Search for Elder Law Attorneys
The Phases of Retirement Planning
The Basics of Saving and Investing
Retirement Programs Where You Work
Retirement Programs for Individuals
Where to Put Your Retirement Money
Case Study: The Consequences of Failing to Plan
Taking Money Out in Retirement
Retirement has changed radically over the last several decades in America. Years ago, when you expected to work most of your life for a single, large employer, you could count on a pension. Retirement planning meant figuring out how to use your free time when you stopped working, not calculating rates of return and deciphering tax rules. You didn't have to worry -- enough money would be there from your pension and Social Security.
All federal employees, 80 percent of state and municipal employees, but just 20 percent of private-sector employees are enrolled in pension plans, and the numbers continue to drop, according to the Congressional Research Service ("401(k) Plans and Retirement Savings: Issues for Congress," 2009). Even though fewer and fewer Americans enjoy the security of company- or government-sponsored pension plans, retirement still means not working for a wage and having more time for yourself. But, as importantly, it means that in all likelihood you will be living on money you, yourself, saved. In addition to having enough to fund your retirement, you must make sure that, once retired, your investments continue to produce at the same time you are tapping into them to meet expenses.
This change from institution-funded to self-funded retirement constitutes a dramatic shift of responsibility. The magnitude of what is required to go from being cared for financially in retirement by your employer to providing for yourself has not fully hit home for most Americans.
What, then, are the implications? Most importantly, it means retirement planning must span the entirety of your adult life --- it is not just something you figure out while cleaning out your desk the day you turn in your keys and say goodbye to co-workers. Additionally, good planning takes time and effort and you bear the responsibility for steering your own course, whether it be done on your own, with help, or by delegating to professionals.
In general, the more you maximize your income and saving and control spending while working, the better off you will be in retirement. Obviously, the fewer resources you have and the more challenges you face (i.e., caring for a disabled child or a frail, elderly parent) the more important it is for you to be fully engaged in understanding your options, get the expertise you need, and make good decisions.
This section of ElderLaw 101 provides you with information you can use no matter where you are in the continuum of retirement planning, which begins in early adulthood (when you are getting established and choosing your pattern of saving and spending) and continues on for the remainder of your natural life.
Without question, the core strategy to succeed in having enough for retirement is living well within your means. Keep in mind, there are significant differences in approach depending on your priorities, age, circumstances, income, and tax bracket. One size does not fit all. But generally speaking, you gain more flexibility and choice the earlier you start putting aside funds for retirement.
Explained below are the five phases of retirement planning and the key aspects of good planning to be carried out during each phase.
PHASE I: Accumulation
This period begins when you enter the workforce and begin setting aside funds for later in your life and ends when you actually retire. A consideration in choosing an employer should be the amount they will contribute to your retirement savings and if they have a pension plan. Sign up for the 401(k), 403(b), or 457(b) plan if offered and contribute the maximum allowed as soon as you start working. In 2007, less than 32 percent of workers under age 35 participated in plans when they were offered at work, according to the Congressional Research Service.
Because you have a number of savings goals (not just retirement) it is tempting to postpone getting started on earmarking savings for retirement. However, it is wisest to acknowledge that the new normal requires retirement savings rates for most Americans to exceed 10 percent, according to the Financial Planning Association. The lower your income, the more of it needs to be saved for retirement because low-income individuals will need to live on 90 to 100 percent of their current income in retirement as opposed to 70 to 90 percent for higher-income individuals.
PHASE I also represents the time when you earn credits for Social Security and private pension benefits. As explained in ElderLawAnswers' detailed discussion of Social Security, the amount you receive from Social Security is calculated on the amount you contribute over at least 40 quarters during your working years. When self-employed individuals maximize deductions to avoid taxes, they may not realize they are also cutting back on payroll taxes which, in part, determine how much they will receive from Social Security in retirement. Typically, private pension payouts are determined by years of service and your last several years of wages.
This initial stage of saving for retirement can easily last 30 years or more. Therefore, it is tempting to do nothing for quite awhile. However, because of the power of compound savings (taking the interest earned and reinvesting it along with regular additional contributions) you gain a great deal by getting started as early as possible.
