are made in the same way--you complete a new beneficiary designation form. A will or trust does not override your beneficiary designation form. However, spouses may have special rights under federal or state law. It's a good idea to review your beneficiary designation form at least every two to three years. Also, be sure to update your form to reflect changes in financial circumstances. Beneficiary designations are important estate planning documents. Seek legal advice as needed.
Designating primary and secondary beneficiaries When it comes to beneficiary designation forms, you want to avoid gaps. If you don't have a named beneficiary who survives you, your estate may end up as the beneficiary, which is not always the best result. Your primary beneficiary is your first choice to receive retirement benefits. You can name more than one person or entity as your primary beneficiary. If your primary beneficiary doesn't survive you or decides to decline the benefits (the tax term for this is a disclaimer), then your secondary (or "contingent") beneficiaries receive the benefits.
Having multiple beneficiaries You can name more than one beneficiary to share in the proceeds. You just need to specify the percentage each beneficiary will receive (the shares do not have to be equal). You should also state who will receive the proceeds
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should a beneficiary not survive you. In some cases, you'll want to designate a different beneficiary for each account or have one account divided into subaccounts (with a beneficiary for each subaccount). You'd do this to allow each beneficiary to use his or her own life expectancy in calculating required distributions after your death. This, in turn, can permit greater tax deferral (delay) and flexibility for your beneficiaries in paying income tax on distributions.
Avoiding gaps or naming your estate as a beneficiary There are two ways your retirement benefits could end up in your probate estate. Probate is the court process by which assets are transferred from someone who has died to the heirs or beneficiaries entitled to those assets. First, you might name your estate as the beneficiary. Second, if no named beneficiary survives you, your probate estate may end up as the beneficiary by default. If your probate estate is your beneficiary, several problems can arise. If your estate receives your retirement benefits, the opportunity to maximize tax deferral by spreading out distributions may be lost. In addition, probate can mean paying attorney's and executor's fees and delaying the distribution of benefits.
Naming your spouse as a beneficiary When it comes to taxes, your spouse is usually the best choice for a primary beneficiary. A spousal beneficiary has the greatest flexibility for delaying distributions that are subject to income tax. In addition to rolling over your 401(k) or IRA to his or her IRA, a surviving spouse can decide to treat your IRA as his or her own IRA. This can provide more tax and planning options. If your spouse is more than 10 years younger than you, then naming your spouse can also reduce the size of any required taxable distributions to you from retirement assets while you're alive. This can allow more assets to stay in the retirement account longer and delay the payment of income tax on distributions. Although naming a surviving spouse can produce the best income tax result, that isn't necessarily the case with death taxes. One possible downside to naming your spouse as the primary beneficiary is that it will increase the size of your spouse's estate for death tax purposes. That's because at your death, your spouse can inherit an unlimited amount of assets and defer federal death tax until both of you are deceased (note: special tax rules and requirements apply for a surviving spouse who is not a U.S. citizen). However, this may result in death tax or increased death tax when your spouse dies. If your spouse's taxable estate for federal tax purposes at his or her death exceeds the applicable exclusion amount (formerly known as the unified credit), then federal death tax may be due at his or her death. The applicable exclusion amount is $3.5 million in 2009 ($2 million in 2008).
Naming other individuals as beneficiaries You may have some limits on choosing beneficiaries other than your spouse. No matter where you live, federal law dictates that your surviving spouse be the primary beneficiary of your 401(k) plan benefit unless your spouse signs a timely, effective written waiver. And if you live in one of the community property states, your spouse may have rights related to your IRA regardless of whether he or she is named as the primary beneficiary. Keep in mind that a nonspouse beneficiary cannot roll over your 401(k) or IRA to his or her own IRA. However, a nonspouse beneficiary may be able to roll over all or part of your 401(k) benefits to an inherited IRA (plans are not required to offer this option until 2010).
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Naming a trust as a beneficiary You must follow special tax rules when naming a trust as a beneficiary, and there may be income tax complications. Seek legal advice before designating a trust as a beneficiary.
Naming a charity as a beneficiary In general, naming a charity as the primary beneficiary will not affect required distributions to you during your lifetime. However, after your death, having a charity named with other beneficiaries on the same asset could affect the tax-deferral possibilities of the noncharitable beneficiaries, depending on how soon after your death the charity receives its share of the benefits.
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Your Home as a Source of Dollars in Retirement If you own a home, you may be wealthier than you think. The equity in your home could be one of your largest assets, especially if your mortgage has been paid down over the years or paid off. This home equity can be a valuable source of extra income during your retirement years.
How do you tap your home equity? There are two ways to tap your home equity if you're approaching retirement (or already retired) and don't want to make mortgage payments: You can trade down, or you can use a reverse mortgage. Trading down involves selling your present home and replacing it with a smaller, less expensive home. A reverse mortgage is a home mortgage in which the lender makes monthly payments to you, rather than you making monthly payments to the lender. Both of these strategies can give you substantial additional income during retirement. Note: You could get money from your home by taking a home equity loan, where you place a regular mortgage on your home. But you must repay the home equity loan, with interest, like other regular home mortgages.
Trading down can give you increased income If your home is larger than you need, trading down to a smaller place may be a good way to increase your retirement income. The difference between the price that you receive for your present home and the cost of a smaller new home can be added to your retirement funds to provide you with additional investment income. The amount of cash that you can get by trading down depends on the value of your present home, the cost of purchasing a new home, and the incidental costs involved in the trade (e.g., brokerage commissions, legal fees, closing costs, and moving expenses). You should estimate these amounts to get some idea of the net amount that you will receive. To check the present value of your home, you should get an estimate of its selling price from two or three real estate agents. You should also get an estimate of the cost of your replacement home by shopping around for the type of home that you think you'll want. Note: If you think that the tax consequences of trading down are a drawback, think again. You may be able to exclude from federal taxation up to $250,000 ($500,000 if you're married and file a joint return) of any resulting capital gain, regardless of your age. To qualify for this exclusion, you generally must have owned and used the home as your principal residence for a total of two out of the five years before the sale. An individual, or either spouse in a married couple, can generally use this exemption only once every two years. However, even if you don't meet these tests, a partial exemption may be available. (For sales and exchanges made after December 31, 2008, this homesale exclusion won't apply to the extent the gain is allocated to periods (not including any period before January 1, 2009) during which the property was not used as your, or your spouse's, principal residence.)
Trading down can reduce your housing costs The other important financial benefit of trading down is that it reduces housing costs--often substantially. A smaller home usually means lower real estate taxes and smaller bills for heating, cooling, insurance, and maintenance costs. If your move is from a single-family house to a condominium, your costs will be reduced even more because outside painting, roof repair, landscaping, and similar costs disappear into lower monthly condo fees. You should carefully estimate the amount of the cost savings that you'll get from trading down. Compare the annual cost of maintaining your present home with the expected annual cost of maintaining your new home. Be sure to prorate expenses that do not occur regularly, such as indoor and outdoor painting and roof repairs.
But trading down may have disadvantages Consider the possible drawbacks of trading down. For instance, you may not want to reduce your living space by moving to a smaller home. Or, you may not be able to find a smaller home as attractive as your present home.
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Another common problem with trading down occurs if you are strongly attached to your present home. You may not want to be uprooted from your home and the social network around it. Still, you may also be troubled by worries that afflict many older homeowners, such as rising property taxes, the threat of escalating insurance, and the unexpected cost of major repairs. You may decide that trading down is warranted to lighten these worries as well as your financial burden. Note: If you sell your home at a gain and aren't eligible for the capital gain homesale exclusion, you'll have to pay federal income taxes on the difference between the selling price and your adjusted basis (the initial cost of your home, plus amounts you've paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes) in the home.
A reverse mortgage can also give you increased income If you are older and have substantial equity in your home, a reverse mortgage can give you a valuable supplemental source of retirement income. You can receive this income based on the equity that you have built up over the years in your home--without having to repay the reverse mortgage during your life. The amount of the monthly payment you receive from a reverse mortgage depends on four factors: • Your age • The amount of equity in your home • The interest rate charged by the lender • Closing costs The older you are and the more the equity in your home, the larger your monthly payments will be. Also, a lower interest rate and lower closing costs will increase your payments.
A reverse mortgage lets you keep your present home for life As discussed, you may not want to trade down for a variety of reasons, including attachment to your present home. With a reverse mortgage, you can increase your income and continue to live in your present home for life. The mortgage typically becomes due when you no longer live in the home. When reverse mortgage payments last as long as you live in your home, the mortgage is known as a tenure reverse mortgage. You can get other types of reverse mortgages, including an annuity advance reverse mortgage. With the annuity mortgage, payments last as long as you live, regardless of whether you continue to live in your home.
But a reverse mortgage is not without drawbacks With a reverse mortgage, you must mortgage your home to the lender. Each payment that you receive from the lender increases the amount of principal and interest that you owe on the mortgage. Although the mortgage typically does not become due while you're still living in the home, the equity value of your home is reduced by each payment that you receive. This reduction in the equity value of your home may have a negative effect on your children's ultimate inheritance. Note: If you face a retirement income shortage, this equity reduction may be preferable to a reduction in your standard of living. Also, in the rare case where the value of your home appreciates more rapidly than the mortgage loan increases, equity reduction does not occur. A reverse mortgage may have other drawbacks, including: • High up-front costs: The closing costs for a reverse mortgage normally exceed the closing costs for a conventional mortgage. This means that a reverse mortgage may not be cost effective if you plan to
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remain in your home for only a few years. • No reduction in homeowner costs: Unlike trading down to a home with lower housing expenses, a reverse mortgage does not reduce your housing costs. Since you stay in your home, you still face real estate taxes, insurance, repairs, and other costs associated with the home.
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Understanding Defined Benefit Plans You may be counting on funds from a defined benefit plan to help you achieve a comfortable retirement. Often referred to as traditional pension plans, defined benefit plans promise to pay you a specified amount at retirement. To help you understand the role a defined benefit plan might play in your retirement savings strategy, here's a look at some basic plan attributes. But since every employer's plan is a little different, you'll need to read the summary plan description, or SPD, provided by your company to find out the details of your own plan.
What are defined benefit plans? Defined benefit plans are qualified employer-sponsored retirement plans. Like other qualified plans, they offer tax incentives both to employers and to participating employees. For example, your employer can generally deduct contributions made to the plan. And you generally won't owe tax on those contributions until you begin receiving distributions from the plan (usually during retirement). However, these tax incentives come with strings attached--all qualified plans, including defined benefit plans, must comply with a complex set of rules under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.
How do defined benefit plans work? A defined benefit plan guarantees you a certain benefit when you retire. How much you receive generally depends on factors such as your salary, age, and years of service with the company. Each year, pension actuaries calculate the future benefits that are projected to be paid from the plan, and ultimately determine what amount, if any, needs to be contributed to the plan to fund that projected benefit payout. Employers are normally the only contributors to the plan. But defined benefit plans can require that employees contribute to the plan, although it's uncommon. You may have to work for a specific number of years before you have a permanent right to any retirement benefit under a plan. This is generally referred to as "vesting." If you leave your job before you fully vest in an employer's defined benefit plan, you won't get full retirement benefits from the plan.
