SECURE Act 2.0 enjoys widespread bipartisan support and builds on SECURE Act 1.0 by strengthening the financial safety net and encouraging Americans to save for retirement. Help clients understand what opportunities it offers them.
The Setting Every Community Up for Retirement Enhancement Act of 2019, popularly known as the SECURE Act, was signed into law in late 2019.
Now called SECURE Act 1.0, it included provisions that raised the requirement for mandatory distributions from retirement accounts and increased access to retirement accounts.
But it didn’t take long for Congress to enhance the landmark bill that was enacted barely three years ago.
Tucked inside a just-passed 4,155-page, $1.7 trillion spending bill are plenty of goodies, including another overhaul of the nation’s retirement laws.
Dubbed SECURE Act 2.0, the bill enjoys widespread bipartisan support and builds on SECURE Act 1.0 by strengthening the financial safety net by encouraging Americans to save for retirement.
9 key takeaways on SECURE Act 2.0
1) Changing the age of the required minimum distributions. Three years ago, SECURE Act 1.0 increased the age for taking the required minimum distribution, or RMD, to 72 years from 70½. If you turn 72 this year, the age required for taking your RMD rises to 73 with SECURE Act 2.0.
If you turned 72 in 2022, you’ll remain on the prior schedule.
If you turn 72 in 2023, you may delay your RMD until 2024, when you turn 73. Or you may push back your first RMD to April 1, 2025. Just be aware that you will be required to take two RMDs in 2025, one no later than April 1, and the second no later than December 31.
Starting in 2033, the age for the RMD will rise to 75.
Employees enrolled in a Roth 401(k) won’t be required to take RMDs from their Roth 401(k). That begins in 2024.
In our view, the SECURE Act 1.0 and 2.0 updates were long overdue. The new rules recognize that Americans are living and working longer.
2) RMD penalty relief. Beginning this year, the penalty for missing an RMD is reduced to 25% from 50%. And 2.0 goes one step further. If the RMD that was missed is taken in a timely manner and the IRA account holder files an updated tax return, the penalty is reduced to 10%.
But let’s be clear, while the penalty has been reduced, you’ll still pay a penalty for missing your RMD.
3) A shot in the arm for employer-sponsored plans. Too many Americans do not have access to employer plans or simply don’t participate.
Starting in 2025, companies that set up new 401(k) or 403(b) plans will be required to automatically enroll employees at a rate between 3% and 10% of their salary.
The new legislation also allows for automatic portability, which will encourage folks in low-balance plans to transfer their retirement account to a new employer-sponsored account rather than cash out.
In order to encourage employees to sign up, employers may offer gift cards or small cash payments. Think of it as a signing bonus.
Employees may opt out of the employer-sponsored plan.
4) Increased catch-up provisions. In 2025, SECURE Act 2.0 increases the catch-up provision for those between 60 and 63 from $6,500 in 2022 ($7,500 in 2023 if 50 or older) to $10,000, (the greater of $10,000 or 50% more than the regular catch-up amount). The amount is indexed to inflation.
Catch-up dollars are required to be made into a Roth IRA unless your wages are under $145,000.
5) Charitable contributions. Starting in 2023, 2.0 allows a one-time, $50,000 distribution to charities through charitable gift annuities, charitable remainder unitrusts, and charitable remainder annuity trusts. One must be 70½ or older to take advantage of this provision.
The $50,000 limit counts toward the year’s RMD.
It also indexes an annual IRA charitable distribution limit of $100,000, known as a qualified charitable distribution, or QCD, beginning in 2023.
6) Back-door student loan relief. Starting next year, employers are allowed to match student loan payments made by their employees. The employer’s match must be directed into a retirement account, but it is an added incentive to sock away funds for retirement.
7) Disaster relief. You may withdraw up to $22,000 penalty-free from an IRA or an employer-sponsored plan for federally declared disasters. Withdrawals can be repaid to the retirement account.
8) Help for survivors. Victims of abuse may need funds for various reasons, including cash to extricate themselves from a difficult situation. SECURE Act 2.0 allows a victim of domestic violence to withdraw the lesser of 50% of an account or $10,000 penalty-free.
9) Rollover of 529 plans. Starting in 2024 and subject to annual Roth contribution limits, assets in a 529 plan can be rolled into a Roth IRA, with a maximum lifetime limit of $35,000. The rollover must be in the name of the plan’s beneficiary. The 529 plan must be at least 15 years old.
In the past, families may have hesitated in fully funding 529s amid fears the plan could wind up being overfunded and withdrawals would be subject to a penalty. Though there is a $35,000 cap, the provision helps alleviate some of these concerns.
A lack of knowledge leaves individual retirees dumping thousands of dollars out of their own pockets.
The graph below says it all. The age at which most people claim Social Security (green line) is opposite to the age at which they should claim Social Security (purple line). According to The Retirement Solution Hiding in Plain Sight: How Much Retirees Would Gain by Improving Social Security Decisions, “retirees will collectively lose $3.4 trillion in potential income that they could spend during their retirement because they claimed Social Security at a financially sub optimal time, or an average of $111,000 per household.”
Figure 1: Optimal vs. Actual Social Security Claim Ages
This comprehensive study observed 2,024 households, considering each household’s outside resources, spending, health, and longevity to determine how much income and wealth they would have if they had taken Social Security at the various ages of eligibility.
Although later claiming typically caused wealth to drop during a person’s 60s as they drew down their personal retirement accounts, this wealth drop was more than made up for by the late 70s, when Social Security income was higher.
