YOUR GUIDE TO PLANNING FOR RETIREMENT by Rickie K

E N T R E T I R E M

G P L A N N I N

Realistic Expectations fying retirement One of the keys to a satis realistic expectations.

is having

80%

The first step in making sure your expectations for retirement are realistic is having a clear sense of what you are spending, both on the everyday costs of living and on the special ng. activities you’re planni

100% You’ll need 75% to t of your preretiremen ortably comf live to me inco during retirement

G P L A N N I N

E N T R E T I R E M DOING THE MATH

of figuring out the The tried and true way ent is to list all cost of living in retirem then estimate and your current expenses and on into what they’ll be next year future years. whether you’ll You can also anticipate on: have what you need, based you The number of years until plan to retire saved already have you t The amoun n rate The anticipated inflatio of return, or The estimated real rate investments what you earn on your n after adjusting for inflatio

like the You can find work charts help guide you one illustrated here to Often they’re through the calculation. nic format, either in an easy-to-use electro you can ask for Or online or on a CD-ROM. ing your costs. professional help in project

FACTORS TO CONSIDER

•

As you prepare a retirement budget, you’ll want to take these factors into account:

• • •

you If you retire at 65, until can expect to live you’re into your 80s.

PECTED CTING THE UNEX

EXPE like to know Ideally, what you would rs estimate you’ll things that may go Some financial planne ahead of time are the rement income al strain on your need 75% of your prereti of living after wrong, putting a financi gh you can’t rd ent income. Althou to maintain your standa retirem need you’ll , you can say you stop working. Others predict what might happen investment las like these may closer to 100%. Formu prepare by creating an what figure to , to six months be too simplistic, though account equal to three for any ked ng. spendi earmar you’ll actually be of living expenses calculate what One place to start is to unexpected emergencies. to keep your you right now: Most experts advise you ay money the essentials are costing home mainand rainy-d heat g, clothin food and liquid, which tenance, utilities, you can turn that means cash insurance, and propeasily Costs that Costs it into erty taxes. You can could if you need it. For be fairly confident could example, you might up: you’ll go on paying go n: go dow put some of these these bills and that money assets in inflation will push Healthcare Home market accounts for their cost up. mortgage Travel immediate access, Next, think about and some in US Commuting the things you’re Second home Treasury bills or less likely to spend ial r Financ Furthe certificates of ge on. Your mortga sibility tion respon educa deposit (CDs) with off, paid may be for children six months to one be es won’t you Hobbi or parents year terms. commuting, and The danger of Second Work-related maybe your financial career investing your clothing responsibilities for emergency fund in children and parents you risk or other equities is that will come to an end. stocks tax, in income period when prices You may be paying less having to sell during a immediately. g you’re no longer and if you’re not workin are down if you need cash a limited ty. on paying into Social Securi This is one case where— ability is additional io—st But also consider the portion of your portfol ter, such as growth or income. expenses you may encoun the cost of more important than to cover and If you don’t need the moneyother medical and dental care place and warm a nt, or in accide , winter for illness your plans a serious you’ll be able or perhaps longsummer in a cool one, unpredictable problems, to your heirs. s and equipment assets unused the leave postponed trips or course to to master new skills.

S WAYS AND MEAN

• •

• • • •

•

• •

•

to savings of your gross annual income time should allocate 10% to 15% your The rule of thumb is that you investment accounts based on your financial goals, may provide and investments. You can chooseyour tolerance for risk. Assets you invest for growth as you age. and frame for achieving them, you to more risk of loss. That may be a greater concern a stronger return but expose

TING KEEP ON INVES

MENT

RE L RETI ACTICA

THE PR

HEET

WORKS

Current age age Retirement

65 $75,000 me sehold inco 3% Annual hou 4 ation rate $93,478.0 Annual infl me needed $250,000 Annual inco s ing rement sav $7,500 Current reti tribution annual con 8% Additional 55 e of return $809,333. Annual rat ent 8 rem $64,746.6 Value at reti s ing me from sav 000 inco $2, ual Ann y cial Securit -So me $400 Monthly inco ents 8 me-investm $93,546.6 Monthly inco income retirement Total annual

At current rates, the cost of living will increase by approximately 75% during that time. You have to anticipate changes in Social , Security in the future which means you may get less income from that source.

You can’t predict the level of healthcare coverage that your e employer will provid after you retire. There’s a direct en relationship betwe age and health costs: cans About 7% of Ameri between ages 65 and 74 need help in of tasks the ng handli everyday living. But by age 85, almost 30% do.* That may mean you’ll face nursing home or home care costs. *Source: Urban Institute

This hypothetical example is for illustration only and is not intended to represent or imply the actual performance of any specific investment.

FUTURE LOOKING AT THE projecting

that The most revealing thing you is how much tell your future needs will your retirement you can withdraw from e the income produc to year each accounts a comfortable life. you need to maintain the assumption is In the example above, aw at the same that you’re able to withdr or 8%. rate as your earnings,

emphasizes Projecting future needs of return is to your how important the rate some periods, when retirement assets. In sed, you may depres investment markets are adequate growth, not be able to achieve down at the time especially if markets are By some esti. income taking you begin have money as long mates, to ensure you’ll you should plan to as you need it, the most 4.5% of your assets. withdraw each year is

yOuR GuIDE TO plANNING fOR RETIREMENT

•

is a straightforward, easy-to-understand introduction to the information you need to set realistic expectations for living comfortably in retirement, make smart investment decisions, choose life insurance to meet your long-term needs, and plan your estate. The guide helps to put your retirement planning in perspective—whether you are anticipating a new phase in your life or are already retired.

Retirement Strategies •

Investing

•

Annuities

•

IRA Rollovers •

Lightbulb Press, Inc. 112 Madison Avenue New York, NY 10016

www.lightbulbpress.com info@lightbulbpress.com Phone: 212-485-8800

•

Your Estate

Social Security

VIRGINIA B. MORRIS

AND

KENNETH M. MORRIS

CASH

MUTUAL FUNDS

c o n t e n t s 2 The Retirement Marathon

14 Making Investments

4 Realistic Expectations

16 Deferred Annuities

6 Personal Investing Goals

18 Mutual Funds

8 Retirement Savings Plans

20 Life Insurance

10 IRAs: What They Are

22 Whatâ&#x20AC;&#x2122;s Your Estate?

12 IRA Rollovers

24 Glossary

G l o s s a R Y Asset classes are categories of

investments that tend to react differently to what’s happening in the investment markets and the economy at large. Stock, bonds, and cash are examples of traditional asset classes. Mutual funds that invest in a particular asset class, such as stock, tend to behave the way the asset class behaves.

Beneficiary is the person or institution you name to receive assets or income from your retirement savings plans, IRAs, insurance company contracts, and trusts. Diversification is an investment

strategy designed to help control risk. Using this strategy, you invest in a variety of individual securities, mutual funds, or exchange-traded funds within each asset class rather than concentrating on a few investments in each class.

Equity is ownership, and equity

investments such as mutual funds give you an ownership share in the investment. With real estate, your equity is equal to the difference between the property’s value and any outstanding mortgage loan or other debt on the property.

Growth investments are investments

you expect to increase in value over time so that you can sell them for more than you paid to buy them—although the rate of growth is not guaranteed. Stock mutual funds and real estate are examples of growth investments.

Income investments are investments

you expect to provide a regular source of income over time. Fixed annuities and certain mutual funds are example of income investments.

Minimum required distribution (MRD) is the base amount you must

withdraw each year from an employersponsored retirement savings plan or a traditional IRA, beginning the year you turn 70½.

Portfolio is a group or collection of investments. You may own a portfolio of mutual funds, each with a different investment objective. Each fund, in turn, owns a portfolio of underlying investments the manager has selected to meet the fund’s objective. Principal is the amount of money

you put into an investment account or use to purchase an annuity or other financial product. The term also means the amount you borrow, which is the base

on which the interest you owe on the loan is calculated. Rollover IRA is an IRA that holds assets you have transferred from an employer’s retirement savings plan when you changed jobs or retired. With a rollover IRA you maintain the tax status of your savings but are likely to have more control over how your assets are invested and how you manage withdrawals. You may be able to move the assets in a rollover IRA into a new employer’s plan if the plan accepts rollovers and all the assets in the IRA qualify. Target date fund is designed to help

investors meet their time-specific investment objectives by preselecting a portfolio of individual mutual funds and rebalancing them regularly, shifting the focus from seeking growth to providing income as the target date approaches.

Taxable investment accounts require you to pay income taxes on earnings in your account in the year you receive them and capital gains taxes when you sell an investment at a profit. If you have held an investment for more than a year before you sell it, you will pay tax at the long-term capital gains rate, not your income tax rate. There are no restrictions on when or how you can withdraw money from taxable accounts. Tax-deferred investment accounts,

such as traditional IRAs and traditional 401(k)s, allow you to postpone paying income taxes on your investment earnings and, in some cases, on your contributions until you withdraw from the accounts. There may be penalties for early withdrawals before you turn 59½, and you may be required to begin taking withdrawals after you turn 70½.