PHASE II: Pre-Retirement
This phase occurs during the final years of the accumulation phase and should begin when you reach 50 years old or are 15 years away from retiring, whichever happens first. Now is the time to get your plan in place, making sure your finances are lined up correctly for retirement day so nothing will be left to chance. If you work for a company with a benefits specialist, arrange an appointment to become informed about the various ways you can convert your employer retirement savings into a stream of income or an IRA. Give yourself time to learn the ropes before you need to make decisions. Also, you may want to research relocating to another part of the country, downsizing, or transitioning to another type of work.
Using a tool known as "scenario planning" can be quite helpful. In this approach, you identify several attractive ways in which you could see your life playing out through retirement. You also list unlikely, but possible, eventualities that would pose serious difficulties. You come up with a plan to handle each scenario. The more "what ifs?" you consider, the better prepared you are for any eventuality.
Start learning about Social Security and your options for beginning to receive retirement benefits. Be sure to factor other income sources into your decision of when to start collecting benefits. Familiarize yourself with the basic forms of Medicare in our ElderLaw 101 section on that topic and start getting acquainted with Medicare's rules and with local insurance providers. Start following the news on changes in the law.
All this takes effort, research and preparation, and all the more so if you are still raising children.
Another important task is to understand how to reduce risks to your retirement savings and at what point to begin shifting to a more conservative mix of investments. Contemplate insurance products, such as long-term care insurance, that can help you in retirement and consider purchasing appropriate ones when you are in your 50s when your health is good and premiums may be less. One of the more difficult aspects of this pre-retirement planning phase is thinking about end-of-life provisions. The more openly the end-of-life issue and your wishes are explored with loved ones, the more prepared everyone will be when the time comes.
These late-life issues dovetail with most of the other sections of ElderLaw 101, but particularly with our discussions of Estate Planning, Nursing Home Issues, and Retirement Living. It is critical to ensure you have done estate planning by the pre-retirement phase so you have the legal pieces in place that you will later need and also to designate through a power of attorney who will handle your finances should you be unable to do so.
PHASE III: Early-Retirement
This phase lasts from the day you retire until you are 70 years old. For those who do not plan to retire until well into their 70s, the first two tasks of this phase may occur later. A key purpose of this phase is to create a clear communication channel with your family so information can be shared, questions asked and answered, and decisions made in a calm, supportive way. If inter-generational communication around money has not been part of your family culture, it may be useful to enlist the help of a third party to get the process going.
There are three primary tasks during this phase. One is to assess how well your finances are working now that you are using your retirement savings. Do you need to modify your investment strategy? Make changes in your living circumstances? Have unexpected events occurred that require re-evaluating your approach?
The second task is to fine-tune your income and expense projections. Although the life expectancy of someone who is 60 years old is estimated by the Congressional Research Service to be 83 years old, many financial planners suggest projecting cash-flow out to age 100, just to be safe. This projection, which includes assumptions about growth of savings, inflation, taxes and living expenses, is an important tool in managing your finances and in making decisions.
The third task involves taking into consideration how you will meet minimum distribution requirements from your tax-deferred accounts -- IRAs, 401(k)s, etc. -- when these required withdrawals kick in at age 70. Even if you have not retired by this point, minimum distributions must begin. (For details, see section below.)
PHASE IV: Mid-Retirement
This phase begins at age 70 and lasts as long as you are able-bodied and high-functioning. Despite your good health, it is helpful to begin looking at what steps you would like your family to take should your condition decline significantly. In most cases your ability to make all your own decisions, care for yourself, engage with the world on your terms, and manage your affairs does not vanish in a split second. The loss of abilities is the natural consequence of the aging process and often happens gradually. At the same time, it is our nature as human beings to resist letting go of our autonomy. Even talking about the possibility is avoided. It takes courage to dive into a conversation about giving up and transferring control.
During this phase, it is common that one member of a couple will be the primary caretaker for the other whose health has already declined. If you are that caretaker, you will need to pay close attention to just about all the issues in ElderLaw 101. Communicate with family members and build a team of professionals around you to advise and help as needed.
PHASE V: Late-Retirement
This phase begins when your health has taken a turn for the worse and there is little likelihood of it being fully restored. You require significant help to function day to day. The hope is that by this point all the planning done in prior years makes this transition as manageable and life-affirming as possible. No one knows ahead of time how his or her life will come to an end. It is that uncertainty that contributes to not taking any action. However, if you have done some scenario planning earlier on --- a technique where you lay out and consider a range of possibilities from worst-case to best-case --- then you may have anticipated the course your life is taking. At this point much of the decision-making over your life is either shared or entirely in someone else's hands.