How are retirement benefits calculated? Retirement benefits under a defined benefit plan are based on a formula. This formula can provide for a set dollar amount for each year you work for the employer, or it can provide for a specified percentage of earnings. Many plans calculate an employee's retirement benefit by averaging the employee's earnings during the last few years of employment (or, alternatively, averaging an employee's earnings for his or her entire career), taking a specified percentage of the average, and then multiplying it by the employee's number of years of service. Note: Many defined benefit pension plan formulas also reduce pension benefits by a percentage of the amount of Social Security benefits you can expect to receive.
How will retirement benefits be paid? Many defined benefit plans allow you to choose how you want your benefits to be paid. Payment options commonly offered include: • A single life annuity: You receive a fixed monthly benefit until you die; after you die, no further payments are made to your survivors. • A qualified joint and survivor annuity: You receive a fixed monthly benefit until you die; after you die,
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your surviving spouse will continue to receive benefits (in an amount equal to at least 50 percent of your benefit) until his or her death. • A lump-sum payment: You receive the entire value of your plan in a lump sum; no further payments will be made to you or your survivors. Choosing the right payment option is important, because the option you choose can affect the amount of benefit you ultimately receive. You'll want to consider all of your options carefully, and compare the benefit payment amounts under each option. Because so much may hinge on this decision, you may want to discuss your options with a financial advisor.
What are some advantages offered by defined benefit plans? • Defined benefit plans can be a major source of retirement income. They're generally designed to replace a certain percentage (e.g., 70 percent) of your preretirement income when combined with Social Security. • Benefits do not hinge on the performance of underlying investments, so you know ahead of time how much you can expect to receive at retirement. • Most benefits are insured up to a certain annual maximum by the federal government through the Pension Benefit Guaranty Corporation (PBGC).
How do defined benefit plans differ from defined contribution plans? Though it's easy to do, don't confuse a defined benefit plan with another type of qualified retirement plan, the defined contribution plan (e.g., 401(k) plan, profit-sharing plan). As the name implies, a defined benefit plan focuses on the ultimate benefits paid out. Your employer promises to pay you a certain amount at retirement and is responsible for making sure that there are enough funds in the plan to eventually pay out this amount, even if plan investments don't perform well. In contrast, defined contribution plans focus primarily on current contributions made to the plan. Your plan specifies the contribution amount you're entitled to each year (contributions made by either you or your employer), but your employer is not obligated to pay you a specified amount at retirement. Instead, the amount you receive at retirement will depend on the investments you choose and how those investments perform. Some employers offer hybrid plans. Hybrid plans include defined benefit plans that have many of the characteristics of defined contribution plans. One of the most popular forms of a hybrid plan is the cash balance plan.
What are cash balance plans? Cash balance plans are defined benefit plans that in many ways resemble defined contribution plans. Like defined benefit plans, they are obligated to pay you a specified amount at retirement, and are insured by the federal government. But they also offer one of the most familiar features of a defined contribution plan: Retirement funds accumulate in an individual account (in this case, a hypothetical account). This allows you to easily track how much retirement benefit you have accrued. And your benefit is portable. If you leave your employer, you can generally opt to receive a lump-sum distribution of your vested account balance. These funds can be rolled over to an individual retirement account (IRA) or to your new employer's retirement plan.
What you should do now It's never too early to start planning for retirement. Your pension income, along with Social Security, personal savings, and investment income, can help you realize your dream of living well in retirement.
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Start by finding out how much you can expect to receive from your defined benefit plan when you retire. Your employer will send you this information every year. But read the fine print. Estimates often assume that you'll retire at age 65 with a single life annuity. Your monthly benefit could end up to be far less if you retire early or receive a joint and survivor annuity. Finally, remember that most defined benefit plans don't offer cost-of-living adjustments, so benefits that seem generous now may be worth a lot less in the future when inflation takes its toll. Here are some other things you can do to make the most of your defined benefit plan: • Read the summary plan description. It provides details about your company's pension plan and includes important information, such as vesting requirements and payment options. Address questions to your plan administrator if there's anything you don't understand. • Review your account information, making sure you know what benefits you are entitled to. Do this periodically, checking your Social Security number, date of birth, and the compensation used to calculate your benefits, since these are common sources of error. • Notify your plan administrator of any life changes that may affect your benefits (e.g., marriage, divorce, death of spouse). • Keep track of the pension information for each company you've worked for. Make sure you have copies of pension plan statements that accurately reflect the amount of benefits you're entitled to receive. • Watch out for changes. Employers are allowed to change and even terminate pension plans, but you will receive ample notice. The key is, read all notices you receive. • Assess the impact of changing jobs on your pension. Consider staying with one employer at least until you're vested. Keep in mind that the longer you stay with one employer, the more you're likely to receive at retirement.
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Closing a Retirement Income Gap When you determine how much income you'll need in retirement, you may base your projection on the type of lifestyle you plan to have and when you want to retire. However, as you grow closer to retirement, you may discover that your income won't be enough to meet your needs. If you find yourself in this situation, you'll need to adopt a plan to bridge this projected income gap.
Delay retirement: 65 is just a number One way of dealing with a projected income shortfall is to stay in the workforce longer than you had planned. This will allow you to continue supporting yourself with a salary rather than dipping into your retirement savings. Depending on your income, this could also increase your Social Security retirement benefit. You'll also be able to delay taking your Social Security benefit or distributions from retirement accounts. At normal retirement age (which varies, depending on the year you were born), you will receive your full Social Security retirement benefit. You can elect to receive your Social Security retirement benefit as early as age 62, but if you begin receiving your benefit before your normal retirement age, your benefit will be reduced. Conversely, if you delay retirement, you can increase your Social Security benefit. Remember, too, that income from a job may affect the amount of Social Security retirement benefit you receive if you are under normal retirement age. Your benefit will be reduced by $1 for every $2 you earn over a certain earnings limit ($14,160 in 2009 and 2010). But once you reach normal retirement age, you can earn as much as you want without affecting your Social Security retirement benefit. Another advantage of delaying retirement is that you can continue to build tax-deferred funds in your IRA or employer-sponsored retirement plan. Keep in mind, though, that you may be required to start taking minimum distributions from your qualified retirement plan or traditional IRA once you reach age 70½, if you want to avoid harsh penalties. And if you're covered by a pension plan at work, you could also consider retiring and then seeking employment elsewhere. This way you can receive a salary and your pension benefit at the same time. Some employers, to avoid losing talented employees this way, are beginning to offer "phased retirement" programs that allow you to receive all or part of your pension benefit while you’re still working. Make sure you understand your pension plan options.
Spend less, save more You may be able to deal with an income shortfall by adjusting your spending habits. If you're still years away from retirement, you may be able to get by with a few minor changes. However, if retirement is just around the corner, you may need to drastically change your spending and saving habits. Saving even a little money can really add up if you do it consistently and earn a reasonable rate of return. Make permanent changes to your spending habits and you'll find that your savings will last even longer. Start by preparing a budget to see where your money is going. Here are some suggested ways to stretch your retirement dollars: • Refinance your home mortgage if interest rates have dropped since you took the loan. • Reduce your housing expenses by moving to a less expensive home or apartment. • Sell one of your cars if you have two. When your remaining car needs to be replaced, consider buying a used one. • Access the equity in your home. Use the proceeds from a second mortgage or home equity line of credit to pay off higher-interest-rate debts.
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• Transfer credit card balances from higher-interest cards to a low- or no-interest card, and then cancel the old accounts. • Ask about insurance discounts and review your insurance needs (e.g., your need for life insurance may have lessened). • Reduce discretionary expenses such as lunches and dinners out. Earmark the money you save for retirement and invest it immediately. If you can take advantage of an IRA, 401(k), or other tax-deferred retirement plan, you should do so. Funds invested in a tax-deferred account will generally grow more rapidly than funds invested in a non-tax-deferred account.
Reallocate your assets: consider investing more aggressively Some people make the mistake of investing too conservatively to achieve their retirement goals. That's not surprising, because as you take on more risk, your potential for loss grows as well. But greater risk also generally entails greater reward. And with life expectancies rising and people retiring earlier, retirement funds need to last a long time. That's why if you are facing a projected income shortfall, you should consider shifting some of your assets to investments that have the potential to substantially outpace inflation. The amount of investment dollars you should keep in growth-oriented investments depends on your time horizon (how long you have to save) and your tolerance for risk. In general, the longer you have until retirement, the more aggressive you can afford to be. Still, if you are at or near retirement, you may want to keep some of your funds in growth-oriented investments, even if you decide to keep the bulk of your funds in more conservative, fixed-income investments. Get advice from a financial professional if you need help deciding how your assets should be allocated. And remember, no matter how you decide to allocate your money, rebalance your portfolio now and again. Your needs will change over time, and so should your investment strategy.
Accept reality: lower your standard of living If your projected income shortfall is severe enough or if you're already close to retirement, you may realize that no matter what measures you take, you will not be able to afford the retirement lifestyle you've dreamed of. In other words, you will have to lower your expectations and accept a lower standard of living. Fortunately, this may be easier to do than when you were younger. Although some expenses, like health care, generally increase in retirement, other expenses, like housing costs and automobile expenses, tend to decrease. And it's likely that your days of paying college bills and growing-family expenses are over. Once you are within a few years of retirement, you can prepare a realistic budget that will help you manage your money in retirement. Think long term: Retirees frequently get into budget trouble in the early years of retirement, when they are adjusting to their new lifestyles. Remember that when you are retired, every day is Saturday, so it's easy to start overspending.
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Understanding Social Security Over 55 million people today receive some form of Social Security benefits, including 90 percent of retired workers over age 65. (Source: Fast Facts & Figures About Social Security, 2009) But Social Security is more than just a retirement program. Its scope has expanded to include other benefits as well, such as disability, family, and survivor's benefits.
How does Social Security work? The Social Security system is based on a simple premise: Throughout your career, you pay a portion of your earnings into a trust fund by paying Social Security or self-employment taxes. Your employer, if any, contributes an equal amount. In return, you receive certain benefits that can provide income to you when you need it most--at retirement or when you become disabled, for instance. Your family members can receive benefits based on your earnings record, too. The amount of benefits that you and your family members receive depends on several factors, including your average lifetime earnings, your date of birth, and the type of benefit that you're applying for. Your earnings and the taxes you pay are reported to the Social Security Administration (SSA) by your employer, or if you are self-employed, by the Internal Revenue Service. The SSA uses your Social Security number to track your earnings and your benefits. Finding out what earnings have been reported to the SSA and what benefits you can expect to receive is easy. Just check out your Social Security Statement, mailed by the SSA annually to anyone age 25 or older who is not already receiving Social Security benefits. You'll receive this statement each year about three months before your birthday. It summarizes your earnings record and estimates the retirement, disability, and survivor's benefits that you and your family members may be eligible to receive. You can also order a statement at the SSA website, at your local SSA office, or by calling (800) 772-1213.
Social Security eligibility When you work and pay Social Security taxes, you earn credits that enable you to qualify for Social Security benefits. You can earn up to 4 credits per year, depending on the amount of income that you have. Most people must build up 40 credits (10 years of work) to be eligible for Social Security retirement benefits, but need fewer credits to be eligible for disability benefits or for their family members to be eligible for survivor's benefits.
Your retirement benefits If you were born before 1938, you will be eligible for full retirement benefits at age 65. If you were born in 1938 or later, the age at which you are eligible for full retirement benefits will be different. That's because full retirement age is gradually increasing to age 67. But you don't have to wait until full retirement age to begin receiving benefits. No matter what your full retirement age, you can begin receiving early retirement benefits at age 62. Doing so is often advantageous: Although you'll receive a reduced benefit if you retire early, you'll receive benefits for a longer period than someone who retires at full retirement age. You can also choose to delay receiving retirement benefits past full retirement age. If you delay retirement, the Social Security benefit that you eventually receive will be as much as 6 to 8 percent higher. That's because you'll receive a delayed retirement credit for each month that you delay receiving retirement benefits, up to age 70. The amount of this credit varies, depending on your year of birth.