Tax-free investment accounts, such

as Roth IRAs and Roth 401(k)s allow you to accumulate investment earnings on which no federal income taxes and sometimes no state income taxes are ever due, provided you follow the specific rules that govern withdrawals.

vesting entitles you to the contributions

your employer has made to a pension or retirement savings plan for you, including matching contributions to salary reduction plans. You become vested when you have been employed at that job for at least the minimum period the plan requires. Those limits are established by federal law.

lIGhtbUlb PRess Project Team Design Director Dave Wilder Designer Kara W. Hatch, Yuliya Karnayeva Editor Mavis Morris Production Thomas F. Trojan Illustration Krista K. Glasser ©2007 bY lIGhtbUlb PRess, Inc. all RIGhts ReseRved.

Lightbulb Press, Inc., 112 Madison Avenue, New York, NY 10016 Tel. 212-485-8800, www.lightbulbpress.com No part of this book may be reproduced, stored, or transmitted by any means, including electronic, mechanical, photocopying, recording, or otherwise, without written permission from the publisher, except for brief quotes used in a review. While great care was taken in the preparation of this book, the author and publisher disclaim any legal responsibility for any errors or omissions, and they disclaim any liability for losses or damages incurred through the use of the information in the book. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering financial, legal, accounting, or other professional service. If legal advice, financial advice, or other expert assistance is required, the services of a competent professional person should be sought.

R e t I R e m e n t

P l a n n I n G

The Retirement Marathon Planning your financial future is planning for retirement— and having the money to enjoy it. If financial security and the satisfaction that comes from meeting your long-term goals is important to you, the first step is deciding what you want to accomplish and when. Then you can set out on a path that should help take you there.

Accumulating investment assets that have the potential to increase in value and provide a source of income is an essential element of planning for the future. So is developing strategies to protect health and wealth—for yourself and your loved ones.

R e t I R e m e n t what the FUtURe holds

The truth is that retirement age is relative, not fixed. Many government workers retire after 20 years of service— sometimes as soon as their early 40s. Some people work productively through their 80s, thinking of retirement as something other people do. Some others retire the first day they’re eligible. Still others leave work unwillingly, taking early retirement packages they can’t refuse. What you do about retirement may fit one of those patterns, or maybe one you

P l a n n I n G design for yourself. But whether retirement is a long way off, or sneaking up on you faster than you care to imagine, planning for your financial future has three main ingredients:

• Your financial security • Adequate healthcare • Benefits for your heirs

ReadY, set, Go

The general wisdom is that planning your financial future starts with your first job. That’s when you can begin putting money into an individual retirement account (IRA) and a 401(k) or 403(b) if your employer offers one. Even though you’ll probably have lots of shorterterm reasons to invest, such as buying a car or a home, you should be thinking early on about long-term goals: your financial security and the security of those you care about. You’ll discover that there are ways to invest for the future that have built-in tax advantages.

In Your 40s & 50s: The Far Turn In Your 20s: Getting Started You can get a head start on building your financial future if you start early. The two opportunities you don’t want to pass up: Contributing to tax-deferred or

• tax-free retirement plans • Setting up an investment account

to invest for other goals While you may be paying off college debts or struggling to meet living expenses, the advantages of getting an early start on a long-term investment plan are too good to pass up. Ideally, you should be investing up to 10% of your pretax income. If you’re in an employer sponsored retirement plan that deducts your contribution from your salary, your taxable income will be reduced. That means tax savings—a reward for doing the right thing. You may want to divide your taxable investment account, keeping part of it liquid in an emergency fund. Then you can put the rest into assets that have the potential to grow in value over time and perhaps provide income to reinvest. 2

In Your 30s & 40s: Hitting Your Stride Even while you’re juggling your income to pay for things that might seem more pressing, like buying a home, supporting a family, or anticipating your children’s college expenses, you need to build your long-term investments. One technique is to split the amount you invest between long- and short-term goals. Even if you put less into long-term plans than you’d like, these investments have the potential to grow, especially if you’re building on a portfolio you started in your 20s. Experts agree that long-term investments should have the potential to grow in value, but short-term investments should be more liquid. Keep in mind that investing for the long term is good for your current financial situation too:

• You save on taxes by participating in a 401(k), 403(b), or other plan • You may qualify for a mortgage •

more easily if you have investment assets You can borrow from some retirement investments without incurring taxes and penalties

You may be earning more than before, but you may be spending more too. College expenses can wreak havoc on long-term investment goals. So can expensive hobbies or moving to a bigger house. On the other hand, if you’ve established good investing habits—like participating in a salary reduction plan and putting money into a variety of growth investments—your long-term goals should be on track. You may also find that the demands on your current income eventually begin to decrease: the mortgage gets paid off, the children eventually grow up, or you inherit assets from your parents. That means you can begin to put more money into your long-term portfolio— possibly through your employer’s voluntary salary reduction plans, through mutual fund or brokerage accounts, and through some income-producing investments that are suitable for you.

In Your 60s: The Home Stretch When you start thinking seriously about retirement, you have to be sure you have enough money to live comfortably. If you have income coming in from a pension and investments, you may have the flexibility to retire when you want. Because many people can expect to live 20 or 30 years after they retire, you’ll want to continue to invest even as you begin collecting on your retirement plans. One approach is to deposit earnings from certain investments into an account earmarked to make new ones. Another is to time the maturity dates of bonds or certificates of deposit (CDs), so that you have capital to reinvest if a good opportunity comes along. Some of the other financial decisions you’ll be facing may be dictated by government rules about when and what you must withdraw from your retirement accounts. Others may be driven by your concerns about healthcare or your desire to leave money to your heirs. At the least, you’ll have to consider:

• Shifting investments to produce

PRotectInG YoUR FUtURe

To safeguard your financial future and the future of people who matter to you, you need a strategy that builds your assets at the same time it protects them against the assaults of taxes, inflation, and market ups and downs. The sooner you put a strategy in place, the stronger your position will be.

• •

more income with fewer risks, in case of a sudden downturn in the financial markets Rolling over retirement payouts to preserve their tax-deferred status Setting up an estate plan that will distribute your assets as you wish

R e t I R e m e n t

P l a n n I n G

R e t I R e m e n t what the FUtURe holds

P l a n n I n G design for yourself. But whether retirement is a long way off, or sneaking up on you faster than you care to imagine, planning for your financial future has three main ingredients:

• Your financial security • Adequate healthcare • Benefits for your heirs

ReadY, set, Go

• tax-free retirement plans • Setting up an investment account

• You save on taxes by participating in a 401(k), 403(b), or other plan • You may qualify for a mortgage •

more easily if you have investment assets You can borrow from some retirement investments without incurring taxes and penalties

• Shifting investments to produce

PRotectInG YoUR FUtURe

• •

R e t I R e m e n t

P l a n n I n G

Realistic Expectations One of the keys to a satisfying retirement is having realistic expectations.

80%

You’ll need 75% to 100% of your preretirement income to live comfortably during retirement

Some financial planners estimate you’ll need 75% of your preretirement income to maintain your standard of living after you stop working. Others say you’ll need closer to 100%. Formulas like these may be too simplistic, though, to figure what you’ll actually be spending. One place to start is to calculate what the essentials are costing you right now: food and clothing, heat and home maintenance, utilities, insurance, and propCosts that erty taxes. You can be fairly confident could you’ll go on paying these bills and that go down: inflation will push their cost up. Home Next, think about mortgage the things you’re Commuting likely to spend less on. Your mortgage Financial may be paid off, responsibility you won’t be for children commuting, and or parents maybe your financial Work-related responsibilities for clothing children and parents will come to an end. You may be paying less in income tax, and if you’re not working you’re no longer paying into Social Security. But also consider the additional expenses you may encounter, such as medical and dental care and the cost of your plans for winter in a warm place and summer in a cool one, or perhaps longpostponed trips or courses and equipment to master new skills.

• • • •

keeP on InvestInG

exPectInG the UnexPected

Ideally, what you would like to know ahead of time are the things that may go wrong, putting a financial strain on your retirement income. Although you can’t predict what might happen, you can prepare by creating an investment account equal to three to six months of living expenses earmarked for any unexpected emergencies. Most experts advise you to keep your rainy-day money liquid, which Costs that means you can turn it into cash easily could if you need it. For example, you might go up: put some of these assets in money Healthcare market accounts for Travel immediate access, and some in US Second home Treasury bills or Further certificates of education deposit (CDs) with six months to one Hobbies year terms. Second The danger of career investing your emergency fund in stocks or other equities is that you risk having to sell during a period when prices are down if you need cash immediately. This is one case where—on a limited portion of your portfolio—stability is more important than growth or income. If you don’t need the money to cover a serious illness, accident, or other unpredictable problems, you’ll be able to leave the unused assets to your heirs.