Saving is about setting money aside to protect it from loss, and investing is about putting money at risk in hopes of making more. At a minimum, your goal is to preserve your savings and earn enough to make up for losses from inflation and taxes.
The critical first steps are choosing not to spend all of your income and not running up credit card balances. In addition, you are best off ear-marking a certain portion of what you save or invest specifically for retirement.
After years of living close to or beyond their means, Americans are beginning to save once again. According to the U.S. Department of Commerce, Americans saved, on average, almost 6 percent of their disposable income in the fourth quarter of 2010, up from less than 2 percent as recently as 2007. [US Dept of Commerce, Bureau of Economic Analysis, News Release: Personal Income Outlays, November 2010]
As mentioned above, you should strive to set aside a minimum of 10 percent of your gross wages for retirement no matter what the economy is doing. If your income is low or you are older and have little saved, this retirement savings rate should ideally be higher, if at all possible. Set aside the maximum allowed by law into retirement accounts like Individual Retirement Accounts (IRAs) or plans at work. You can always cut back in later years if your account balances prove to be more than adequate to fund your retirement. It is the nature of compounding that gives an advantage to those who begin saving at an early age. If you reinvest interest and dividends or capital gains earned when investments are sold at a profit, you maximize your possible return.
There are two main ways to invest: (1) With a lump sum acquired through a gift, inheritance or sale of a home or other large asset, or (2) a little bit at a time. When you save the same amount regularly over time (such as $500 every month) you are doing something called dollar-cost-averaging, buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. This is what most Americans do when they have a fixed amount taken out of their paycheck and invested for retirement.
How Much Will You Need?
The main goal before you retire is to make sure that you have enough money when you do retire so you can maintain your standard of living. How much is enough depends on when you wish to retire, what your anticipated living expenses will be, what rate of return you can expect on your savings, and whether you will continue to work at all after retirement.
The anticipated date of your retirement affects two important factors: how much time you will have to save up for retirement and the number of years you can expect to live after you retire. A qualified financial advisor can help you sketch out your retirement plans in terms of timing and lifestyle. Once you put these down on paper, she can help you calculate how much money you need to have set aside to meet your goals and how it should be invested. Unfortunately, one likely answer will be that "You'll probably need more money than you think." Americans are living longer than ever before and inflation inevitably eats away at the value of dollars saved.
Many Web sites now offer free tools and information to assist with retirement planning, including so-called "retirement calculators". By providing a few details about yourself and your finances, these calculators can predict how much you need to save to achieve your retirement objectives. You can find links to a number of different calculators by clicking on the Calculators button of the Resources section of this site.
Once you have an idea of how much you will need, here are other factors involved in determining how well you will manage your retirement savings:
- The total amount you contribute over time
- How you save (all at once or little by little)
- What kind of investment you use (savings accounts, bonds, stocks)
- How much your savings or investments grow, less expenses
- Whether or not you reinvest that growth
- How long you have before you begin spending your retirement savings
- How you plan to take money out (again, all at once or little by little)
- How and when your money will be taxed and by how much
- The inflation rate over the life of your retirement planning.
Ways to Save for Retirement
The government has created and regulates a variety of plans and programs that help you put aside money specifically for use in retirement. The main advantages of using these programs are deferring tax on contribution, the income, or both, and protecting these savings from use for other purposes. Each program targets specific groups: from highly compensated business employees, to business owners, to regular employees, to self-employed individuals, to all workers. Any retirement savings program where there is a tax benefit or deferral is known as a tax-qualified program or, simply, "qualified." Retirement programs where there are no particular tax advantages are called non-qualified.
Certain individuals with low enough incomes are eligible for a tax credit when they put money into just about any retirement program. For individuals to be eligible, their modified adjusted gross income (MAGI) must be less than $28,250; for heads of households, their MAGI must be less than $42,375; and for couples their MAGI must be less than $56,500.(2011 figures). The calculation is based on contributions of up to $2,000 per individual (you may contribute more but the IRS does not recognize additional amounts in computing your tax credit). The maximum credit received per individual is $1,000 and $2,000 per couple on retirement contributions up to $2,000 per person. The amount of tax credit ranges from 10 to 50 percent of your contribution depending on your income. Complete IRS Form 8880 to see if you qualify.