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Disability benefits If you become disabled, you may be eligible for Social Security disability benefits. The SSA defines disability as a physical or mental condition severe enough to prevent a person from performing substantial work of any kind for at least a year. This is a strict definition of disability, so if you're only temporarily disabled, don't expect to receive Social Security disability benefits--benefits won't begin until the sixth full month after the onset of your disability. And because processing your claim may take some time, apply for disability benefits as soon as you realize that your disability will be long term.
Family benefits If you begin receiving retirement or disability benefits, your family members might also be eligible to receive benefits based on your earnings record. Eligible family members may include: • Your spouse age 62 or older, if married at least 1 year • Your former spouse age 62 or older, if you were married at least 10 years • Your spouse or former spouse at any age, if caring for your child who is under age 16 or disabled • Your children under age 18, if unmarried • Your children under age 19, if full-time students (through grade 12) or disabled • Your children older than 18, if severely disabled Each family member may receive a benefit that is as much as 50 percent of your benefit. However, the amount that can be paid each month to a family is limited. The total benefit that your family can receive based on your earnings record is about 150 to 180 percent of your full retirement benefit amount. If the total family benefit exceeds this limit, each family member's benefit will be reduced proportionately. Your benefit won't be affected.
Survivor's benefits When you die, your family members may qualify for survivor's benefits based on your earnings record. These family members include: • Your widow(er) or ex-spouse age 60 or older (or age 50 or older if disabled) • Your widow(er) or ex-spouse at any age, if caring for your child who is under under 16 or disabled • Your children under 18, if unmarried • Your children under age 19, if full-time students (through grade 12) or disabled • Your children older than 18, if severely disabled • Your parents, if they depended on you for at least half of their support Your widow(er) or children may also receive a one-time $255 death benefit immediately after you die.
Applying for Social Security benefits You can apply for Social Security benefits in person at your local Social Security office. You can also begin the process by calling (800) 772-1213 or by filling out an on-line application on the Social Security website. The SSA suggests that you contact its representative the year before the year you plan to retire, to determine when you
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should apply and begin receiving benefits. If you're applying for disability or survivor's benefits, apply as soon as you are eligible. Depending on the type of Social Security benefits that you are applying for, you will be asked to furnish certain records, such as a birth certificate, W-2 forms, and verification of your Social Security number and citizenship. The documents must be original or certified copies. If any of your family members are applying for benefits, they will be expected to submit similar documentation. The SSA representative will let you know which documents you need and help you get any documents you don't already have.
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Social Security Retirement Benefits Social Security was originally intended to provide older Americans with continuing income after retirement. Today, though the scope of Social Security has been widened to include survivor's, disability, and other benefits, retirement benefits are still the cornerstone of the program.
How do you qualify for retirement benefits? When you work and pay Social Security taxes (FICA on some pay stubs), you earn Social Security credits. You can earn up to 4 credits each year. If you were born after 1928, you need 40 credits (10 years of work) to be eligible for retirement benefits.
How much will your retirement benefit be? Your retirement benefit is based on your average earnings over your working career. Higher lifetime earnings result in higher benefits, so if you have some years of no earnings or low earnings, your benefit amount may be lower than if you had worked steadily. Your age at the time you start receiving benefits also affects your benefit amount. Although you can retire early at age 62, the longer you wait to retire (up to age 70), the higher your retirement benefit. You can check your earnings record and get an estimate of your future Social Security benefits by filling out a request at your local Social Security office or by visiting the Social Security Administration (SSA) website. You can also find this information on your Social Security Statement, which the SSA mails annually to every worker over age 25. You will receive this statement about three months before your birthday. Review it carefully to make sure your paid earnings were accurately reported--mistakes are common. Call the SSA at (800) 772-1213 for more information.
Retiring at full retirement age If you retire at full retirement age, you'll receive an unreduced retirement benefit. Your full retirement age depends on the year in which you were born. If you were born in: Your full retirement age is: 1937 or earlier
65
1938
65 and 2 months
1939
65 and 4 months
1940
65 and 6 months
1941
65 and 8 months
1942
65 and 10 months
1943-1954
66
1955
66 and 2 months
1956
66 and 4 months
1957
66 and 6 months
1958
66 and 8 months
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66 and 10 months
1960 and later
67
Retiring early will reduce your benefit You can begin receiving Social Security benefits before your full retirement age, as early as age 62. However, if you retire early, your Social Security benefit will be less than if you wait until your full retirement age to begin receiving benefits. Your retirement benefit will be reduced by 5/9ths of 1 percent for every month between your retirement date and your full retirement age, up to 36 months, then by 5/12ths of 1 percent thereafter. For example, if your full retirement age is 67, you'll receive about 30 percent less if you retire at age 62 than if you wait until age 67 to retire. This reduction is permanent--you won't be eligible for a benefit increase once you reach full retirement age. Still, receiving early Social Security retirement benefits makes sense for many people. Even though you'll receive less per month than if you wait until full retirement age to begin receiving benefits, you'll receive benefits several years earlier.
Delaying retirement will increase your benefit For each month that you delay receiving Social Security retirement benefits past your full retirement age, your benefit will increase by a certain percentage. This percentage varies depending on your year of birth. For example, if you were born in 1936, your benefit will increase 6 percent for each year that you delay receiving benefits. If you were born in 1943 or later, your benefit will increase 8 percent for each year that you delay receiving benefits. In addition, working past your full retirement age has another benefit: It allows you to add years of earnings to your Social Security record. As a result, you may receive a higher benefit when you do retire, especially if your earnings are higher than in previous years.
Working may affect your retirement benefit You can work and still receive Social Security retirement benefits, but the income that you earn before you reach full retirement age may affect the amount of benefit that you receive. Here's how: • If you're under full retirement age: $1 in benefits will be deducted for every $2 in earnings you have above the annual limit • In the year you reach full retirement age: $1 in benefits will be deducted for every $3 you earn over the annual limit (a different limit applies here) until the month you reach full retirement age Once you reach full retirement age, you can work and earn as much income as you want without reducing your Social Security retirement benefit.
Retirement benefits for qualified family members Even if your spouse has never worked outside your home or in a job covered by Social Security, he or she may be eligible for spousal benefits based on your Social Security earnings record. Other members of your family may also be eligible. Retirement benefits are generally paid to family members who relied on your income for financial support. If you're receiving retirement benefits, the members of your family who may be eligible for family benefits include: • Your spouse age 62 or older, if married at least one year • Your former spouse age 62 or older, if you were married at least 10 years • Your spouse or former spouse at any age, if caring for your child who is under age 16 or disabled
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• Your children under age 18, if unmarried • Your children under age 19, if full-time students (through grade 12) or disabled • Your children older than 18, if severely disabled Your eligible family members will receive a monthly benefit that is as much as 50 percent of your benefit. However, the amount that can be paid each month to a family is limited. The total benefit that your family can receive based on your earnings record is about 150 to 180 percent of your full retirement benefit amount. If the total family benefit exceeds this limit, each family member's benefit will be reduced proportionately. Your benefit won't be affected.
How do you sign up for Social Security? You should apply for benefits at your local Social Security office or on-line two or three months before your retirement date. However, the SSA suggests that you contact your local office a year before you plan on applying for benefits to discuss how retiring at a certain age can affect your finances. Fill out an application on the SSA website, or call the SSA at (800) 772-1213 for more information on the application process.
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Tax-Deferred Annuities: Are They Right for You? Tax-deferred annuities can be a valuable tool, particularly for retirement savings. However, they are not appropriate for everyone.
Five questions to consider Think about each of the following questions. If you can answer yes to all of them, an annuity may be a good choice for you. 1. Are you making the maximum allowable pretax contribution to employer-sponsored retirement plans (a 401(k) or 403(b) plan through your employer, or a Keogh plan or SEP-IRA if you are self-employed), or to a deductible traditional IRA? These are tax-advantaged vehicles that should be fully utilized before you contribute to an annuity. 2. Are you making the maximum allowable contribution to a Roth IRA, Roth 401(k), or Roth 403(b), which provide additional tax benefits not available in a nonqualified annuity? 3. Will you need more retirement income than your current retirement plan(s) will provide? If you begin making the maximum allowable contributions to both a qualified plan and an IRA in your 30s or early 40s, you may have enough retirement income without an annuity. 4. Are you sure you won't need the money until at least age 59½? Withdrawals from an annuity made before this age are usually subject to a 10 percent early withdrawal penalty tax on earnings levied by the IRS. 5. Will you take distributions from your annuity on an ongoing basis throughout your retirement? You typically have the option of making a lump-sum withdrawal from an annuity, but this is almost always a bad idea. If you do, you'll have to pay taxes on all of the earnings that have built up over the years. If you take gradual distributions, you pay taxes a little at a time, allowing the rest of the money to continue growing tax deferred. In addition, if the annuity is nonqualified and you elect to receive an annuity payout, you will enjoy an exclusion allowance on each payment, in which a portion of each payment is considered a return of principal and is not taxable.
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Annuity Basics An annuity is a contract between you, the purchaser or owner, and an insurance company, the annuity issuer. In its simplest form, you pay money to an annuity issuer, and the issuer pays out the principal and earnings back to you or to a named beneficiary. Life insurance companies first developed annuities to provide income to individuals during their retirement years. One of the attractive aspects of an annuity is that its earnings are tax deferred until you begin to receive payments back from the annuity issuer. In this respect, an annuity is similar to a qualified retirement plan. Over a long period of time, your investment in an annuity can grow substantially larger than if you had invested money in a comparable taxable investment. Like a qualified retirement plan, a 10 percent tax penalty may be imposed if you begin withdrawals from an annuity before age 59½. Unlike a qualified retirement plan, contributions to an annuity are not tax deductible, and taxes are paid only on the earnings when distributed.
Four parties to an annuity contract There are four parties to an annuity contract: the annuity issuer, the owner, the annuitant, and the beneficiary. The annuity issuer is the company (e.g., an insurance company) that issues the annuity. The owner is the individual or other entity who buys the annuity from the annuity issuer and makes the contributions to the annuity. The annuitant is the individual whose life will be used as the measuring life for determining the timing and amount of distribution benefits that will be paid out. The owner and the annuitant are usually the same person but do not have to be. Finally, the beneficiary is the person who receives a death benefit from the annuity at the death of the annuitant.
Two distinct phases to an annuity There are two distinct phases to an annuity: (1) the accumulation (or investment) phase and (2) the distribution phase. The accumulation (or investment) phase is the time period when you add money to the annuity. When using this option, you'll have purchased a deferred annuity. You can purchase the annuity in one lump sum (known as a single premium annuity), or you make investments periodically, over time. The distribution phase is when you begin receiving distributions from the annuity. You have two general options for receiving distributions from your annuity. Under the first option, you can withdraw some or all of the money in the annuity in lump sums. The second option (commonly referred to as the guaranteed income or annuitization option) provides you with a guaranteed income stream from the annuity for your entire lifetime (no matter how long you live) or for a specific period of time (e.g., 10 years). (Guarantees are based on the claims-paying ability of the issuing insurance company.) This option can be elected at any time on your deferred annuity. Or, if you want to invest in an annuity and start receiving payments within the first year, you'll purchase what is known as an immediate annuity. You can also elect to receive the annuity payments over both your lifetime and the lifetime of another person. This option is known as a joint and survivor annuity. Under a joint and survivor annuity, the annuity issuer promises to pay you an amount of money on a periodic basis (e.g., monthly, quarterly, or yearly). The amount you receive for each payment period will depend on how much money you have in the annuity, how earnings are credited to your account (whether fixed or variable), and the age at which you begin the annuitization phase. The length of the distribution period will also affect how much you receive. If you are age 65 and elect to receive annuity distributions over your entire lifetime, the amount you will receive with each payment will be less than if you had elected to receive annuity distributions over five years.