• • • • • •

The rule of thumb is that you should allocate 10% to 15% of your gross annual income to savings and investments. You can choose investment accounts based on your financial goals, your time frame for achieving them, and your tolerance for risk. Assets you invest for growth may provide a stronger return but expose you to more risk of loss. That may be a greater concern as you age. 4

R e t I R e m e n t doInG the math

The tried and true way of figuring out the cost of living in retirement is to list all your current expenses and then estimate what they’ll be next year and on into future years. You can also anticipate whether you’ll have what you need, based on:

P l a n n I n G You can find work charts like the one illustrated here to help guide you through the calculation. Often they’re in an easy-to-use electronic format, either online or on a CD-ROM. Or you can ask for professional help in projecting your costs.

• The number of years until you

FactoRs to consIdeR

plan to retire

• The amount you have already saved • The anticipated inflation rate • The estimated real rate of return, or

As you prepare a retirement budget, you’ll want to take these factors into account:

what you earn on your investments after adjusting for inflation

If you retire at 65, you can expect to live until you’re into your 80s.

eet

ksh ent woR

the

l RetIRem PRactIca

Current age Retirement age

You have to anticipate changes in Social Security in the future, which means you may get less income from that source.

d income Annual househol rate Annual inflation

eded Annual income ne t savings Current retiremen al contribution Additional annu turn Annual rate of re ent Value at retirem om savings Annual income fr Social Security Monthly incomeinvestments Monthly incomeement income Total annual retir

$75,000 3% $93,478.04 $250,000 $7,500 8% $809,333.55 $64,746.68 $2,000 $400 $93,546.68

This hypothetical example is for illustration only and is not intended to represent or imply the actual performance of any specific investment.

lookInG at the FUtURe

The most revealing thing that projecting your future needs will tell you is how much you can withdraw from your retirement accounts each year to produce the income you need to maintain a comfortable life. In the example above, the assumption is that you’re able to withdraw at the same rate as your earnings, or 8%.

At current rates, the cost of living will increase by approximately 75% during that time.

You can’t predict the level of healthcare coverage that your employer will provide after you retire. There’s a direct relationship between age and health costs: About 7% of Americans between ages 65 and 74 need help in handling the tasks of everyday living. But by age 85, almost 30% do.* That may mean you’ll face nursing home or home care costs. *Source: Urban Institute

Projecting future needs emphasizes how important the rate of return is to your retirement assets. In some periods, when investment markets are depressed, you may not be able to achieve adequate growth, especially if markets are down at the time you begin taking income. By some estimates, to ensure you’ll have money as long as you need it, the most you should plan to withdraw each year is 4.5% of your assets. 5

R e t I R e m e n t

P l a n n I n G

Realistic Expectations One of the keys to a satisfying retirement is having realistic expectations.

80%

You’ll need 75% to 100% of your preretirement income to live comfortably during retirement

• • • •

keeP on InvestInG

exPectInG the UnexPected

• • • • • •

R e t I R e m e n t doInG the math

• The number of years until you

FactoRs to consIdeR

plan to retire

• The amount you have already saved • The anticipated inflation rate • The estimated real rate of return, or

As you prepare a retirement budget, you’ll want to take these factors into account:

what you earn on your investments after adjusting for inflation

If you retire at 65, you can expect to live until you’re into your 80s.

eet

ksh ent woR

the

l RetIRem PRactIca

Current age Retirement age

You have to anticipate changes in Social Security in the future, which means you may get less income from that source.

d income Annual househol rate Annual inflation

$75,000 3% $93,478.04 $250,000 $7,500 8% $809,333.55 $64,746.68 $2,000 $400 $93,546.68

This hypothetical example is for illustration only and is not intended to represent or imply the actual performance of any specific investment.

lookInG at the FUtURe

At current rates, the cost of living will increase by approximately 75% during that time.

R e t I R e m e n t

P l a n n I n G

Personal Investing Goals The Growth Stage

• Making your

investment grow

principal

FIRst thInGs FIRst

If you’re putting money into a tax-deferred savings plan, you’re already investing for retirement in one of the most potentially productive ways you can. That contribution may be most, or even all, of what you feel you can put away. Yet, the truth is, being able to afford the kind of retirement you want will depend—in most cases—on the personal investments you make in addition to the money you put in taxdeferred plans. If you don’t start until retirement is within sight, it’s tough to invest enough to produce the income you’ll need.

One of the important things you do as an investor is reviewing your portfolio on a regular basis—perhaps once a year—and making adjustments as your goals or your time frame change. You’ll also want to evaluate how well your investments are meeting your expectations and replace them if that makes sense. It’s smart to work with a professional to put the future in perspective and to take advantage of retirement planning calculators that are available online at many financial services websites. 6

IRA Bonds

Mutua Funds l

• Producing income • Preserving your

makInG adJUstments

Stocks

401(k) Plan

T-bills

NOTE:

Contribute regularly Reinvest earnings

Growth is the first order of business, and investments may grow in many ways.

• You can beef up your principal on

a regular basis by contributing a percentage of your income to your investment account or contributing NOTE: the maximum to an IRA or Roth IRA

•

P l a n n I n G

The Preservation Stage

Chances are, living the life you want after you retire will depend on your investment income. In many ways, investing for retirement is just like investing for any other reason. You invest your principal, or the money you have, to earn more money, which you can use to pay your bills, buy something you want, or make a new investment. But when you’re investing for longterm financial security, there’s no fixed moment when you Tax rred e need the money. Instead, def Plan it’s a continuous process. That means you always have to think about doing three things:

R e t I R e m e n t

Contribute regularly Reinvest earnings

You can reinvest your investment earnings rather than spend them, either by using an official reinvestment plan offered by a mutual fund reinvestment program, or by putting all your interest and dividend payments into a special investment account

• You can invest your money in equity

products like stock mutual funds, which have the potential to provide strong long-term returns though may be volatile in the short term

• You can diversify, or put your

money into a variety of investments, to take advantage of ups and downs in the stock market and interest rates

The Income Stage

If you’re living on the income your investments provide, you’ve got a vested interest in making sure they don’t shrink in value or, worse yet, disappear altogether. Curiously, the best preservation technique is often to concentrate on growth—slower, safer growth than you were looking for when you first began to build your nest egg, but growth nonetheless. You may also want to gradually shift more of your investment portfolio into income producing assets, including bond funds, Treasury bills, and CDs. That could reduce the impact a drop in equity markets could have on your budget.

Income-producing investments are especially important when you need the money to live on, typically after you retire. For example, you may be able to arrange systematic distributions from certain mutual funds, such as bond funds, whose investment objective is to provide regular income. You may also switch from automatically reinvesting all your mutual fund distributions to purchase more shares to taking some of those distributions as cash. You may want to gradually shift the balance in your IRA portfolio from growth investments to income investments. There are no capital gains taxes when you sell investments in a traditional IRA or Roth IRA, though you do pay income taxes on withdrawals from a traditional IRA.

comInG UP shoRt Most experts agree that you need 70% to 80% of your preretirement income after you retire if you want to maintain a similar style of living. Social Security benefits and, in some cases, an employer sponsored pension, will supply some of what you need. For example, if you’re earning $75,000 when you retire, your financial picture might look like this:

$ 75,000 Preretirement income x .80 = $ 60,000 Post retirement need – 15,600 Social Security benefits – 22,500 Retirement plan benefits = $ 21,900 FIRst YeaR Income shoRtFall

makInG UP the dIFFeRence* You might go on working part-time—though that may not be your idea of retirement. The other option—short of winning the lottery—is a regular income from the investments you’ve built up over the years. The more carefully you’ve diversified those investments, the more likely it is that you can count on them to produce the earnings you’ll need. Here are three examples. Remember, though, that you may owe income or capital gains tax on some or all of your investment income.

T-bills

IRA Stocks

Bonds

TaxMutual $150,000 Treasury bonds401(k) paying 5.5% deferred 1 1 + $ 8,250 7,500 $150,000 IRA withdrawal at 5% Funds Plan Plan + 6,930 Liquidating 4.5% of a $154,000 stock fund portfolio = $ 22,680 Income FRom InvestInG $ 10,000 $200,000 SEP-IRA

2 + +

withdrawn at 5% 1,500 $75,000 in stock fund yielding 2% 11,500 Maturing certificate of deposit (CD)

= $ 23,000 Income FRom InvestInG

3 $ + +

4,200 Rental on real estate holdings 4,500 Liquidating 5% of a $90,000

stock fund portfolio

13,750 $275,000 in an IRA

withdrawn at 5%

= $ 22,450 Income FRom InvestInG

* This hypothetical example is for illustrative purposes only and is not intended to represent or imply the actual performance of

any specific investment. It is important to note that any investment involves risks that may result in the loss of principal and there is no guarantee that the strategies illustrated will produce positive investment results.

R e t I R e m e n t

P l a n n I n G

Personal Investing Goals The Growth Stage

• Making your

investment grow

principal

FIRst thInGs FIRst

IRA Bonds

Mutua Funds l

• Producing income • Preserving your

makInG adJUstments

Stocks

401(k) Plan

T-bills

NOTE:

Contribute regularly Reinvest earnings

Growth is the first order of business, and investments may grow in many ways.

