Retirement planning today has taken on many new dimensions that never had to be considered by earlier generations. For one, people are living longer. A person who turns 65 today could be expected to live as many as 20 or more years in retirement as compared to a retiree in 1950 who lived, on average, an additional 15 years. Longer life spans have created a number of new issues that need to be taken into consideration when planning for retirement.
Cash Flow Analysis
We use our Cash Flow Analysis tools for multiple purposes. Initially, it helps us develop a baseline. We will project your retirement based on the information you provide. This allows us to determine whether you are currently on track or whether you need to make some changes to allow you to pursue your retirement goals. In retirement, we continue to make projections. Although investment returns, inflation, taxation and life’s surprises make it impossible for the tools to guarantee a successful retirement, the tools will give you a realistic view of retirement under multiple scenarios.
Income in Retirement
Retirees who have prepared for their retirement usually rely upon three main sources of income: Social Security, individual or employer-sponsored qualified retirement plans, and their own savings or investments. A sound retirement plan will emphasize qualified plans and personal savings as the primary sources with Social Security as a safety net for steady income.
Social Security was established in the 1930’s as a safety net for people who, after paying into the system from their earnings, could rely upon a steady stream of income for the rest of their lives. The age of retirement, when the income benefit starts was, originally, age 65 which was referred to as the “normal retirement age”. Now, for a person born after 1937, the normal retirement age is being increased gradually until it reaches age 67 for all people born in 1960 and beyond. The amount paid in benefits is based upon the earnings of an individual while working. If a person wanted to continue to work and delay receiving benefits, they could do so build up a larger benefit. Conversely, early retirement benefits are available, at a reduced level, as early as age 62.
Employer-Sponsored Qualified Plans
Many employer-sponsored plans today are established as “defined contribution” plans whereby an employer and/or the employee contributes a percentage of earnings into an account that will accumulate until retirement. As a qualified plan, employer contributions are deducted by the employer and the employee contributions are deductible from the employee’s current income. The amount of income received at retirement is based on the total amount of contributions, the returns earned, and the employee’s retirement time horizon. As in all qualified plans, withdrawals made prior to age 59 ½ may be subject to a penalty of 10% on top of ordinary taxes that are due.
A few employers still provide “defined benefit” plans whereby the employer contributes to the plan. At retirement time, a specific monthly benefit will be paid to the employee. The employee may elect to take a reduced benefit to ensure continued payments to a beneficiary. In many cases the employee may elect to take the pension benefit in the form of a lump sum. Our Cash Flow Analysis tools will allow us to compare the different election options.
Depending on the size and type of the organization, employers may offer a 401(k) Plan, a Simplified Employee Pension Plan or, in the case of a non-profit organization, a 403(b) plan.
Traditional and Roth IRAs
Individual Retirement Accounts (IRA) are tax qualified retirement plans that were established as way for individuals to save for retirement with the benefit of tax favored treatment. The traditional IRA allows for contributions to be made on a tax deductible basis and to accumulate without current taxation of earnings inside the account. Distributions from a traditional IRA are taxable. A Roth IRA is different in that the contributions are not tax deductible, however, the earnings growth is not taxable. To qualify for tax-free and penalty-free withdrawals of earnings, a Roth IRA must be in place for at least five tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state taxes..
Distributions from traditional IRAs and employer-sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching 59 ½ , may be subject to an additional 10% federal tax penalty.