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When is an annuity appropriate? It is important to understand that annuities can be an excellent tool if you use them properly. Annuities are not right for everyone. Annuity contributions are not tax deductible. That's why most experts advise funding other retirement plans first. However, if you have already contributed the maximum allowable amount to other available retirement plans, an annuity can be an excellent choice. There is no limit to how much you can invest in an annuity, and like other retirement plans, the funds are allowed to grow tax deferred until you begin taking distributions. Annuities are designed to be very-long-term investment vehicles. In most cases, you'll pay a penalty for early withdrawals. And if you take a lump-sum distribution of your annuity funds within the first few years after purchasing your annuity, you may be subject to surrender charges imposed by the issuer. As long as you're sure you won't need the money until at least age 59½, an annuity is worth considering. If your needs are more short term, you should explore other options.
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Health Insurance in Retirement At any age, health care is a priority. When you retire, however, you will probably focus more on health care than ever before. Staying healthy is your goal, and this can mean more visits to the doctor for preventive tests and routine checkups. There's also a chance that your health will decline as you grow older, increasing your need for costly prescription drugs or medical treatments. That's why having health insurance is extremely important.
Retirement--your changing health insurance needs If you are 65 or older when you retire, your worries may lessen when it comes to paying for health care--you are most likely eligible for certain health benefits from Medicare, a federal health insurance program, upon your 65th birthday. But if you retire before age 65, you'll need some way to pay for your health care until Medicare kicks in. Generous employers may offer extensive health insurance coverage to their retiring employees, but this is the exception rather than the rule. If your employer doesn't extend health benefits to you, you may need to buy a private health insurance policy (which will be costly) or extend your employer-sponsored coverage through COBRA. But remember, Medicare won't pay for long-term care if you ever need it. You'll need to pay for that out of pocket or rely on benefits from long-term care insurance (LTCI) or, if your assets and/or income are low enough to allow you to qualify, Medicaid.
More about Medicare As mentioned, most Americans automatically become entitled to Medicare when they turn 65. In fact, if you're already receiving Social Security benefits, you won't even have to apply--you'll be automatically enrolled in Medicare. However, you will have to decide whether you need only Part A coverage (which is premium-free for most retirees) or if you want to also purchase Part B coverage. Part A, commonly referred to as the hospital insurance portion of Medicare, can help pay for your home health care, hospice care, and inpatient hospital care. Part B helps cover other medical care such as physician care, laboratory tests, and physical therapy. You may also choose to enroll in a managed care plan or private fee-for-service plan under Medicare Part C (Medicare Advantage) if you want to pay fewer out-of-pocket health-care costs. If you don't already have adequate prescription drug coverage, you should also consider joining a Medicare prescription drug plan offered in your area by a private company or insurer that has been approved by Medicare. Unfortunately, Medicare won't cover all of your health-care expenses. For some types of care, you'll have to satisfy a deductible and make co-payments. That's why many retirees purchase a Medigap policy.
What is Medigap? Unless you can afford to pay for the things that Medicare doesn't cover, including the annual co-payments and deductibles that apply to certain types of care, you may want to buy some type of Medigap policy when you sign up for Medicare Part B. There are 12 standard Medigap policies available. Each of these policies offers certain basic core benefits, and all but the most basic policy (Plan A) offer various combinations of additional benefits designed to cover what Medicare does not. Although not all Medigap plans are available in every state, you should be able to find a plan that best meets your needs and your budget. When you first enroll in Medicare Part B at age 65 or older, you have a six-month Medigap open enrollment period. During that time, you have a right to buy the Medigap policy of your choice from a private insurance company, regardless of any health problems you may have. The company cannot refuse you a policy or charge you more than other open enrollment applicants.
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Thinking about the future--long-term care insurance and Medicaid The possibility of a prolonged stay in a nursing home weighs heavily on the minds of many older Americans and their families. That's hardly surprising, especially considering the high cost of long-term care. Many people in their 50s and 60s look into purchasing LTCI. A good LTCI policy can cover the cost of care in a nursing home, an assisted-living facility, or even your own home. But if you're interested, don't wait too long to buy it--you'll need to be in good health. In addition, the older you are, the higher the premium you'll pay. You may also be able to rely on Medicaid to pay for long-term care if your assets and/or income are low enough to allow you to qualify. But check first with a financial professional or an attorney experienced in Medicaid planning. The rules surrounding this issue are numerous and complicated and can affect you, your spouse, and your beneficiaries and/or heirs.
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Insurance Needs in Retirement Your goals and priorities will probably change as you plan to retire. Along with them, your insurance needs may change as well. Retirement is typically a good time to review the different parts of your insurance program and make any changes that might be needed.
Stay well with good health insurance After you retire, you'll probably focus more on your health than ever before. Staying healthy is your goal, and that may require more visits to the doctor for preventive tests and routine checkups. There's also a chance that your health will decline as you grow older, increasing your need for costly prescription drugs and medical treatments. All of this can add up to substantial medical bills after you've left the workforce (and probably lost your employer's health benefits). You need health insurance that meets both your needs and your budget. Fortunately, you'll get some help from Uncle Sam. You typically become eligible for Medicare coverage at the same time you become eligible for Social Security retirement benefits. Premium-free Medicare Part A covers inpatient hospital care, while Medicare Part B (for which you'll pay a premium) covers physician care, laboratory tests, physical therapy, and other medical expenses. But don't expect Medicare to cover everything after you retire. For instance, you'll have to pay a large deductible and make co-payments for certain types of care. Medicare prescription drug coverage is only available through a managed care plan (a Medicare Advantage plan), or through a Medicare prescription drug plan offered by a private company or insurer (premiums apply). To supplement Medicare, you may want to purchase a Medigap policy. These policies are specifically designed to fill the holes in Medicare's coverage. Though Medigap policies are sold by private insurance companies, they're regulated by the federal government. There are 12 standard Medigap plans, but not all of them are offered in every state. All of these plans provide certain core benefits, and all but one offer combinations of additional benefits. Be sure to look at both cost and benefits when choosing a plan. What if you're retiring early and won't be eligible for Medicare for a number of years? If you're lucky, your employer may give you a retirement package that includes health benefits at least until Medicare kicks in. If not, you may be able to continue your employer's coverage at your own expense through COBRA. But this is only a short-term solution, because COBRA coverage typically lasts only 18 months. Another option is to buy an individual policy, though you may not be insurable if you're in poor health. Even if you are insurable, the coverage may be very expensive.
Don't overlook long-term care insurance If you're able to stay healthy and active throughout your life, you may never need to enter a nursing home or receive at-home care. But the fact is, many people aged 65 and older will require some type of long-term care during their lives. And that number is likely to go up in future years because people are increasingly living longer. On top of that, long-term care is expensive. You should be prepared in case you do need long-term care at some point. Unfortunately, Medicare provides very limited coverage for long-term care. You may be covered for a short-term nursing home stay immediately following hospitalization, but that's about it. Other government and military-sponsored programs may help foot the bill, but generally only if you meet strict eligibility requirements. For example, Medicaid requires that you exhaust most of your assets before you can qualify for long-term care benefits. Even a good private health insurance policy will not offer much coverage for long-term care. But most long-term care insurance (LTCI) policies will. LTCI is sold by private insurance companies and typically covers skilled, intermediate, and custodial care in a nursing home. Most policies also cover home care services and care in a community-based setting (e.g., an assisted-living facility). This type of insurance can be a cost-effective way to protect yourself against long-term care costs--the key is to buy a policy when you're still relatively young (most companies won't sell you a policy if
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you're under age 40). If you wait until you're older or ill, LTCI may be unavailable or much more expensive.
Weigh your need for life insurance If you're married, you want to make sure that your spouse will have enough money when you die. You may also have children and other heirs you want to take care of. Life insurance can be one way to accomplish these goals, but several questions arise as you near retirement. Should you keep that existing policy in place? If so, should you change the coverage amount? What if you don't have any life insurance because you lost your group coverage at work (though some employers let you keep the coverage at your own expense)? Should you go out and buy some? The answers depend largely on your particular circumstances. Your life insurance needs may not be as great during retirement because your financial picture may have improved. When you're working and raising a family, the loss of your job income could be devastating. You often need life insurance to replace that income, meet your outstanding debts (e.g., your mortgage, car loans, credit cards), and fund your kids' college education in case something happens to you. But after you retire, there's usually no significant job income to protect. Plus, your kids may be grown and most of your debts paid off. You may even be financially secure enough to provide for your loved ones without insurance. It may make sense to go without life insurance in these cases, especially if you have term life insurance and your premium has increased dramatically. But what if you still have financial obligations and few assets of your own? Or what if you're looking for a way to pay your estate tax bill? Then you may want to keep your coverage in force (or buy coverage, if you have none). If you need life insurance but not as much as you have now, you can always lower your coverage amount. It's best to talk to a professional before making any decisions. He or she can help you weigh your needs against the cost of coverage.
Take a look at your auto and homeowners policies If you stay in your home after you retire, your homeowners insurance needs may not change much. But you should still review your liability coverage to make sure it's sufficient to protect your assets. If you're liable for an accident on or off your premises, claims against you for medical bills and other expenses can be substantial. For additional protection, you might consider buying an umbrella liability policy. It's also a good idea to review the coverage you have on your home itself and the property inside it. Finally, if you plan to buy a second home, find out if your insurer will cover both homes and give you a discount on your premium. Auto insurance raises some similar issues. Review your policy to make sure your coverage limits are high enough in each area. Again, having the right amount of liability coverage is especially important--you don't want your assets to be put at risk if you cause an auto accident that injures other people or damages property. Weigh your need for any coverages that are optional in your state. Finally, look into ways to save on your premium now that you're retired (e.g., discounts for low annual mileage or senior driving courses).
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Medicare Medicare is a federal program that provides health insurance to retired individuals, regardless of their medical condition. Here are some basic facts about Medicare that you should know.
What does Medicare cover? Medicare coverage consists of two main parts: Medicare Part A (hospital insurance) and Medicare Part B (medical insurance). A third part, Medicare Part C (Medicare Advantage), is a program that allows you to choose among several types of health-care plans. A fourth part, Medicare Part D, offers prescription drug coverage that can help you handle the rising costs of prescriptions.
Medicare Part A (hospital insurance) Generally known as hospital insurance, Part A covers services associated with inpatient hospital care. These are the costs associated with an overnight stay in a hospital, skilled nursing facility, or psychiatric hospital, including charges for the hospital room, meals, and nursing services. Part A also covers hospice care and home health care.
Medicare Part B (medical insurance) Generally known as medical insurance, Part B covers other medical care. Physician care--whether you received it as an inpatient at a hospital, as an outpatient at a hospital or other health-care facility, or at a doctor's office--is covered under Part B. Laboratory tests, physical therapy or rehabilitation services, and ambulance service are also covered.