• You can beef up your principal on

a regular basis by contributing a percentage of your income to your investment account or contributing NOTE: the maximum to an IRA or Roth IRA

•

P l a n n I n G

The Preservation Stage

R e t I R e m e n t

Contribute regularly Reinvest earnings

• You can invest your money in equity

products like stock mutual funds, which have the potential to provide strong long-term returns though may be volatile in the short term

• You can diversify, or put your

money into a variety of investments, to take advantage of ups and downs in the stock market and interest rates

The Income Stage

$ 75,000 Preretirement income x .80 = $ 60,000 Post retirement need – 15,600 Social Security benefits – 22,500 Retirement plan benefits = $ 21,900 FIRst YeaR Income shoRtFall

T-bills

IRA Stocks

Bonds

2 + +

withdrawn at 5% 1,500 $75,000 in stock fund yielding 2% 11,500 Maturing certificate of deposit (CD)

= $ 23,000 Income FRom InvestInG

3 $ + +

4,200 Rental on real estate holdings 4,500 Liquidating 5% of a $90,000

stock fund portfolio

13,750 $275,000 in an IRA

withdrawn at 5%

= $ 22,450 Income FRom InvestInG

* This hypothetical example is for illustrative purposes only and is not intended to represent or imply the actual performance of

R e t I R e m e n t

P l a n n I n G

Retirement Savings Plans

how the Plans woRk

With a salary reduction plan, you put money into an account set up through your employer and usually administered by a brokerage firm, a mutual fund company, or other financial institution. The amount you contribute and the earnings in your account are not taxed until you start withdrawing the money, usually at retirement. Your employer may also offer a Roth 401(k) or 403(b). With this option, you contribute after-tax rather than pretax income, so your current taxes aren’t reduced. But when you retire you can take tax-free withdrawals from your account if you’re old enough—usually 59½ but sometimes younger—and your account has been open at least five years. The key difference is whether you pay lower taxes now or no taxes later. PIckInG Investments

Retirement savings plans are typically self-directed, which means you choose how and where your money is invested. The specific choices you have depend on the plan, but typically you can choose from a mix of investments, including annuities, mutual funds, fixed-income investments, and company stock.

tYPes oF Plans There are a variety of salary reduction plans, each with some distinctive characteristics. The type that’s available to you depends on the company or organization you work for. 8

loweR taxes If you contribute to your plan on a pretax basis, the amount you put in is not reported to the IRS as earnings. That reduces your taxable income—and your take-home salary—for the year. For example, if you earned $50,000 and contributed $5,000 to your company’s plan, your employer would report you had a taxable income of $45,000.

Your salary Plan contribution YOUR TAXABLE SALARY

$50,000 –

5,000

= $45,000

no GUaRantees Retirement savings plans provide no guarantees on the amount of retirement income you’ll receive. That’s because any growth in your account depends on the amount you contribute and the performance of your investment accounts. History has shown that equity investments—including those you can matchInG make with stock mutual funds and variable FUnds annuities—increase in value over the Employers often match a percentage of the long term, but no promises can be amount you contribute to your retirement savings made. In fact, your investment plan. A typical plan might match 50% of what you may actually lose money, contribute, to a maximum of 6% of your salary. especially in the short Let’s say you earn $50,000 and contribute 6% term, because the of your salary, or $3,000 a year, to your plan. If value of the underthe employer matches 50% of your contribution, or lying investments, $1,500, the total added to the account at year end will such as the stocks a fund or annuity be $4,500. But if you contributed 15% of your salary, invests in, may go down. or $7,500, your employer’s contribution would still be capped at $3,000, which is 6% of your salary and the maximum match. You Contribute

Employer Contributes

6% = $3,000

50% = $1,500 of your contribution

15% = $7,500

Up to = $3,000 6% of your salary

of salary

If you have a broad choice of investments, you should compare their specific objectives and their performance records before choosing among them. You can get information from the mutual fund companies or annuity providers directly, and you can find reports and analysis in financial magazines and the financial pages of big city newspapers. Some experts advise you to put most of your salary reduction account in equity investments. Alternatives that may seem safer may not produce enough growth to offset inflation and the eventual tax you’ll owe.

401(k) plans

401(k) plans are offered by corporations, non-profit organizations, and other employers, who may match a percentage of your contribution. There’s an annual contribution limit, with increases linked to the rate of inflation. If you’re 50 or older, you can make an additional catch-up contribution each year.

P l a n n I n G

Your plan will provide a report at least once a year that will let you track your contributions and how the investments you’ve chosen are doing. That way, you’ll be able to tell where you stand.

You can reduce your taxes and invest for retirement at the same time. If you want to save for retirement, the first thing to check is whether your employer offers a retirement savings plan. These varieties of defined contribution plans, including 401(k)s, 403(b)s, and 457s, offer convenience, tax savings, and opportunity to provide long-term growth.

R e t I R e m e n t

403(b) plans

403(b) plans are available to employees of educational, healthcare, and non-profit, tax-exempt organizations. There’s an annual contribution limit, with increases linked to the rate of inflation. If you’re 50 or older, you can make an additional catch-up contribution each year.

It’s also smart to diversify your equity investments by choosing several within the plan, rather than putting all your money into one investment account or fund choice. That lets you benefit from those that turn in a strong performance and offset potentially weaker returns by others in any given period. If you want to change your investment mix or rebalance your holdings, most salary reduction plans let you transfer assets among the various choices. You owe no tax on any earnings you transfer, since the plans provide tax-deferred growth.

Section 457 plans

Section 457 plans are designed for employees of state and municipal governments. There’s no provision for matching contributions. There’s an annual contribution limit, with increases linked to the rate of inflation. If you’re 50 or older, you can make an additional catch-up contribution each year.

wIthdRawInG assets

When you retire, you can roll the assets in your retirement savings plan into a similar type of IRA, either traditional to traditional or Roth to Roth. The IRA can be either an account or annuity. You’ll have to begin systematic withdrawals or annuitize after you reach age 701⁄2, and you’ll owe tax at your regular income tax rates on each withdrawal. If you prefer, you can take a lump sum payout and reinvest, though you’ll owe a lot of tax immediately. With what is left you could buy an immediate annuity, taxable investments such as stocks or bonds, or income-producing, tax-exempt municipal bonds. You may want professional help to figure out if that approach makes sense for you. It may not be a good idea to put all the money into low-paying accounts that promise safety of principal. They may not keep pace with inflation or provide the income you need to live comfortably.

Thrift or savings plans

These plans are available to federal employees and to employees of corporations that offer plans. Your employer may match a percentage of your contribution. Contribution limits are set as a percentage of your salary based on the plan you’re in.

SIMPLE

SIMPLE plans are designed for employers with 100 or fewer workers. These plans require an employer contribution. There’s an annual contribution limit, with increases linked to the rate of inflation. If you’re 50 or older, you can make an additional catch-up contribution each year. 9

R e t I R e m e n t

P l a n n I n G

Retirement Savings Plans

how the Plans woRk

tYPes oF Plans There are a variety of salary reduction plans, each with some distinctive characteristics. The type that’s available to you depends on the company or organization you work for. 8

Your salary Plan contribution YOUR TAXABLE SALARY

$50,000 –

5,000

= $45,000

Employer Contributes

6% = $3,000

50% = $1,500 of your contribution

15% = $7,500

Up to = $3,000 6% of your salary

of salary

401(k) plans

P l a n n I n G

Your plan will provide a report at least once a year that will let you track your contributions and how the investments you’ve chosen are doing. That way, you’ll be able to tell where you stand.

R e t I R e m e n t

403(b) plans

Section 457 plans

wIthdRawInG assets

Thrift or savings plans

SIMPLE

R e t I R e m e n t

P l a n n I n G

IRAs: What They Are • All traditional IRAs are tax

retirement plans. You can contribute every year you earn income whether or not you participate in an employer’s retirement plan. There are two types: the traditional IRAs, to which contributions may be deductible or nondeductible, and the Roth IRA.

deferred, which means you owe no tax

on your earnings until you withdraw

• Roth IRAs are tax free, which

means you owe no tax at all on your earnings as they accumulate or when you withdraw, if you follow the rules for withdrawing

weIGhInG the choIce

If you have a choice of which IRA to open, you’ll want to weigh the pros and cons:

PRos

Roth

tRadItIonal IRa

• Tax-free income at withdrawal • No required

• Tax-deferred earnings • Immediate tax savings on tax-deductible • No tax due at withdrawal on contributions contribution • Tax-deferred earnings • Not deductible • Tax due at regular rates at withdrawal • Tax due at regular rates at withdrawal • Required withdrawals beginning at 70 ⁄ • Required withdrawals

Nondeductible

withdrawals

cons

• AGI limits • Not deductible • Requirements to qualify for tax-free provision

Deductible

beginning at 70 ⁄2

do YoU QUalIFY FoR a Roth IRa?

a sweet deal

Married

Single

You don’t qualify for a Roth

You don’t qualify for a Roth $160,000

$166,000

Partial Roth $110,000

$114,000

$150,000 (2006)