Below are thumbnail descriptions of the major retirement savings programs. Because individual circumstances, risk tolerance, and objectives vary greatly, no single path will serve everyone. The main purpose here is to help you match your needs with the most appropriate program. The assistance of a qualified financial advisor may help you determine which of these programs makes the most sense for you.
Those who individually earn more than $200,000 annually or as a couple, $300,000, or who have a net worth in excess of $1,000,000 are classified as Accredited Investors by the Securities and Exchange Commission and thereby gain access to very sophisticated investments that may be perfect for retirement planning.
A number of retirement programs are available through employers. Try to become informed about all the programs offered by your employer so you can select what is best for you. The US Department of Labors Employee Benefits Security Administration Web site provides helpful information: http://www.dol.gov/ebsa/consumer_info_pension.html
The bulk of programs fall under one of two headings: Defined Benefit (DB) plans or Defined Contribution (DC) plans.
Defined Benefit plans are commonly known as pensions. That means the amount that the participant receives is determined by a formula unrelated to the amount of money contributed and the subsequent investment return. The pension plan sponsor, whether it is a company or government, shoulders the responsibility to come up with payments when a participant retires. Typically, that payment amount is determined by years of service and salary level. Receiving the benefit as a stream of periodic payments (usually monthly, like Social Security retirement benefits) is called annuitization. Most pensions allow beneficiaries to select the length of payout and whether or not to name his or her spouse to continue receiving benefits upon the death of the primary beneficiary. Most plans offer participants beginning retirement the choice of receiving a lump sum payout instead. Your decision on taking a lump sum is very important and should be made with full understanding of the consequences. While you can use the proceeds to buy an immediate annuity, which might provide a larger monthly payout than what the pension plan offers, others choose to invest the money and rely on those returns to provide income.
Another form of pension program, where only the employer contributes, is known as a Cash Balance plan. Because it has some features of a 401(k) plan, it is also known as a hybrid pension plan. The formula for determining benefits favors younger employees and employees unlikely to spend their entire work life with this one employer. The value of an individual employees pension account can be determined at any time as either a lump sum or as a lifetime monthly retirement payment.
Finally, an employer may simply purchase an annuity contract for the employee. (See below for a discussion of annuities available to individuals.)
Many people eligible for pension benefits don't know it. If you believe you might be entitled to a pension from a previous employer (even if they have gone out of business or have been acquired), check with a pension counseling project near you or visit http://www.pbgc.gov/wr/trusteed/plans.html to see if you might be eligible.
Today, more and more attention is being focused on pension programs that have insufficient funds to meet their oblications and are attempting to renegotiate benefits with participants. The Pension Benefit Guranty Corporation (PBGC), a government safety net funded by premiums assessed on private pension funds, will step in if a pension fund becomes insolvent. However, the maximum monthly benefit permitted when the PBGC takes over is $4,500 regardless of what an employee had been entitled to under the original pension rules. PBGC currently protects the pensions of more than 44 million American workers and retirees in more than 27,500 private single-employer and multi-employer defined benefit pension plans.
Unlike Defined Benefit plans, Defined Contribution plans do not guarantee a specified benefit. What you receive is determined by the combined market value of contributions and accrued growth (or loss) at the time you want to begin withdrawals. Depending on program specifics, contributions can be made by your employer, the employee (you), or both. You, as the beneficiary of the Defined Contribution plan, take on all the risks associated with investing and the performance of the underlying securities.
The primary Defined Contribution plans authorized by the IRS include profit-sharing, stock bonuses, money purchase plans, 401(k), 403(b), 457(b), Thrift Savings Plan (TSP), SIMPLE 401(k), SIMPLE IRA plans, and SEP IRAs. A separate account is provided for each employee covered by the plan. The retirees benefit is based solely on the contributions to the account and any investment gains and earnings. There are no guarantees.
Because of the wide variation among plans, we will focus our discussion on Defined Contribution plans where you make important decisions in the accumulation phase as well as beginning and during retirement.
Defined Contribution Plans
The government has created a broad array of savings vehicles with assorted tax incentives if you promise to keep your money untouched until you reach 59 1/2 years of age (but no later than age 70 1/2 ). The trade-off is control. You lose the right to access these assets for other purposes without incurring a penalty.