Medicare Part C (Medicare Advantage) The 1997 Balanced Budget Act expanded the kinds of private health-care plans that may offer Medicare benefits to include managed care plans and private fee-for-service plans. Medicare Part C programs are in addition to the fee-for-service options available under Medicare Parts A and B. Medicare Part C programs vary, but generally provide all Medicare-covered benefits. Many also offer extra benefits, including prescription drug coverage, and coverage for additional days in the hospital.
Medicare Part D (prescription drug coverage) All Medicare beneficiaries are eligible to join a Medicare prescription drug plan offered by private companies or insurers that have been approved by Medicare. Although these plans vary in price and benefits, they all cover a broad number of brand name and generic drugs available at local pharmacies or through the mail. Medicare prescription drug coverage is voluntary, but if you decide to join a plan, keep in mind that some plans cover more drugs or offer a wider selection of pharmacies (for a higher premium) than others. You can get information and help with comparing plans on the Medicare website, www.medicare.gov, or by calling a Medicare counselor at 1-800-Medicare.
What is not covered by Medicare Parts A and B? Some medical expenses are not covered by either Part A or B. These expenses include: • Your Part B premium • Deductibles, coinsurance, or co-payments that apply
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• Most prescription drugs • Dental care • Hearing aids • Eye care • Custodial care at home or in a nursing home Medicare Part C may cover some of these expenses, or you can purchase a supplemental Medigap insurance policy that will help cover what Medicare does not.
Are you eligible for Medicare? Most people age 65 or older who are citizens or permanent residents of the United States are eligible for Medicare Part A (hospital insurance) without paying a monthly premium. You are eligible at age 65 if: • You receive or are eligible to receive Social Security or Railroad Retirement Board benefits based on your own work record or on someone else's work record (as a spouse, divorced spouse, widow, widower, divorced widow, divorced widower, or parent), or • You or your spouse worked long enough in a government job where Medicare taxes were paid In addition, if you are under age 65, you can get Part A without paying a monthly premium if you have received Social Security or Railroad Retirement Board disability benefits for 24 months, or if you are on kidney dialysis or are a kidney transplant patient. Even if you're not eligible for free Part A coverage, you may still be able to purchase it by paying a premium. Call the Social Security Administration (SSA) at (800) 772-1213 for more information. Although Medicare Part B (medical insurance) is optional, most people sign up for it. If you want to join a Medicare managed care plan or a Medicare private fee-for-service plan, you'll need to enroll in both Parts A and B. And Medicare Part B is never free--you'll pay a monthly premium for it, even if you are eligible for premium-free Medicare Part A.
How much does Medicare cost? Medicare deductible amounts and premiums change annually. Here's what you'll pay for Medicare in 2010: Premium
Deductible
Part A (hospital) None for most people, but $1,100 per benefit period noneligible individuals pay either $254 per month (if they have 30 to 39 quarters of Medicare-covered employment) or $461 per month (if they have 29 or fewer quarters of Medicare-covered employment)
Coinsurance $275 a day for the 61st to 90th day each benefit period; $550 a day for the 91st to 150th day for each lifetime reserve day (total of 60 lifetime reserve days); up to $137.50 a day for the 21st to 100th day each benefit period for skilled nursing facility care
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After satisfying a deductible, you normally pay 20 percent of the approved amount for medical expenses (50 percent for outpatient mental health services, 20 percent for hospital charges for outpatient hospital services, nothing for laboratory services)
Note: Your monthly Medicare Part B premium will be $110.50 if you did not have the Social Security Administration withhold your premium in 2009. You will pay an even higher premium if you file an individual income tax return and your annual modified adjusted gross income is more than $85,000, or if you file a joint income tax return and your annual modified adjusted gross income is more than $170,000 (in 2010). For more information, visit www.medicare.gov. Since Medicare doesn't cover every type of medical care, and you'll have to pay deductibles and coinsurance, you may want to buy a Medicare supplemental insurance (Medigap) policy.
Who administers the Medicare program? The Centers for Medicare & Medicaid Services (formerly known as the Health Care Financing Administration), a division of the U.S. Department of Health and Human Services, has overall responsibility for administering the Medicare program and sets standards and policies. But it's the SSA that processes Medicare applications and answers questions about eligibility. However, as a beneficiary, you deal mostly with the private insurance companies that actually handle the claims on the local level for individuals with Medicare coverage. Insurance companies that handle Medicare Part A claims are known as Medicare intermediaries, and insurance companies that handle Part B claims are known as Medicare carriers. Managed care plans handle Part C claims. Although the same private insurance company may handle both Part A and Part B claims, Part A and Part B are very different in regard to administration (e.g., different deductibles and co-payment requirements). There is virtually no overlap; it is as if you have two separate health insurance policies.
How do you sign up for Medicare? Any individual who is receiving Social Security benefits will automatically be enrolled in Medicare Parts A and B at age 65 when he or she becomes eligible. If you are not receiving Social Security benefits before age 65, you will be automatically enrolled when you apply for benefits at age 65. But if you decide to delay retirement until after age 65, remember to enroll in Medicare Parts A and B at age 65 anyway, because your enrollment won't be automatic. If you're going to be automatically enrolled in Medicare, you'll receive an initial enrollment package by mail from the SSA, usually three months before your 65th birthday. Of course, even if you sign up for Part A, you don't have to enroll in Part B, or you can decide to delay enrolling. But first, carefully read the information contained in your initial enrollment package. It explains the consequences of not enrolling at age 65 (e.g., you may have to pay a higher premium later) and will help you learn more about the Medicare program. For more information about enrolling in Medicare, call the SSA at (800) 772-1213.
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Buying Supplemental Health Insurance: Medigap Medicare won't cover all of your health-care costs during retirement, so you may want to buy a supplemental medical insurance policy known as Medigap. Offered by private insurance companies, Medigap policies are designed to cover costs not paid by Medicare, helping you fill the gaps in your Medicare coverage.
When's the best time to buy a Medigap policy? The best time to buy a Medigap policy is during open enrollment, when you can't be turned down or charged more because you are in poor health. If you are age 65 or older, your open enrollment period starts when you first enroll in Medicare Part B. If you are not yet 65, your open enrollment period starts when you turn 65 and then lasts for six months. A few states also require that a limited open enrollment period be offered to Medicare beneficiaries under age 65. If you don't buy a Medigap policy during open enrollment, you may not be able to buy the policy that you want later. You may find yourself having to settle for whatever type of policy an insurance company is willing to sell you. That is because insurers have greater freedom to deny applications or charge higher premiums for health reasons once open enrollment closes.
What's covered in a Medigap policy? Under federal law, only 12 standardized plans can be offered as Medigap plans (except in Massachusetts, Minnesota, and Wisconsin, which have their own standardized plans). Each Medigap policy is labeled with the letters A through L. Plan A is the basic benefit plan, while Plan J offers the most coverage. All cover certain services, including Medicare coinsurance amounts. Plans B through J also offer some combination of other benefits. These include coverage of Medicare Part A and B deductibles, and preventive medical care. Plans K and L are designed to provide protection against catastrophic expenses. They have lower premium costs than other Medigap plans, but require you to pay some higher coinsurance costs until you meet an annual out-of-pocket limit. You can buy the Medigap plan that best suits your needs. But it's important to note that not all Medigap plans are available in every state.
Are all Medigap policies created equal? Generally, yes. Although Medigap policies are sold through private insurance companies, they're standardized and regulated by state and federal law. A Plan B purchased through an insurance company in New York will offer the same coverage as a Plan B purchased through an insurance company in Texas. All you have to do is decide which plan that you want to buy. However, even though the plans that insurance companies offer are identical, the quality of the companies that offer the plans may be different. Look closely at each company's reputation, financial strength, and customer service standards. And check out what you'll pay for Medigap coverage. Medigap premiums vary widely, both from company to company and from state to state. You can find a tool on the Medicare website (www.medicare.gov) that will help you compare Medigap policies offered in your area.
Does everyone need Medigap? No. In fact, it's illegal for an insurance company to sell you a Medigap policy that substantially duplicates any existing coverage you have, including Medicare coverage. In general, you won't need a Medigap policy if you participate in a Medicare managed care plan or private fee-for-service plan, or if you qualify for Medicaid or have group coverage through your spouse.
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You may also not need to buy a Medigap policy if you work past age 65 and have employer-sponsored health insurance. You can still enroll in Medicare, but your employer-sponsored insurance will be your primary payer, so you'll submit claims to them first. Medicare will be the secondary payer, paying costs covered by Medicare but not covered by your employer's plan. If you find yourself in this situation, you may want to enroll in Medicare Part A, since it's free. Remember that if you enroll in Medicare Part B, your open enrollment period for Medigap starts. If you don't buy a Medigap policy within six months, you may be denied coverage later or charged a higher premium. In addition, you may not need to buy a Medigap policy if you are covered by an employer-sponsored health plan after you retire (e.g., as part of a retirement severance package). In this case, your employer's plan will be your primary payer, and Medicare will be your secondary payer. However, if you wish, you can convert your employer-provided plan into a Medigap policy. In fact, some insurance policies automatically change coverage when you reach age 65 because they assume that you will sign up for Medicare. Keep in mind, though, that coverage and premium amounts may change.
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Understanding Long-Term Care Insurance It's a fact: People today are living longer. Although that's good news, the odds of requiring some sort of long-term care increase as you get older. And as the costs of home care, nursing homes, and assisted living escalate, you probably wonder how you're ever going to be able to afford long-term care. One solution that is gaining in popularity is long-term care insurance (LTCI).
What is long-term care? Most people associate long-term care with the elderly. But it applies to the ongoing care of individuals of all ages who can no longer independently perform basic activities of daily living (ADLs)--such as bathing, dressing, or eating--due to an illness, injury, or cognitive disorder. This care can be provided in a number of settings, including private homes, assisted-living facilities, adult day-care centers, hospices, and nursing homes.
Why you need long-term care insurance (LTCI) Even though you may never need long-term care, you'll want to be prepared in case you ever do, because long-term care is often very expensive. Although Medicaid does cover some of the costs of long-term care, it has strict financial eligibility requirements--you would have to exhaust a large portion of your life savings to become eligible for it. And since HMOs, Medicare, and Medigap don't pay for most long-term care expenses, you're going to need to find alternative ways to pay for long-term care. One option you have is to purchase an LTCI policy. However, LTCI is not for everyone. Whether or not you should buy it depends on a number of factors, such as your age and financial circumstances. Consider purchasing an LTCI policy if some or all of the following apply: • You are between the ages of 40 and 84 • You have significant assets that you would like to protect • You can afford to pay the premiums now and in the future • You are in good health and are insurable
How does LTCI work? Typically, an LTCI policy works like this: You pay a premium, and when benefits are triggered, the policy pays a selected dollar amount per day (for a set period of time) for the type of long-term care outlined in the policy. Most policies provide that certain physical and/or mental impairments trigger benefits. The most common method for determining when benefits are payable is based on your inability to perform certain activities of daily living (ADLs), such as eating, bathing, dressing, continence, toileting (moving on and off the toilet), and transferring (moving in and out of bed). Typically, benefits are payable when you're unable to perform a certain number of ADLs (e.g., two or three). Some policies, however, will begin paying benefits only if your doctor certifies that the care is medically necessary. Others will also offer benefits for cognitive or mental incapacity, demonstrated by your inability to pass certain tests.