$156,000 (2007)

Partial Roth $95,000 (2006)

$99,000 (2007)

You qualify for a Roth

Adjusted Gross Income

The only requirement for opening an IRA is having earned income—money you get for work you do. Your total annual contribution is limited to the annual cap. That’s $4,000 through 2007 and $5,000 in 2008, whether you choose a traditional IRA or a Roth. If you’re 50 or over, you can also make annual catch-up contributions. Any amount you earn qualifies, and you can contribute as much as you want, up to the cap. But you can’t contribute more than you earn. sPoUsal accoUnts

You qualify for a Roth

Adjusted Gross Income

P l a n n I n G

While you can’t deduct your contribution to a Roth IRA, taxes on earnings If you qualify to contribute to all types in your account are deferred as they of IRAs, based on your adjusted gross accumulate, and you make tax-free income (AGI), you’ll have to choose withdrawals if you qualify. In most cases, among a traditional deductible IRA, a that means you are at least 59½ and have traditional nondeductible IRA, or a had your account open at least five years Roth IRA. before you withdraw. The traditional deductible IRA has the strictest qualifying limits, and the nondeductible has the fewest. The Roth It’s YoUR accoUnt is in between. It’s easy to open an IRA. All you do is You qualify for fill out a relatively a fully deductible simple application deductions are gradually IRA contribution provided by the mutual phased out if you are covwhen you file your fund company, bank, ered by a retirement plan federal income brokerage firm, insurtax return if you ance company, or other were not covered financial institution you by an employer choose to be custodian sponsored retireof your account. Because IRAs are self-directed, meaning ment plan that you decide how during that year. to invest the money, If you were covyou’re responsible for ered by a plan, following the rules that you may be able govern the accounts. to deduct some Basically, that means or all of your conputting in only the tribution based amount you’re entitled Single taxpayer on your modified to each year. You must $4,000 For 2007. adjusted gross also report your contriincome (MAGI). bution to a traditional The income limits are lower if your IRA to the IRS, on your basic return if it’s $0 filing status is single than they are if deductible and on Form 8606 ifMarried it’s not.deduction $52K you’re married filing jointly. Married You can invest your IRA money any way $58K $4,000 Income couples who file separate returns usually that is available through your custodian aren’t eligible for the deduction. including mutual funds, bank products, If you’re married and file jointly, either Married and annuities. The only things you can’t filing jointly $0 of you can deduct your own contribution if buy are fine art, gems, non-US coins, and you are not covered by a retirement plan collectibles. And you can buy and sell $80K Income at work. But if your spouse is covered by a investments in your IRA account without plan, your right to a deduction is reduced paying tax on your gains until you withgradually if your MAGI is over $156,000 draw from your account, but there may $83K $93K $103K and eliminated if it’s over $166,000. be transaction costs. whIch IRa FoR YoU?

IRAs are easy to set up—but not always easy to understand. IRAs, or individual retirement accounts, are tax-deferred, personal

R e t I R e m e n t

If your husband or wife doesn’t work, but you do, you can put up to the annual limit into a separate spousal IRA in addition to your own contribution. The advantage for the nonworking spouse is being able to build an individual retirement fund.

You have until the day taxes are of the tax year you’re making due—usually April 15—to open the contribution for, to give an IRA and make the contribuyour money the longest time to tion for the previous tax year. grow. If you’re like most people, to You can contribute to your you’re more apt to make the contRIbUte deposit the IRA in a lump sum or spread last possible the deposit out over the day. The most practical year. You may put in the solution may be making whole amount the first contributions on a day you can, January 2 regular schedule.

WHEN

Ê 10

R e t I R e m e n t

P l a n n I n G

IRAs: What They Are • All traditional IRAs are tax

deferred, which means you owe no tax

on your earnings until you withdraw

• Roth IRAs are tax free, which

means you owe no tax at all on your earnings as they accumulate or when you withdraw, if you follow the rules for withdrawing

weIGhInG the choIce

If you have a choice of which IRA to open, you’ll want to weigh the pros and cons:

PRos

Roth

tRadItIonal IRa

• Tax-free income at withdrawal • No required

Nondeductible

withdrawals

cons

• AGI limits • Not deductible • Requirements to qualify for tax-free provision

Deductible

beginning at 70 ⁄2

do YoU QUalIFY FoR a Roth IRa?

a sweet deal

Married

Single

You don’t qualify for a Roth

You don’t qualify for a Roth $160,000

$166,000

Partial Roth $110,000

$114,000

$150,000 (2006)

$156,000 (2007)

Partial Roth $95,000 (2006)

$99,000 (2007)

You qualify for a Roth

Adjusted Gross Income

You qualify for a Roth

Adjusted Gross Income

P l a n n I n G

IRAs are easy to set up—but not always easy to understand. IRAs, or individual retirement accounts, are tax-deferred, personal

R e t I R e m e n t

WHEN

Ê 10

R e t I R e m e n t

P l a n n I n G

R e t I R e m e n t

IRA Rollovers

The answer will depend on:

• How much you have to transfer • Your current and anticipated tax rates • Your age • The time until you plan to withdraw

Rollovers are a hop, skip, and a jump from conventional IRAs.

conveRtInG to a Roth

You can roll over money from one traditional IRA to another traditional IRA, from one Roth IRA to another Roth IRA, or from an employer sponsored retirement plan to an IRA, keeping the tax-deferred status of your assets intact. To begin the process, you choose a financial services company to be the custodian of your account. Most companies that offer IRAs provide a range of investment alternatives, so you should have no trouble finding one that offers the types of investments you want to be able to make. In fact, you may already have an account with the custodian you choose or you may select a new one. The best approach to moving the money is almost always a direct rollover, or transfer, of assets from your old account to your new one. While the time it takes to complete the process varies, your chief responsibilities are to be sure you’ve provided the information the custodians or plan provider needs and to follow up to be sure the transfer has been completed. FRom Plan to IRa

You can move from one IRA to another when you choose, but you can move employer sponsored retirement plan assets to an IRA only when you retire, change jobs, or the plan ends. The 12

P l a n n I n G

advantages of an IRA are that you often have more control over how you invest your savings than you do in an employer’s plan and also over how you withdraw after you retire.

Making wise moves You can make the most of the opportunity to roll over your retirement assets if you know what you can accomplish by moving your money and the most effective ways to meet those goals.

You may handle a rollover yourself Follow rather than with a the direct transfer. But you RUles take on more responsibility and face potential problems that don’t arise with a direct rollover or transfer. The one advantage of an indirect rollover may be that you have shortterm access to cash for 60 days between taking money out of one account and putting it in another. However, if you miss the 60-day deadline, your money is no longer tax deferred and you owe income tax plus a potential 10% tax penalty if you’re younger than 59½.

One way to take advantage of the tax-free income a Roth IRA provides is to convert your current IRA to a Roth. You’ll owe the tax due on your earnings (and on your investment amount if you deducted your contributions), but no tax penalty. The catch is, your adjusted gross income can’t be more than $100,000 in the year you make the conversion. The cap is the same whether you’re single or married. You’ll probably want to get some expert advice on whether this strategy pays for you. There’s an added complication if you are moving money from an employer’s plan to an IRA. By law, your employer must withhold 20% of the total you’re moving yourself—for example, $20,000 of an account worth $100,000—to cover potential income taxes if you miss the 60-day deadline. If you want all of your savings to continue to be tax deferred, you must come up with an amount equal to the 20% that was withheld from some other source. If you do that, you’ll get back the money that was withheld as a tax refund. But if you can’t, any amount you don’t deposit is considered a withdrawal.

When you’ve rolled over the money from your old Invest plan to your IRA, it’s wIselY your responsibility to invest it to meet your long-term goals. You’ll want to have a strategy for choosing investments for your portfolio and a plan for evaluating your progress toward your goals. Working with a professional can be a big help.

As with other Roth accounts, you must keep an account with transferred funds open for at least five FUtURe years before consIdeRatIons you can take You can extend the taxtax-free deferred life of your IRA withdrawals. by naming a living benefiIf you’re not ciary rather than leaving confident it to your estate. That’s you’ll wait because IRA withdrawals are that long, based on life expectancy it’s probably and an estate hasn’t got not smart to one. So your account comes move your to a quick (and bad) end, funds, pay with a tax bill to settle. It’s the tax due an easy mistake to avoid. and withdraw early, only to be faced with more taxes (and potentially a tax penalty). One consideration if you are planning to convert to a Roth IRA is that the tax on the entire amount will be due in the year the money is moved. That could be a very large tax bill which you’ll want to pay from savings or other non-IRA sources.