Keep in mind that Defined Contribution plans always take place through your workplace. Accordingly, a key question is how much, if any, your employer contributes on your behalf. Although employers do not have to contribute anything, the more additional funding that comes from the employer the better. If your employer does contribute, you should at least put in what you have to in order to receive the maximum match. A common arrangement is for the employer to contribute half of what you put in. For example, the employer may add up to a maximum of 3 percent of your compensation if you save 6 percent from your wages. In this case, you would want to contribute at least 6 percent to take advantage of the full match.
Even if you receive no match from your employer, it is still advantageous to participate in your employer-sponsored retirement plan. You decide whether or not you participate, how much you have taken out of your paycheck, and how you want the funds invested. You enjoy the benefits of dollar-cost-averaging (explained above) and you have a wide selection of investments to pick from.
When stock from the company itself is offered as a choice be cautious because your risk is great --- your paycheck already depends on the viability of your employer. If your employer runs into hard times, you may lose your job, take a pay cut, or be asked to work less. If the stock price plummets as well, you risk losing retirement savings.
401(k), 403(b), 457(b), Thrift Savings Plan (TSP)
All these employer-sponsored retirement plans are similar in design, but there are subtle, but meaningful, differences and it is important to know them. Check with your Human Resources department at work to get complete information, and consult your financial advisor. Common to all is the opportunity to avoid paying income taxes now on the wages you have earned but are putting into your retirement account through work. Taxes will be due when you take the money out in retirement on both what was contributed and the growth. Some 401(k) and 403(b) plans also permit after-tax contributions to be made. These plans are known as a Roth 401(k) or Roth 403(b).
The most you can contribute in 2012 is $17,000. If the plan allows for catch-up contributions when you are 50 or older, this permits you to contribute an additional $5,500. 403(b) and 457(b) plans have different formulas for catch-up contributions. It is always wise to check with your plan administrator on the specifics that apply at your company and for you individually. If you are eligible for multiple plans and programs, keep in mind the total contributed by you and your employer(s) cannot exceed 100 percent of your compensation or $50,000, whichever is less.
401(k) plans are available to for-profit and non-profit organizations.
403(b) plans are available only to non-profit organizations. Originating as Tax Sheltered Annuities, they have evolved over the years to mirror 401(k) plans in most respects. Most differences pertain more to administrative issues.
Employers may offer a Roth 401(k), Roth 403(b), or Roth 457(b) as a benefit to employees in place of or in addition to a traditional 401(k), 403(b), or 457(b). These differ from traditional plans the same way a Roth IRA differs from a traditional IRA. Contributions to a traditional 401(k), 403(b), or 457(b) are made pre-tax, so while it reduces your taxable income in the year you contribute, you have to pay taxes on the money you withdraw during retirement. On the other hand, contributions to the Roth versions are made after taxes. This means you won't have to pay any taxes when you withdraw the money. The Roth 401(k),Roth 403(b), or Roth 457(b) have the same contribution cap as the traditional versions: a maximum of $17,000 a year or $22,000 a year if you are over age 50. (Beginning in 2012, these limits were indexed for inflation.) However, there are no income eligibility limits to contribute to the Roth plans (as there are for traditional 401(k), 403(b), and 457(b) plans. You cannot change your mind on a contribution, your choice is irrevocable. Although these Roth accounts are subject to minimum distribution rules, this restriction can be avoided by rolling over your Roth 401(k), Roth 403(b), or Roth 457(b) into a Roth IRA when you retire. (See below for a fuller discussion of Roth IRAs.)
457(b) plans are available to state and local governments and non-profit organizations.
Thrift Savings Plans (TSP) are exclusively for federal employees and have contribution limits comparable to those of 401(k)s. Differences between this plan and those available to non-federal government employees are becoming fewer. Nevertheless, it is prudent to seek advice from someone expert in government employee benefit programs.
Profit-Sharing plans permit a variable contribution year-to-year by the employer. The business or non-profit organization need not be profitable to make contributions.
Money Purchase plans require a fixed contribution by employers regardless of profitability.
Stock Bonus Plans and Employee Stock Ownership Plans (ESOPs) are similar to Profit-Sharing plans except the contribution employers make is in the form of company stock. ESOPS have additional tax advantages over Stock Bonus plans.
For smaller employers and the self-employed, there are less cumbersome workplace plans that still offer many of the benefits of traditional, larger ones. The most common are SIMPLE 401(k)s and SIMPLE IRAs. The most you can