Comparing LTCI policies Before you buy LTCI, it's important to shop around and compare several policies. Read the Outline of Coverage portion of each policy carefully, and make sure you understand all of the benefits, exclusions, and provisions. Once you find a policy you like, be sure to check insurance company ratings from services such as A. M. Best,
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Moody's, and Standard & Poor's to make sure that the company is financially stable. When comparing policies, you'll want to pay close attention to these common features and provisions: • Elimination period: The period of time before the insurance policy will begin paying benefits (typical options range from 20 to 100 days). Also known as the waiting period. • Duration of benefits: The limitations placed on the benefits you can receive (e.g., a dollar amount such as $150,000 or a time limit such as two years). • Daily benefit: The amount of coverage you select as your daily benefit (typical options range from $50 to $350). • Optional inflation rider: Protection against inflation. • Range of care: Coverage for different levels of care (skilled, intermediate, and/or custodial) in care settings specified in policy (e.g., nursing home, assisted living facility, at home). • Pre-existing conditions: The waiting period (e.g., six months) imposed before coverage will go into effect regarding treatment for pre-existing conditions. • Other exclusions: Whether or not certain conditions are covered (e.g., Alzheimer's or Parkinson's disease). • Premium increases: Whether or not your premiums will increase during the policy period. • Guaranteed renewability: The opportunity for you to renew the policy and maintain your coverage despite any changes in your health. • Grace period for late payment: The period during which the policy will remain in effect if you are late paying the premium. • Return of premium: Return of premium or nonforfeiture benefits if you cancel your policy after paying premiums for a number of years. • Prior hospitalization: Whether or not a hospital stay is required before you can qualify for LTCI benefits. When comparing LTCI policies, you may wish to seek assistance. Consult a financial professional, attorney, or accountant for more information.
What's it going to cost? There's no doubt about it: LTCI is often expensive. Still, the cost of LTCI depends on many factors, including the type of policy that you purchase (e.g., size of benefit, length of benefit period, care options, optional riders). Premium cost is also based in large part on your age at the time you purchase the policy. The younger you are when you purchase a policy, the lower your premiums will be.
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Life Insurance at Various Life Stages Your need for life insurance changes as your life changes. When you're young, you typically have less need for life insurance, but that changes as you take on more responsibility and your family grows. Then, as your responsibilities once again begin to diminish, your need for life insurance may decrease. Let's look at how your life insurance needs change throughout your lifetime.
Footloose and fancy-free As a young adult, you become more independent and self-sufficient. You no longer depend on others for your financial well-being. But in most cases, your death would still not create a financial hardship for others. For most young singles, life insurance is not a priority. Some would argue that you should buy life insurance now, while you're healthy and the rates are low. This may be a valid argument if you are at a high risk for developing a medical condition (such as diabetes) later in life. But you should also consider the earnings you could realize by investing the money now instead of spending it on insurance premiums. If you have a mortgage or other loans that are jointly held with a cosigner, your death would leave the cosigner responsible for the entire debt. You might consider purchasing enough life insurance to cover these debts in the event of your death. Funeral expenses are also a concern for young singles, but it is typically not advisable to purchase a life insurance policy just for this purpose, unless paying for your funeral would burden your parents or whomever would be responsible for funeral expenses. Instead, consider investing the money you would have spent on life insurance premiums. Your life insurance needs increase significantly if you are supporting a parent or grandparent, or if you have a child before marriage. In these situations, life insurance could provide continued support for your dependent(s) if you were to die.
Going to the chapel Married couples without children typically still have little need for life insurance. If both spouses contribute equally to household finances and do not yet own a home, the death of one spouse will usually not be financially catastrophic for the other. Once you buy a house, the situation begins to change. Even if both spouses have well-paying jobs, the burden of a mortgage may be more than the surviving spouse can afford on a single income. Credit card debt and other debts can contribute to the financial strain. To make sure either spouse could carry on financially after the death of the other, both of you should probably purchase a modest amount of life insurance. At a minimum, it will provide peace of mind knowing that both you and your spouse are protected. Again, your life insurance needs increase significantly if you are caring for an aging parent, or if you have children before marriage. Life insurance becomes extremely important in these situations, because these dependents must be provided for in the event of your death.
Your growing family When you have young children, your life insurance needs reach a climax. In most situations, life insurance for both parents is appropriate. Single-income families are completely dependent on the income of the breadwinner. If he or she dies without life insurance, the consequences could be disastrous. The death of the stay-at-home spouse would necessitate
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costly day-care and housekeeping expenses. Both spouses should carry enough life insurance to cover the lost income or the economic value of lost services that would result from their deaths. Dual-income families need life insurance, too. If one spouse dies, it is unlikely that the surviving spouse will be able to keep up with the household expenses and pay for child care with the remaining income.
Moving up the ladder For many people, career advancement means starting a new job with a new company. At some point, you might even decide to be your own boss and start your own business. It's important to review your life insurance coverage any time you leave an employer. Keep in mind that when you leave your job, your employer-sponsored group life insurance coverage will usually end, so find out if you will be eligible for group coverage through your new employer, or look into purchasing life insurance coverage on your own. You may also have the option of converting your group coverage to an individual policy. This may cost significantly more, but may be wise if you have a pre-existing medical condition that may prevent you from buying life insurance coverage elsewhere. Make sure that the amount of your coverage is up-to-date, as well. The policy you purchased right after you got married might not be adequate anymore, especially if you have kids, a mortgage, and college expenses to consider. Business owners may also have business debt to consider. If your business is not incorporated, your family could be responsible for those bills if you die.
Single again If you and your spouse divorce, you'll have to decide what to do about your life insurance. Divorce raises both beneficiary issues and coverage issues. And if you have children, these issues become even more complex. If you and your spouse have no children, it may be as simple as changing the beneficiary on your policy and adjusting your coverage to reflect your newly single status. However, if you have kids, you'll want to make sure that they, and not your former spouse, are provided for in the event of your death. This may involve purchasing a new policy if your spouse owns the existing policy, or simply changing the beneficiary from your spouse to your children. The custodial and noncustodial parent will need to work out the details of this complicated situation. If you can't come to terms, the court will make the decisions for you.
Your retirement years Once you retire, and your priorities shift, your life insurance needs may change. If fewer people are depending on you financially, your mortgage and other debts have been repaid, and you have substantial financial assets, you may need less life insurance protection than before. But it's also possible that your need for life insurance will remain strong even after you retire. For example, the proceeds of a life insurance policy can be used to pay your final expenses or to replace any income lost to your spouse as a result of your death (e.g., from a pension or Social Security). Life insurance can be used to pay estate taxes or leave money to charity.
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I'm having a hard time selling my home. Should I take out a reverse mortgage? Question: I'm having a hard time selling my home. Should I take out a reverse mortgage?
Answer: A reverse mortgage is a loan secured by the equity in your home. With a reverse mortgage, you borrow against the equity you have built up in your home using a mortgage loan. In return, the mortgage lender either gives you a lump sum of cash or pays you a predetermined monthly amount for a fixed number of years or until the house is sold. At the end of that time, you'll owe the mortgage lender the principal and interest due on the house. To repay the loan, you or your estate may have to sell the house or turn it over to the mortgage lender. It's known as a reverse mortgage because unlike a traditional mortgage, the principal balance of the loan gets larger over time, rather than smaller. Reverse mortgages were developed to assist elderly citizens who own their own homes but need an additional source of income. They work best in situations where homeowners wish to stay in their homes until they die. If you are approaching retirement and are unable to sell your home, a reverse mortgage may be an option for you. However, it can limit your ability to move in the future, because you will need to repay the reverse mortgage from the sale proceeds. In addition, if you are unable to afford or qualify for a refinanced mortgage when the term of the reverse mortgage is up, you may be forced to sell your home. A reverse mortgage also lowers the value of your estate, because it reduces the equity you have built up in your home. This is a disadvantage if you were planning to leave your house as an inheritance for your family.
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Should I retire now at age 62 and collect Social Security benefits? Question: Should I retire now at age 62 and collect Social Security benefits, or should I wait until
Answer: There's no right time to begin collecting Social Security benefits, but the age at which you begin receiving benefits will affect how much retirement income you have, so you should weigh the consequences carefully. Keep in mind that if you collect Social Security before your full retirement age, your benefit will be permanently reduced. Depending on the year you were born, you'll receive between 25 and 30 percent less per month if you collect benefits at age 62 than if you wait until full retirement age to begin collecting benefits. However, this doesn't necessarily mean that collecting benefits at age 62 is unwise. In fact, unless you live to an especially old age, you may actually end up with more money if you start collecting Social Security benefits at age 62 than if you wait until full retirement age, because you'll receive more benefit checks. However, there are also good reasons to wait until full retirement age to start collecting benefits. For example, if you work full-time past age 62, you'll have the opportunity to increase your eventual retirement benefit, particularly if you are in your peak earnings years, because your benefit will be figured using your 35 highest earnings years. Additionally, if you'll barely scrape by after you retire, you may want to receive as much as possible from Social Security each month. Other things to consider include whether other people will be eligible to receive benefits based on your work record, your eligibility for Medicare, and your estimated life expectancy. The Social Security Administration has several online benefit estimators available at www.ssa.gov that can help you make an informed decision, or you can talk to a representative by calling (800) 772-1213 if you have questions.
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What happens if I start collecting Social Security after full retirement age? Question: What happens if I start collecting Social Security after full retirement age?
Answer: You'll get a bigger check every month. However, how much bigger depends upon what year you reach full retirement age, and how long you postpone collecting benefits. The following chart shows how much more you'll get for every year you delay collecting benefits past your full retirement age, based on the year you were born (up to age 70, when you have to start collecting Social Security): Year you were born The extra benefit you'll get if you postpone collecting benefits 1937-1938
6.5% more per year
1939-1940
7% more per year
1941-1942
7.5% more per year
1943 or later
8% more per year
To get an estimate of how much you'll receive when you begin collecting Social Security, call (800) 772-1213 or visit the Social Security website (www.ssa.gov) to request a Social Security Statement or to use the Social Security Administration's Retirement Estimator.
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How do I enroll in Medicare? Question: How do I enroll in Medicare?
Answer: You'll be automatically enrolled in Medicare when you turn 65 if you're already receiving Social Security benefits, or when you apply for Social Security benefits at age 65. In either case, the Social Security Administration will notify you that you're being enrolled. Although there's no cost to enroll in Medicare Part A (Hospital Insurance), you'll pay a premium to enroll in Medicare Part B (Medical Insurance). If you've been automatically enrolled in Part B, you'll be notified that you have a certain amount of time after your enrollment date to decline coverage. Even if you decide not to enroll in Medicare Part B during the initial enrollment period, you can enroll later during the annual general enrollment period that runs from January 1 to March 31 each year. However, you may pay a slightly higher premium as a result. If you decide to postpone applying for Social Security past your 65th birthday, you can still enroll in Medicare when you turn 65. The Social Security Administration suggests that you call (800) 772-1213 three months before you turn 65 to discuss your options. You can apply by visiting your local Social Security office. If you are unable to visit your local office, you may be able to enroll over the phone.
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Will my children receive money from Social Security when I die? Question: Will my children receive money from Social Security when I die?