If you take a new job where the employer offers a retirement savings plan that accepts rollovers from IRAs or other employer plans, you may choose to move your money into the plan. One thing to consider is the quality of the plan offerings, and whether you believe they will help you meet your objectives as well as investments you select on your own for your IRA. You are allowed to move money from one type of plan—say a 403(b)—to another type, such as a 401(k), if the plan accepts rollovers. That increases your flexibility, and allows you to consolidate your retirement assets. consIdeR anotheR RolloveR

You can put all or part of your lump sum pension payout in a rollover IRA. If the payout is made in a series of partial lump sums over a period of less than ten years, you can put some or all of those payments into a rollover IRA too. PUt awaY PensIon PaYoUts

R e t I R e m e n t

P l a n n I n G

R e t I R e m e n t

IRA Rollovers

The answer will depend on:

• How much you have to transfer • Your current and anticipated tax rates • Your age • The time until you plan to withdraw

Rollovers are a hop, skip, and a jump from conventional IRAs.

conveRtInG to a Roth

You can move from one IRA to another when you choose, but you can move employer sponsored retirement plan assets to an IRA only when you retire, change jobs, or the plan ends. The 12

P l a n n I n G

advantages of an IRA are that you often have more control over how you invest your savings than you do in an employer’s plan and also over how you withdraw after you retire.

R e t I R e m e n t

P l a n n I n G

Making Investments

bUIldInG a PoRtFolIo

Making a variety of investments helps you create a diversified portfolio. Most investors—from the newest to the most experienced—focus on three investment categories: stocks and stock mutual funds, bonds and bond mutual funds, and cash or cash equivalents, including money market mutual funds. Each type of investment puts your money to work in a different way, but they

R e t I R e m e n t

have similarities that help make them attractive. They’re easy to buy and sell. They’re available at a wide range of prices. And they have the potential to provide the primary benefit of investing—the possibility for growth.

Your goal as an investor is to build a diversified portfolio, or collection of varied investments. Diversification means that rather than buying just one stock, or stock fund, you buy a number of different types. At the same time, you put some of your principal, or investment capital, into a number of bonds or bond funds, and some in cash or cash equivalents. The reason you diversify is that investment categories, also called asset

Stocks

Mutual Funds

Stocks are equity investments, or ownership shares in a business. When you and other investors buy shares, you actually buy part of the business. If it prospers, you may make money because you’re paid dividends, or a portion of the profits, because the value of the stock increases, or both. But stocks, though they historically have provided stronger returns than other securities, can lose value, especially in the short term. You’ll want to consider that risk before you invest.

A mutual fund invests money that you and others put into the fund. With those resources, a fund can buy many different investments and provide more diversification, or variety, than you could achieve on your own for the amount you have to invest. Since each fund is professionally managed, you benefit from that investment expertise. What’s more, each fund’s prospectus describes the investments it makes, its goals and management style, as well as the level of risk that you’re taking.

FIndInG mIddle GRoUnd

oTHER INvESTMENT oPPoRTuNITIES CDs CDs are income investments that pay interest on a specific amount of money for a specific period of time.

REAL ESTATE

Real estate may increase in value and can provide tax advantages.

ANNuITIES

Annuities are tax-deferred savings plans designed to provide future income, at either a fixed or variable rate.

a dIstInctIve dIFFeRence

Saving and investing both have a place in your financial plan, and while they’re not the same, they are complementary. Saving is holding money, usually in savings or money market accounts, often for a specific short-term purpose, as a way to accumulate money to invest, or as an emergency fund. Investing is buying things of intrinsic value—such as stocks, bonds, real estate, and the funds that invest in them—that have the potential to provide income, increase in value over the long term, or do both. One important difference is that savings you hold in a bank account are insured by the FDIC up to the limit Congress sets. Most investments aren’t insured, even if you invest through a bank, and you could lose money. 14

You may seek out a middle ground between saving and investing, where products like certificates of deposit (CDs) and US Treasury bills fit. You generally earn more than on basic bank accounts but your money is still safe. CDs are FDIC insured. T-bills pose limited risk because they have short terms and they’re backed by the credit of the federal government. In other words, this is conservative investing, which means there’s little risk of losing what you have. In contrast, you may choose either a moderate or aggressive approach, which may increase your risk of losing principal but increases the opportunity for larger gains over the long term.

P l a n n I n G classes, have their ups and downs. When

stocks are strong, bonds may not be. The reverse is true as well. When bonds are strong, stocks are often weak. Sometimes, though not all the time, cash equivalents, such as certificates of deposit (CDs) or US Treasury bills, do better than stocks or bonds. Since there is no way to predict which category will be the best investment to own at any given time, you can be ahead of the game by having some money in all three categories, either directly or through mutual funds.

Bonds

Bonds are loans that investors make to corporations or governments. When they borrow, these bond issuers promise to pay back the full amount of the loan at a specific time, plus interest, or a percentage of the loan amount, for the use of your money. Investors buy bonds, also known as fixed-income investments, because they expect to receive their investment amount back, and because they like the idea of regular interest income. keePInG YoUR FocUs

Picking investments for your portfolio is only the first step toward achieving your financial goals. You also have to monitor their performance over time, asking whether the ones you’ve chosen are still right for you. Further, as you accumulate more assets, you may add some investment categories you hadn’t considered before. Or, your goals or your life style may change, which may require a different investment strategy. For example, if you’re getting ready to retire and want to begin collecting income from your portfolio, you may want to shift some of your growth assets to income producing investments.

RIsk and RewaRd

With all investments, there’s an expectation of reward—known as return—and an element of risk. And in general, the greater the chance for a substantial reward, the greater the risk of a loss. Though it’s almost impossible to predict any investment’s behavior accurately, a time-honored approach to achieving a better balance between risk and return is to own a number of investments in several asset classes. In fact, the ideal investment portfolio for a typical investor is often described as a pyramid, with low-risk/low-reward investments providing the base and high-risk/high-reward opportunities at the apex. 15

R e t I R e m e n t

P l a n n I n G

Making Investments

bUIldInG a PoRtFolIo

R e t I R e m e n t

Stocks

Mutual Funds

FIndInG mIddle GRoUnd

oTHER INvESTMENT oPPoRTuNITIES CDs CDs are income investments that pay interest on a specific amount of money for a specific period of time.

REAL ESTATE

Real estate may increase in value and can provide tax advantages.

ANNuITIES

Annuities are tax-deferred savings plans designed to provide future income, at either a fixed or variable rate.

a dIstInctIve dIFFeRence

P l a n n I n G classes, have their ups and downs. When

Bonds

RIsk and RewaRd

R e t I R e m e n t

P l a n n I n G

Deferred Annuities

collectInG on YoUR annUItY

Annuities are appealing because they grow tax deferred. A deferred annuity is a contract you make with an insurance company. You invest money, either as a lump sum or over a period of years, building up a pool of income you can tap after you retire. The insurance company administers the

R e t I R e m e n t

contract and pays out your benefit either as a lump sum or a series of payments. Because annuities are retirement plans, your investment grows tax deferred, increasing the rate at which your earnings are able to accumulate.

A fixed annuity is a contract you make with an insurance company.

After the accumulation phase, when your annuity investment grows, there comes a point when you start collecting—and paying the taxes you’ve deferred. You can choose annuitizing, which means receiving lifetime payouts based on factors including your age and the value of your contract. This option, which carries no sales charge, is one of the benefits of purchasing an annuity. Other choices are buying an immediate annuity from another source or taking a lump sum withdrawal. If you’re taking the regular payments, you owe tax on the earnings portion of each payout, a calculation that the

the InvestoR

company will provide. If you take a lump sum, though, you owe all the tax that’s due up front, since you can’t roll the amount over into an IRA. Those taxes are figured at your regular income tax rate. You can usually take money out of your annuity from time to time. If you’re over 59½, there’s no penalty, but you will owe tax on the earnings. The risk is that the IRS may rule that the entire withdrawal is made up of earnings, not principal. It’s also possible to begin regular withdrawals before you retire, taking up to 10% of the total value of your account each year. Then you owe tax on the earnings portion only.

the InsURance comPanY

I agree to “invest a set

amount in the annuity, either in a lump sum or over a period of years.

FIxed oR vaRIable

If you choose a deferred annuity, you’ll have to choose between a fixed or a variable account. A fixed annuity is the more conservative choice. It promises a set rate of return, though the rate can be—and usually is—reset regularly. In some cases, the initial rate, or the one you’re quoted when you buy your annuity, may be higher than the rate that your investment will pay later. If the rates drop, the earnings that have been projected for your investment based on the promotional rate will decline.

Annuities that aren’t part of a qualified employer plan are described as nonqualified. Two major differences are that you can add more money each year and postpone withdrawals longer with a nonqualified than with a qualified annuity.

“to Wepayagree a benefit

Your money grows tax deferred

You have a source of retirement income

”

P l a n n I n G

While most fixed annuities have a floor, or guarantee of a minimum rate, it can be as low as current bank savings rates. Unlike a fixed annuity, a variable annuity lets you choose how your money is invested. The selection of subaccounts, or underlying funds, may be limited, and the return is not guaranteed. But you can put your money into potentially higher paying investments than a fixed annuity, and you can profit by putting what you know to work for your own benefit. Advocates of variable annuities point out that a number of new products are being introduced that let you combine the assurance of a steady long-term income with the opportunity to put money into investments whose returns reflect the ups and downs of the markets. In addition, as an increasing number of providers offer annuities, many have responded to the competition by lowering their fees.

based on the plan’s earnings, beginning at an agreed retirement date.

”

deFeRRed annUItIes—the PRos and cons Deferred annuities, both fixed and variable, provide major investment benefits. For all their charms, however, deferred annuities also have some drawbacks. advantaGes

dRawbacks

• Tax-deferred growth • No limit on the amount

• Surrender fees and penalties

• •

•

you can contribute to a nonqualified annuity each year A wide choice of plans to suit your investing style and goals Promise of lifetime income if contract is annuitized

A side benefit of receiving income from an annuity contract is that the part that’s return of principal doesn’t count when you’re figuring out whether your Social Security benefit is taxable. Unlike income from other investments—including tax-exempt municipal bonds—which you have to add when you figure your annual income, you can ignore this percentage of your annuity income.

• •

if you withdraw early, or in some cases, if you make a lump sum withdrawal Minimized tax advantages for high-income taxpayers because earnings are taxed as regular income, not capital gains Potentially large fees, which reduce investment growth, a particular problem with variable annuities Lack of liquidity, especially in fixed annuities, though they may grow at a rate similar to cash-equivalent investments, including uS Treasuries 17

R e t I R e m e n t

P l a n n I n G

Deferred Annuities

collectInG on YoUR annUItY

R e t I R e m e n t

A fixed annuity is a contract you make with an insurance company.

the InvestoR

the InsURance comPanY

I agree to “invest a set

amount in the annuity, either in a lump sum or over a period of years.

FIxed oR vaRIable

“to Wepayagree a benefit

Your money grows tax deferred

You have a source of retirement income

”

P l a n n I n G

based on the plan’s earnings, beginning at an agreed retirement date.

”

dRawbacks

• Tax-deferred growth • No limit on the amount

• Surrender fees and penalties

• •

•

you can contribute to a nonqualified annuity each year A wide choice of plans to suit your investing style and goals Promise of lifetime income if contract is annuitized

• •

R e t I R e m e n t

P l a n n I n G

Mutual Funds When you invest in mutual funds, you pool your money with money from other investors. When you invest in a mutual fund, your money is combined with the money of the fund’s other investors. A professional manager decides how to invest those assets based on the fund’s investment objective, what’s happening in the financial markets, and his or her investment style, or approach to choosing what to buy and when to sell. An investment objective describes the financial results the fund aims to deliver. For example, one fund’s objective may be long-term price appreciation, or growth in value, while another fund may invest to produce a combination of current income and long-term growth. FUnd Facts

Mutual funds come in three basic varieties: stock funds, bond funds, and money market funds. Stock funds invest primarily in stocks, though the stocks they buy vary from fund to fund. Most stock funds invest primarily for growth, but some, called growth and income funds or equity income funds, invest for current income as well by buying dividend-paying stocks. Since most stock funds invest in dozens of companies, they’re by

nature diversified investments. Weak performances by some stocks that the fund owns can be offset by strong performances from others. That makes the fund more price-stable overall than individual stocks. However, if the stock market as a whole drops in value, the value of most funds invested in the market will drop as well. Bond funds buy bonds. Investing in a bond fund provides current income, just as investing in individual bonds does. But you can invest smaller amounts and get greater diversification by buying shares in a fund. And you can automatically reinvest your fund income to buy more shares in the fund, something you can’t do with individual bonds. But bond funds aren’t bonds. Your shares in a bond fund don’t mature at a particular time, they don’t earn a fixed rate of interest, and there’s no promise that you’ll get your original investment back. Instead, the value of bond fund shares goes up and down to reflect the changing values of its bonds in the secondary market.

R e t I R e m e n t Money market funds invest in short-term bonds and other debt investments, with the goal of maintaining a share price of $1 per share. These funds pay interest, usually at about the same rate as short-term CDs. While they’re not federally insured, and you could lose money, they’ve generally been considered safe. taRGet date FUnds

Target date funds are mutual funds designed to help investors meet timespecific goals, such as retirement. The managers regularly rebalance the assets the fund holds, seeking growth in the early years and reducing investment risk as the target date draws closer. Companies offer funds with a range of target dates, such as 2015, 2025, and 2035, to meet the needs of people at different stages of their lives. maRket PRIces

A mutual fund’s value, or price per share, is based on the value of its underlying investments, which are the stocks or bonds it owns, and the number of shares it has issued. To find the fund’s net asset value (NAv), or the market value of one share of the fund, you divide the total combined value of its underlying investments, minus fund expenses, by the number of existing shares. Both the underlying value and the number of shares change all the time. So each fund computes its NAV at the end of every business day.

P l a n n I n G a FUnd oveRvIew Mutual funds offer their investors several advantages, many of which can be especially attractive if you’re just getting started. Affordability. You can open a mutual fund account for as little as $1,000, and add to it in even smaller amounts. Diversification. When you buy shares in a fund, you’re investing through the fund in the dozens of stocks or bonds the fund owns. If the fund is diversified, your investment is diversified. Liquidity. You can redeem your shares at any time by selling them back to the fund. The price you get is determined by the fund’s current NAV, and may be higher or lower than the amount you originally paid for the shares. But remember that you pay a number of fees and expenses to buy and hold mutual funds that reduce your return. They include management fees, 12b-1 fees, fees for shareholder services, and fund operating expenses, among others. You may also pay sales charges. When you buy shares in a mutual fund, you typically pay a sales charge known as a load to the professional who handles the transaction. You may have a choice of share classes. With Class A shares, you pay the load when you buy. With Class B shares, you pay a load only if you sell within a certain number of years—often but not always seven. Class B shares often have higher management fees though. two waYs to Get PaId

MANAGER

INvESToRS 18

FuND CoMPANY

INvESTMENTS

Mutual funds pay out their profits to their shareholders each year. Income distributions are paid from the dividends or interest the fund earns on its investments. Capital gains distributions are paid from any profits the fund makes by selling investments it owns. You can take these distributions in cash or you can reinvest them automatically to buy more shares in the fund. Reinvesting is an easy way to buy more shares, and can help build the value of your account. There is one catch: You owe some tax on your distributions every year even if you reinvest. The only exception is if you own the fund through a 401(k) plan, IRA, or another tax-deferred account.

R e t I R e m e n t

P l a n n I n G

MANAGER

INvESToRS 18

FuND CoMPANY

INvESTMENTS

R e t I R e m e n t

P l a n n I n G

R e t I R e m e n t

Life Insurance

acceleRated beneFIts

Before your death, you may face significant costs because of a serious injury or terminal illness. Life insurance may help cover these expenses if your coverage has an accelerated death benefit, available on many term and permanent policies. If you qualify, accelerated death benefits let you take part of your death benefit while you’re alive. When you die, your death benefit is reduced by whatever portion you took early. Some insurance companies offer accelerated death benefits at no additional cost.

Life insurance can help make your retirement more secure. As you approach retirement, you may wonder if you still need life insurance, especially if your children are grown and your mortgage is paid off—two traditional reasons for having coverage. There may be cases when the answer is no, but for most people life insurance always has an important part to play in an overall financial plan. Once you retire, you may want life insurance to:

FInancIal PRotectIon

financial security for your spouse or other family members

emergency cash loans

After your death, your survivors might confront big expenses: your funeral and burial, final medical bills, federal and state income taxes, and even unpaid credit card balances. These expenses can add up to tens of thousands of dollars. You might earmark a life insurance death benefit to cover these costs.

BIL LS

PREMIUM 50

60 70 AGE

CASH VALUE ACCOUNT

PERMANENT

PREMIUM 40

As you pay premiums on a permanent life insurance policy, its cash value gradually accumulates—and you may be able to borrow against it in emergencies. If you borrow, you will owe interest on the loan. If you don’t repay the principal, your death benefit will be reduced by the amount you borrowed plus any interest that’s due. Or, if your circumstances change, you may decide you don’t need life insurance any longer. In that case, you can terminate your policy and take a lump sum withdrawal of your cash surrender value though you may pay surrender fees. Unlike a loan, you may owe taxes on any portion of the cash value that exceeds the premiums you paid.

60 70 AGE

LOAN

E AT LER AC CE

There are two basic types of life insurance: term, which lasts for a specific period and permanent, sometimes called cash value, which continues as long as you pay the premiums, or in some cases until you turn 100. Term life insurance policies are issued for initial periods of 5, 10, 20, or 30 years, after which you can continue coverage, often for shorter periods, typically a year or two. The premiums become more expensive as you get older. Unlike term policies, permanent policies usually have level, or fixed premiums, and build a tax-deferred cash value that you can borrow against in emergencies if you need cash.

cash valUe

You can also include life insurance in your estate planning. For example, you might use your policy to equalize your bequests. If you leave your home to one adult child, you could leave death benefits worth the approximate amount to another child. Or you might name your grandchildren as beneficiaries, providing money for college or other financial goals. Remember, though, if the children are minors, you must name an adult who will be responsible for managing the money until they turn 18 or 21, depending on the state. Among the advantages of life insurance proceeds, or death benefits, are that they aren’t normally subject to income tax and usually pass directly to the beneficiary you name without going through probate. However, if you own the policy that insures you, the death benefit becomes part of your estate, potentially increasing its value enough so that estate taxes may be due. If you risk potential estate taxes, you might consider having someone else, such D as your spouse or adult child, own the policy on your life. The beneficiaries could remain the same, but the death benefit isn’t part of your estate. You’ll want to consult your tax and legal advisers before making such a decision, though.