Answer: Maybe. It depends on how old your children are, and how long you've worked in a job where you've paid Social Security taxes. To be eligible for Social Security benefits when you die, your children must be age 18 or under (19 if still in high school), and unmarried. In addition, you must have earned at least six Social Security credits, also known as quarters of coverage. You earn credits by working in a job where you pay Social Security taxes on your earnings. Because you can earn only four credits per year, you must have worked at least a year and a half to earn the required number of credits. To find out if your survivors will be eligible for benefits based on your earnings record when you die, you can order a Social Security Statement from the Social Security Administration (SSA). You can do this by calling (800) 772-1213 or by visiting the SSA website at www.ssa.gov. The statement will also tell you how much your survivors could expect to receive, based on your current earnings record. Another option is to use one of the SSA's benefit calculators, available online, to estimate benefits available to your survivors.
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If I'm covered by Medicare, should I have additional health insurance? Question: If I'm covered by Medicare, should I have additional health insurance?
Answer: It's wise to purchase health insurance to supplement your Medicare coverage, because Medicare generally won't cover all of your medical expenses. Usually, you'll have to satisfy a deductible before Medicare pays anything, and you'll also pay a co-payment when you visit a physician or are admitted to the hospital. Fortunately, you can buy supplemental insurance from private companies that will help you plug the gaps in your Medicare coverage. These Medigap plans are regulated and standardized by the federal government. There are 12 different kinds of plans, although your state may not offer all of them (and three states, Massachusetts, Minnesota, and Wisconsin, have their own standardized plans). If cost is a concern, you can purchase low-cost Medigap plans that offer coverage through managed care plans. Conversely, if you want extensive coverage and don't mind paying more for it, you can purchase a Medigap plan that covers most of the deductibles, co-payments, and extra charges associated with Medicare. You can compare plans at the Health Care Financing Administration's website (www.medicare.gov). Whatever plan you choose, you have the right to cancel it within a certain amount of time (usually 30 days, sometimes longer) if you don't like the policy after you buy it. In addition, the policy must be guaranteed renewable and cannot duplicate existing coverage, including Medicare. Another way to supplement Medicare is to keep in effect any employer-sponsored health-care insurance you have. Depending on the type of coverage you have, and whether you're retired, one plan will pay your health-care costs first, and the other plan will cover some or all of the remaining costs. To make sure claims are properly paid, let your health provider know when you have health insurance in addition to Medicare.
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Are my Social Security benefits subject to income tax? Question: Are my Social Security benefits subject to income tax?
Answer: A portion of your benefits may be subject to income tax if your modified adjusted gross income (MAGI), plus one-half your Social Security benefits, exceeds specific limits. Your MAGI equals: • Adjusted gross income (or the adjusted gross income of you and your spouse if married and filing jointly), including wages, interest, dividends, taxable pensions, and other sources, • Tax-exempt interest income (e.g., interest from municipal bonds and qualified U.S. savings bonds), and • Amounts earned in a foreign country, U.S. possession, or Puerto Rico that are exempt from tax Up to 50 percent of your Social Security benefits may be subject to income tax if your combined income (MAGI plus one-half your Social Security benefits) exceeds $25,000 for an individual filing single, unmarried head of household, or qualified widow(er) with dependent ($32,000 if married and filing jointly). If your combined income exceeds $34,000 ($44,000 if married and filing jointly), up to 85 percent of your benefits is taxable. If you are married and filing separately, up to 85 percent of your benefits will be taxed unless you and your spouse live apart for the entire year. Consult an accountant or other tax professional for more information. Or, contact the Internal Revenue Service at (800) 829-1040 or www.irs.gov. Ask for Publication 554, Tax Guide for Seniors, and Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
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I'm traveling to Europe and won't need my car. Can I get my auto insurance suspended to save money? Question: I'm traveling to Europe this summer and won't need my car. Can I get my auto insurance suspended to save money?
Answer: You may be able to, but it's not always a good idea. Many bad things can happen to your car, even when it's not being driven. The other-than-collision (also known as comprehensive) coverage portion of your auto policy insures you against damage to your vehicle caused by fire, flooding, theft, vandalism, and other events. And it's also important to remember that you may continue to need auto insurance coverage if you drive while on vacation. But if you're confident there's little risk that your car will be damaged or stolen while you're gone, it may be possible to temporarily suspend or reduce your coverage. Suspending or reducing your coverage may be difficult, though. Your state probably requires that you carry a minimum amount of insurance coverage while your vehicle is registered. So, unless you intend to suspend or cancel your registration, you may not be able to completely suspend your auto insurance. However, depending on the laws in your state, you may be able to suspend parts of your policy--ask your insurer. But if you have a car loan, the lender may require that you keep your car fully insured. Check your loan documentation carefully before you take steps to suspend any portion of your insurance coverage. But don't just stop paying your premiums and let your policy lapse while you're away. If you do, you may have trouble getting affordable auto insurance in the future, because this type of cancellation will be listed in the insurance company records and may even show up on your credit report.
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I'm confused--is an annuity an investment vehicle or an insurance policy? Question: I'm confused--is an annuity an investment vehicle or an insurance policy?
Answer: An annuity is a distinctive financial product. Although it's not an insurance policy per se, it is a contract with an insurance company. Many different types of annuities exist, with many different features. A deferred annuity is a savings vehicle that accumulates earnings on a tax-deferred basis. An immediate annuity is a financial instrument that converts a lump-sum premium into a stream of payments over a certain period of time or for as long as the annuitant lives. Here's how it works. You (the annuitant) pay cash to an annuity issuer (the insurance company) for either a deferred or an immediate annuity, which will accumulate earnings at a fixed interest rate (a fixed annuity) or a variable rate determined by the growth (or losses) in investment options known as subaccounts (a variable annuity). With a deferred annuity, you (or the beneficiary you chose) can receive the principal and earnings in one lump sum when the contract is surrendered (i.e., cashed in). With an immediate annuity, you (or your beneficiary) receive the principal and earnings over a predetermined period of time. An annuity may have certain guaranteed or insurance-like characteristics. (Guarantees are based on the claims-paying ability of the issuing insurance company.) For example, a deferred variable annuity may guarantee that your beneficiary will receive at least the amount of your original principal if you die, even if the value of the annuity has declined due to poor performance of the subaccounts you selected. And whether you purchase a fixed or variable immediate annuity (or if you've chosen to annuitize a deferred annuity), you're guaranteed to receive payments for life if you elected that payout option, no matter how long you live. Deferred annuities are most commonly used to help save for retirement. Immediate annuities are generally used to provide a guaranteed income during retirement.
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I can choose a single life annuity for my pension or a joint and survivor annuity. Which is better? Question: I can choose a single life annuity for my pension or a joint and survivor annuity that makes payments to my spouse when I die. Which is better?
Answer: It depends on your circumstances. If you're not married, the single life annuity is clearly the best choice (and may be your only option). You'll receive the maximum payout from your pension during your life, and all benefits will cease when you die. This option may even make sense if you're married (assuming that you have other ways to take care of your surviving spouse, such as investments or retirement plan assets), and the difference between the higher-paying single life annuity and the joint and survivor annuity is very great. (The joint and survivor annuity benefits paid to you during your life will be smaller than if you elected a single life annuity, because they are payable as long as either person is alive.) One common strategy is to choose the single life annuity and buy life insurance to protect your spouse, using some or all of the difference in benefits between the higher-paying single life annuity and the joint and survivor annuity to pay the premiums. That way, you may maximize your pension benefits while you are alive, and your spouse will receive insurance proceeds when you die that may be more valuable than what he or she would get under the joint and survivor annuity option. You may need a financial professional to help you assess whether this strategy is right for you. But you may be better off choosing the joint and survivor annuity. This might be the case if your assets are insufficient to meet your surviving spouse's needs, if you can't obtain the insurance coverage you need (or that coverage is too expensive), or if the difference between the higher-paying single life annuity and the joint and survivor annuity is small. This option would enable your spouse to receive pension survivor benefits after you die (usually a percentage of your full retirement benefit), as well as provide your spouse with guaranteed income until his or her death. Electing a joint and survivor annuity may also enable your surviving spouse to continue to receive medical coverage from your former employer after your death, if the plan allows. One final note: If you're married, most plans will only allow you to choose a single life annuity if your spouse waives the joint and survivor annuity. You and your spouse should discuss your options and agree on the one that will best meet the needs of both of you. This is a complicated decision, so get professional guidance before you make your choice.
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Will Medicare alone be enough to cover my health-care needs in retirement? Question: Will Medicare alone be enough to cover my health-care needs in retirement?
Answer: No. Medicare coverage comes with deductibles and significant co-payments for many types of treatments, including hospitalizations. Typically, the deductible amounts are increased each year. If you're not prepared to pay these expenses out of pocket, you may want to consider a Medigap policy (a supplemental medical insurance policy). Medigap insurance policies are sold by private health insurers. These policies are standardized and regulated by both state and federal law. There are 12 standard Medigap plans, although not all are available in all states. These plans, known as Plans A through L, cover certain specified services, but offer different combinations of coverages. Some cover all or part of your Medicare deductibles. A few also cover (up to certain policy limits) preventive care, prescription medications, and at-home recovery expenses. If you're covered by an employer-sponsored health plan in retirement, you may not need to purchase Medigap insurance. In this case, your primary insurance coverage continues to be your employer's health plan; for eligible unpaid expenses, Medicare would provide secondary coverage.
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What happens if my Medicare HMO goes out of business? Question: What happens if my Medicare HMO goes out of business?
Answer: You have several choices: • Return to the original fee-for-service Medicare plan • Supplement your fee-for-service Medicare plan with a Medigap policy • Enroll in another Medicare Advantage managed care plan if one is available in your area The decision to return to your original fee-for-service Medicare plan is an important one. Make sure you consider your need for Medigap insurance before you disenroll from your HMO. You can disenroll in early October when you receive the final notice from your HMO. This will give you time for your Medigap policy to start on the first day of the next month so you will not have a lapse between plans. A disenrollment form is available from your HMO plan administrator or a Social Security Administration office. You can stay with your HMO until the end of the year. You then have 63 days after your HMO coverage expires to purchase a Medigap A, B, C, or F plan with guaranteed insurability. This means that the Medigap insurance company cannot turn you down for pre-existing conditions or discriminate in the price of the policy because of your health or claims experience. Carefully read the information you receive from your HMO, which should explain your options and provide a list of other Medicare Advantage plans available in your area. A disenrollment form is not required if you go to another HMO. If you have questions, call your plan administrator or Social Security Administration office.
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I'm planning on living in Europe for several months. Do I need special health insurance? Question: I'm planning on living in Europe for several months. Do I need special health insurance?
Answer: Unless you're in the military or working for an American company abroad that has a health plan in place, you'll need to make sure that your health insurance will cover your needs--and don't wait until you're already sick or injured to do it. If you're planning to travel overseas, be aware that your health insurance plan may not cover you at all. Most managed care plans, such as health maintenance organizations (HMOs) or preferred provider organizations (PPOs), will cover emergency treatment. But HMOs may pay nothing if you see an out-of-network health-care provider for routine care, while PPOs will pay only part of the cost. So before you set foot on foreign soil, check the limitations of your policy and call your insurer's customer service department if you have any questions. If you're going to be away for less than six months, a short-term supplemental health insurance policy may be sufficient for your needs. These policies are available from insurance companies or travel agents, and they offer accident and sickness coverage. However, read the policy carefully because the coverage is often limited. If you'll be out of the United States for more than six months, you may want to purchase expatriate health insurance. Underwritten by large insurers such as Lloyd's of London, these policies offer standard emergency and routine care coverage, and can be customized to meet your specific needs. Be sure to check for pre-existing condition limitations, including pregnancy. Options available include maternity coverage, acupuncture, chiropractic services, language translation and foreign currency exchanges, and even emergency evacuation coverage. The application process for expatriate health insurance can be detailed and extensive; you'll have to list any health problems you've had in the past 10 years. The cost of a plan will depend on several factors, such as your age, state of health, sex, and travel itinerary.