FI T DEA TH BENE

There are many variations on these standard approaches to life insurance, so it makes sense to shop around for one that meets your particular needs. For instance, some insurers offer modified permanent policies that will endow, or pay out, a portion of the face value at a certain age, such as 65, while the rest becomes your death benefit. If you die before the endowment date, your beneficiaries receive the entire face value. Some term policies can be converted to permanent coverage if you act before a certain age. By converting, you might avoid a physical exam—an important way to control the cost of coverage if your health has declined since you bought the term policy.

the RIGht PolIcY

TERM

estate PlannInG

FInal exPenses

• Pay for expenses related to your • Provide

D TE ER A ACC EL FIT NE DE ATH BE

When you die, your spouse or another family member, such as a disabled child, may need continuing financial protection. A dependant spouse is likely to face reduced Social Security and pension benefits after your death. At the same time, he or she might encounter increasing medical bills and other expenses. A life insurance death benefit could replace this lost retirement income and cover future expenses.

• Continue to provide

death, such as funeral costs

P l a n n I n G

INSURANCE COVERAGE

InsURance In a nUtshell

When you die, a life insurance policy pays your beneficiaries a death benefit, which is usually exempt from federal income tax. You choose the amount of that benefit when you buy your policy, and the amount you pay for the coverage is based on that benefit, and other factors including your age, your health, and your lifestyle.

R e t I R e m e n t

P l a n n I n G

R e t I R e m e n t

Life Insurance

acceleRated beneFIts

FInancIal PRotectIon

financial security for your spouse or other family members

emergency cash loans

BIL LS

PREMIUM 50

60 70 AGE

CASH VALUE ACCOUNT

PERMANENT

PREMIUM 40

60 70 AGE

LOAN

E AT LER AC CE

cash valUe

FI T DEA TH BENE

the RIGht PolIcY

TERM

estate PlannInG

FInal exPenses

• Pay for expenses related to your • Provide

D TE ER A ACC EL FIT NE DE ATH BE

• Continue to provide

death, such as funeral costs

P l a n n I n G

INSURANCE COVERAGE

InsURance In a nUtshell

R e t I R e m e n t

P l a n n I n G

What’s Your Estate? An estate isn’t just expensive property surrounded by a fence. Your estate is everything you own in your own name, and your share of anything you own with other people. Your property can be real—meaning land and buildings—or personal, such as jewelry, a stamp collection, or a favorite table or chair. Money is property, too, as are stocks and bonds, a mutual fund account, or a life insurance policy. The actual value of your estate is computed only after you die— when you’re not around to figure it out. But it isn’t a mystery. The

An estate’s worth is figured by finding the fair market value of its real, personal, and investment property. That’s not easy to determine ahead of time, in part because market values change over time, and in part because evaluators may appraise the same property differently. Just as everything you own is part of your estate, what you owe reduces its value. Your income taxes, mortgages or other debts, funeral expenses, and the costs of settling your estate—which can be substantial—are all deducted from your estate’s assets. So is

An Estate Inventory If you own your home, investments, an IRA or 401(k), and an insurance policy, the value of your estate may be greater than you think. Here’s a checklist of what might be included: Real estate Securities (stocks, bonds, and mutual funds) Interest and dividends you’re owed that haven’t been paid Bank accounts All tangible personal property Life insurance policies you own No-fault insurance payments due to you Annuities paid by contract or agreement

idea behind estate planning is that you know what you own, what it’s worth, and what you want to happen to it—both during your lifetime and after your death. If your estate is large enough, you may have to do some tax planning as well.

the value of any property you transfer to a charity or to your surviving spouse. What’s left is the value of your estate. not In YoUR estate?

leavInG YoUR estate

Since you own the property in your estate, it’s your right to say what will happen to it. You might tell your spouse, your children, or your lawyer what you want to happen, but unless it’s written down, there’s no assurance your wishes will be respected. There are several ways to make clear what you want to happen to your estate:

• You can write a will to specify who gets what after you die

• You can create one or more trusts

to pass property, or income from that property, to others

• You can name beneficiaries on

pension funds, insurance policies, and other investments so they will receive the payouts directly

Since wills and trusts are legal documents, you should consult your lawyer about them. Naming beneficiaries is simpler, usually requiring only your signature. And owning property such as homes and bank accounts jointly—especially with your spouse—is fairly standard. what’s YoUR estate woRth?

Finding the value of an estate is a twostep process—adding up what it’s worth and then subtracting the expenses of settling it. Usually, the valuation is figured as of the date of your death. The alternative is to value the estate six months after you die, if waiting will decrease its value and therefore reduce the potential tax.

CASH

• You can own property jointly with other people, so that it becomes theirs when you die

MUTUAL FUNDS

If you no longer own property, it’s out of your estate. Something you give away belongs to the new owner. The same is true of something you sell. You might owe gift or capital gains taxes on the transfer, but its value isn’t included in your estate. The larger your estate, the more important it is to plan ahead as carefully as possible to reduce potential estate taxes. settInG a valUe

one workable definition of fair market value is the amount someone would be willing to pay for your property, and that you’d be willing to accept—assuming that neither one of you is under any pressure to buy or sell, nor guilty of any misrepresentation.

value of any retirement savings plan, including IRAs Claims paid for pain and suffering, even after your death (but not claims for wrongful death) Income tax refunds Forgiven debts Dower and curtesy interests uGMA and uTMA custodial accounts for which you are the custodian, if you created the accounts Closely held businesses

R e t I R e m e n t

P l a n n I n G

the value of any property you transfer to a charity or to your surviving spouse. What’s left is the value of your estate. not In YoUR estate?

leavInG YoUR estate

• You can write a will to specify who gets what after you die

• You can create one or more trusts

to pass property, or income from that property, to others

• You can name beneficiaries on

pension funds, insurance policies, and other investments so they will receive the payouts directly

CASH

• You can own property jointly with other people, so that it becomes theirs when you die

MUTUAL FUNDS

G l o s s a R Y Asset classes are categories of

Beneficiary is the person or institution you name to receive assets or income from your retirement savings plans, IRAs, insurance company contracts, and trusts. Diversification is an investment

Equity is ownership, and equity

Growth investments are investments

Income investments are investments

you expect to provide a regular source of income over time. Fixed annuities and certain mutual funds are example of income investments.

Minimum required distribution (MRD) is the base amount you must

withdraw each year from an employersponsored retirement savings plan or a traditional IRA, beginning the year you turn 70½.

you put into an investment account or use to purchase an annuity or other financial product. The term also means the amount you borrow, which is the base

Tax-free investment accounts, such

vesting entitles you to the contributions

G l o s s a R Y Asset classes are categories of

Beneficiary is the person or institution you name to receive assets or income from your retirement savings plans, IRAs, insurance company contracts, and trusts. Diversification is an investment

Equity is ownership, and equity

Growth investments are investments

Income investments are investments

you expect to provide a regular source of income over time. Fixed annuities and certain mutual funds are example of income investments.

Minimum required distribution (MRD) is the base amount you must

withdraw each year from an employersponsored retirement savings plan or a traditional IRA, beginning the year you turn 70½.

you put into an investment account or use to purchase an annuity or other financial product. The term also means the amount you borrow, which is the base

Tax-free investment accounts, such

vesting entitles you to the contributions

E N T R E T I R E M

G P L A N N I N

Realistic Expectations fying retirement One of the keys to a satis realistic expectations.

is having

80%

100% You’ll need 75% to t of your preretiremen ortably comf live to me inco during retirement

G P L A N N I N

E N T R E T I R E M DOING THE MATH

FACTORS TO CONSIDER

•

As you prepare a retirement budget, you’ll want to take these factors into account:

• • •

you If you retire at 65, until can expect to live you’re into your 80s.

PECTED CTING THE UNEX

S WAYS AND MEAN

• •

• • • •

•

• •

•

TING KEEP ON INVES

MENT

RE L RETI ACTICA

THE PR

HEET

WORKS

Current age age Retirement

This hypothetical example is for illustration only and is not intended to represent or imply the actual performance of any specific investment.

FUTURE LOOKING AT THE projecting

yOuR GuIDE TO plANNING fOR RETIREMENT

•

Retirement Strategies •

Investing

•

Annuities

•

IRA Rollovers •

Lightbulb Press, Inc. 112 Madison Avenue New York, NY 10016

www.lightbulbpress.com info@lightbulbpress.com Phone: 212-485-8800

•

Your Estate

Social Security

VIRGINIA B. MORRIS

AND

KENNETH M. MORRIS

CASH

MUTUAL FUNDS