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What is an annuity? Answer: An annuity is a contract between you (the purchaser or owner) and an insurance company. In its simplest form, you pay money to an annuity issuer, and the issuer then pays an income stream back to you or to a named beneficiary. Annuities are generally used to provide income in retirement. In an annuity, your money is tax deferred until you withdraw it. The tradeoff is that if you take your money out before age 59½, you'll usually have to pay a 10 percent early withdrawal penalty to the IRS, unless an exception applies. Most life insurance companies sell annuities. You pay the insurance company a sum of money, either all at once or incrementally. The type of annuity you own determines whether your money earns a fixed amount or an amount that depends on the equities in which the annuity is invested. At a designated time chosen by you, the insurance company generally begins to send you regular distributions from the annuity's account. Or, you may be able to withdraw the money over time or in one lump sum. There are many different kinds of annuities. Four of the most common are the following: • Single premium immediate annuity: You pay the insurance company a lump sum now and begin to receive withdrawal distributions for a period of time you specify. The amount you receive will vary according to the length of time the payments are to last and whether anyone will receive the remaining balance at your death. • Single premium deferred annuity: You pay the insurance company a lump sum now and defer receiving withdrawals until later. The amount of those distributions will depend on the value of your account at the time your payments begin, the length of time the payments are to last, and whether anyone will receive the remaining balance at your death. • Additional premium deferred annuity: You send money to the insurance company usually monthly, quarterly, or annually. You defer your withdrawals to a later date. • Variable annuity: This type of contract is a vehicle for equity investments. You can do a one-time deposit or contribute throughout the life of the contract. You have choices as to how your money is invested in an offering of investment portfolios, and you may invest conservatively or aggressively. The growth of your account value will vary, depending on your choice of investments. Variable annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk including the possibility of loss of principal. Variable annuities contain fees and charges including, but not limited to mortality and expense risk charges, sales and surrender (early withdrawal) charges, administrative fees and charges for optional benefits and riders. Variable annuities are sold by prospectus. You should consider the investment objectives, risk, charges and expenses carefully before investing. The prospectus, which contains this and other information about the variable annuity, can be obtained from the insurance company issuing the variable annuity, or from your financial professional. You should read the prospectus carefully before you invest.
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What is Medigap? Question: What is Medigap?
Answer: Medigap is health insurance that supplements the benefits covered under Medicare. It also fills in some of the gaps left by Medicare, such as your deductible and coinsurance contributions. Sold by private insurance companies, Medigap insurance is offered in 12 different versions, Plans A through L (except in Massachusetts, Minnesota, and Wisconsin, which have their own standardized plans). Each provides a different level of coverage, but not all plans are available in all states. Plan A covers the following basic benefits: • Your coinsurance contribution for hospital visits that Medicare covers • Full coverage for 365 additional hospital days for use after Medicare's coverage of 60 days is used up • Your coinsurance contribution on doctors' bills that Medicare covers • The first three pints of blood you may need in a year (Medicare pays for any additional blood) Plans B through J cover the same basic benefits, plus some extra benefits that include different combinations of the following: • The hospital deductible for visits that Medicare covers • Daily coinsurance contribution for skilled nursing facility care • The deductible for doctors' services that Medicare covers • Eighty percent of emergency medical costs that are needed during the first two months of a trip outside the United States • The difference between your doctor's fee and Medicare's allowance • Custodial care, working together with Medicare's coverage • Routine annual medical checkups and other preventive care Plans K and L have lower premium costs than other Medigap plans, but require you to pay some higher coinsurance costs. However, they provide protection against catastrophic illnesses by limiting your annual out-of-pocket expenses. These plans include the following benefits: • 50 percent (Plan K) or 75 percent (Plan L) coverage of the skilled nursing facility, hospice, and respite care coinsurance costs and the hospital deductible under Medicare Part A • 100 percent coverage of hospital inpatient coinsurance costs and 365 additional lifetime days of coverage for inpatient hospital services • 100 percent coverage of the Medicare Part B coinsurance costs for preventative benefits
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• 100 percent coverage of all coinsurance costs for the rest of the year once an annual out-of-pocket limit is met Some of the benefits not covered by Medigap include long-term nursing home care, and vision and dental care. Medigap will follow Medicare in excluding what is unnecessary or experimental. If you are covered by your former employer's health insurance plan, you may not need Medigap.
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Should I accept my employer's early retirement offer? Question: Should I accept my employer's early retirement offer?
Answer: The right answer for you will depend on your situation. First of all, don't underestimate the psychological impact of early retirement. The adjustment from full-time work to a more leisurely pace may be difficult for you. So ask yourself if you're ready to retire yet. Next, look at what you're being offered. Most early retirement offers share certain basic features that need to be evaluated. To decide if your employer's offer is worth taking, you'll want to break it down. Does the offer include a severance package? If so, how does the package compare with your projected job earnings (including future salary raises and bonuses) if you remained employed? Can you live on that amount (and for how long) without tapping into your retirement savings? If not, is your retirement fund large enough that you can start using it early? Will you be penalized for withdrawing from your retirement plans? Does the offer include post-retirement medical insurance? If not, you may have to look into COBRA or a private individual policy. Private insurance can be expensive, depending on your health and other factors. If your employer's offer includes medical insurance, make sure it's affordable and provides adequate coverage. Also, since Medicare doesn't start until you're 65, make sure your employer's coverage lasts until you reach that age. How will accepting the offer affect your retirement plan benefits? If your employer has a traditional pension plan, leaving the company before normal retirement age (usually 65) may greatly reduce the final payout you receive from the plan. If you participate in a 401(k) plan, what price will you pay for retiring early? You could end up forfeiting employer contributions that you're not yet vested in. You'll also be missing out on the opportunity to make additional contributions to the plan.
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What if my income during retirement won't be enough to meet my retirement expenses? Question: What should I do if I determine that my income during retirement won't be enough to meet my retirement expenses?
Answer: Fortunately, you may have no need to despair. The further you are from retirement, the more time you have to resolve the expected shortfall. Even if you are closing in on retirement, there may be steps you can take to bridge the gap. In some cases, the best solution is to cut back current expenses and use that money toward retirement. This will enable you to put more money into your IRA, 401(k), and other retirement savings vehicles. Although you may not think you spend much on dining out and entertainment, such expenses really add up over time. Eliminating large purchases like boats and other luxury items will also make a big difference. Another way to save a bundle is to look into public colleges where your child can get a quality education for a fraction of what a private college costs. But you might be unwilling to make such sacrifices. If so, or if you simply can't afford to save any more than you already are, consider investing more aggressively. Weight your portfolio more heavily toward stocks and growth mutual funds, and less toward fixed-income securities. A more aggressive investment portfolio exposes you to heightened volatility, but it may also provide a much greater return over the long run. The result: a potentially larger nest egg for you to draw on during retirement. Another alternative is to lower your planned expenses during retirement by setting more modest goals. Instead of buying that beach mansion on the Riviera, settle for a smaller house a few miles from the ocean. Similarly, instead of taking expensive trips around the world on a regular basis, travel closer to home and less often. The idea of a more frugal retirement lifestyle may not appeal to you, but financial reality may require it. You can take a variety of other steps to make sure that retirement income will at least keep pace with retirement expenses. Some of the most common: work part-time during retirement or simply put off retiring until you're in a better financial position. Consult your financial planner for further advice.
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What are required minimum distributions and how are they calculated? Question: What are required minimum distributions and how are they calculated?
Answer: Required minimum distributions are the amounts that you must withdraw each year from your traditional IRA, employer-sponsored retirement plan, or tax-sheltered annuity. You must begin to take the annual distributions by April 1 of the year following the year in which you reach age 70½. This is known as your required beginning date. If you work for your employer past age 70½ and are still participating in the employer's retirement plan, you may postpone your first distribution from that plan until April 1 of the year following the year of your retirement (as long as you are not more than a 5 percent owner of the employer). Note: The Worker, Retiree and Employer Recovery Act of 2008 waives required minimum distributions for the 2009 calendar year. Regardless of your required beginning date, you must take subsequent distributions by December 31 of each calendar year. You'll continue to take the annual distributions each year until your death or until your account balance is reduced to zero. You can always withdraw more than the required minimum amount in any given year. However, if you withdraw less, you will be subject to a 50 percent federal penalty on the difference between the amount you should have taken and what you actually took. The basic calculation for individual accounts provides that the required minimum distribution is determined by dividing the account balance by the distribution period. For lifetime required minimum distributions, there is a uniform distribution period for almost all individuals of the same age. The uniform lifetime distribution period table is based on the joint life and last survivor life expectancy of you and a hypothetical beneficiary 10 years younger. However, if your sole beneficiary is your spouse and he or she is more than 10 years younger than you, a longer distribution period measured by the joint life and last survivor life expectancy of you and your spouse is permitted to be used. However, the specific rules on required minimum distribution calculations are complicated, and you should consult a tax professional regarding your situation.
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I'm retired now and own my home outright. How can I use it to raise money without selling it? Answer: You may want to consider a reverse annuity mortgage, more commonly known as a reverse mortgage. Developed to help the elderly find an additional source of income while remaining in their homes, reverse mortgages are steadily proliferating and in many instances are federally insured. Generally speaking, reverse mortgages are offered at fixed rates of interest. (Federally insured Home Equity Conversion Mortgages are also offered at adjustable rates.) All parties to the deed must be 62 or older before you can qualify. When you apply, your lender appraises your property to determine how much equity is available for you to borrow against. The older you are at the time of your application, the larger the percentage of your equity you may access. Once this amount is determined, you may borrow against it through one of three types of reverse mortgages. A tenure reverse mortgage pays you a designated sum of money each month. The payment amount depends on your age, the equity in your home, and the interest rate of the loan. As you receive your payments, both the principal balance and the interest owed on the loan grow. Accumulated principal and interest are repaid upon sale of the property, which may not occur (unless you choose to sell) until after the death of the last party to the mortgage. Thus, you can use a tenure reverse mortgage to supplement your monthly income indefinitely. You do not run the risk of being required to sell your home. However, the size of your estate will be reduced because you are continuously reducing the equity in your home. A term reverse mortgage allows you to receive preset monthly payments for a specified length of time (the term of the mortgage). Generally, all other factors being equal, term reverse mortgages will give you larger monthly payments than do tenure reverse mortgages, simply because the term of the mortgage is fixed rather than indefinite. When the term is up, the loan must be repaid. This might be accomplished by refinancing your home with a conventional "forward" mortgage. If this is not possible, however, and you have no other means to repay the loan, you must sell your home to satisfy the reverse mortgage. Thus, you might want to consider a term reverse mortgage only if you plan to sell your home before the expiration of the term, and need money in the meantime for medical care or home repairs. An equity line reverse mortgage allows you to take different lump-sum amounts of equity out of your home as desired or needed up to a predetermined maximum amount. Depending on the mortgage agreement, the principal amount you borrow, plus accumulated interest, may become due either at a preset future date (as with a term loan) or at an unspecified date (as with a tenure loan).
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