In order to isolate the effect of claiming age, the study did not consider the effect of working longer. But in real life, a person who decides to maximize benefits by claiming at 70 might choose to work a few years longer, and this would mitigate some or all of the wealth drop in their 60s. This appears to be the first study of its kind to consider the impact of claiming age on not just the Social Security income, but other assets and income as well, as optimal Social Security claimingcan lead to higher account balances, which in turn generate more income. Only 4% of retirees make the optimal claiming decision.
The study found that a claiming age of 62–64 is optimal for only about 8% of adults (primarily those with short life expectancies or low-earning spouses)—yet about 79% of eligible adults in the sample claimed at those ages. A claiming age of 70 is optimal for 71% of primary wage earners—yet only 4% of the adults in the sample claimed at that age.
Among those at the highest wealth levels, 99% make suboptimal claiming decisions. Yes, you read that right. Ninety-nine percent of higher-wealth households make suboptimal claiming decisions. While it’s true that wealthy individuals can afford to leave Social Security benefits on the table, what’s troubling is that they are not getting good advice from their financial advisors.
Here at Boston Harbor Group, we pride ourselves for making this matter a very important one when elaborating the financial strategies for our clients. We show our clients calculator reports and different scenarios to reveal their personalized and optimal claiming time.
For retirees, financially suboptimal decisions add up to a loss of $2.1 trillion in wealth and a loss of $3.4 trillion in income. In its conclusion the report mentions a few ways to deal with this, including:
Make early claiming an exception, reserved for those who have a demonstrable need to claim benefits before full retirement age.
Change the way we refer to early or delayed claiming, labeling a claiming age of 62 as the “minimum benefit age” and 70 as the “maximum benefit age.”
Remove the disincentives wealth management firms have for delivering optimal claiming advice (i.e., the near-term drop in assets) by providing “cover” for executives to make the right financial decision for their clients and the right long-term decision for their shareholders.
Provide SSA with more resources, perhaps in partnership with third-party fiduciaries, to help households determine their optimal claiming age. “That limited investment could help recapture some of the $5.5 trillion lost in wealth and income to retirees and the U.S. economy because of the struggles retirees currently face making the right decision.”
MORE NONRETIRED AMERICAN EXPECT COMFORTABLE RETIREMENT
Meanwhile, a recent Gallup poll found that 57% of nonretired Americans now expect that they will live comfortably in retirement, a six-point increase in positivity since last year and the highest reading since 2004.
Only 33% of nonretirees see Social Security as a major source of income in retirement (compared to 57% of retirees). Eighteen percent of nonretirees aren’t counting on it at all. Instead, nonretirees tend to focus on 401(k)s, IRAs and other retirement savings accounts as being a major source of income. They also are planning on having multiple sources of income in retirement, including part-time work, home equity, and rent and royalties.
Distributions taken before an IRA owner reaches age 59½ are subject to a 10% early distribution penalty, unless an exception applies. For those who claim exceptions, it’s vital to maintain documented proof, as the IRS may deny the claim for exception in the absence of sufficient documentation. And that can be costly.
According to the National Center for Education Statistics (NCES), the average cost of college for an academic year can be over $39,000. Faced with the high costs of student loans and challenges with getting scholarships and grants, some individuals choose to take distributions from their retirement accounts to help defray higher education expenses. If those distributions are made before the account owner reaches age 59½, any tax deferred amount would not only be subject to income tax, but also an additional 10% tax (early distribution penalty). However, the penalty is waived if the IRA owner qualifies for an exception.
Individuals who plan to claim the higher education expenses exception must ensure that they have documented proof that the amount was in fact used to cover such expenses, so as to ensure that the IRS does not deny any claims for the exception.
Generally, distributions from IRAs are subject to ordinary income tax. If the distribution occurs while the IRA owner is under age 59½, an additional tax of 10% (early distribution penalty) applies to any taxable amount, unless an exception applies. One of the exceptions to the early distribution penalty applies to amounts used to cover qualified higher education expenses.
Qualified higher education expenses
Amounts used to pay for tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution
Expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with enrollment or attendance
Expenses for the purchase of computer or peripheral equipment, computer software, or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution
Room and board included for students who are at least half-time
Some caveats and exceptions apply. You should consult with your tax professionals, to identify amounts for which you can claim as qualified higher education expenses.
For this purpose, an eligible educational institution is generally any accredited college, university, vocational school, or other postsecondary educational institution; eligible to participate in a student aid program administered by the U.S. Department of Education.
An educational institution should be able to tell interested parties whether it meets the requirements to be considered an eligible educational institution.
A new PLR confirms: When multiple beneficiaries inherit an IRA, each beneficiary is independently responsible for any income taxes and/or penalties assessed on their share of the inheritance. Proper accounting must be done to ensure accurate accountability of individual responsibility.
Beneficiaries who inherit IRAs are responsible for paying any income taxes owed on tax deferred amounts that they distribute from the inherited IRAs. If there are multiple beneficiaries of one IRA, each beneficiary is independently and separately responsible for any income taxes owed on his or her share. Taxes are usually assessed on amounts that are distributed, for the year in which the distributions occur. This includes required minimum distributions (RMD).
Inherited IRAs are subject to RMD rules, and failure to take RMDs by the applicable deadline would result in the offending beneficiary owing the IRS a 50% excess accumulation penalty on the RMD shortfall. If an IRA is inherited by multiple beneficiaries, individual beneficiaries are separately responsible for any excess accumulation penalty owed because of any RMD shortfall for his or her inherited share.
Taxation status of moving inherited IRAs to beneficiaries
Generally, when a beneficiary inherits amounts held in an IRA, that amount is moved to an inherited IRA, using the trustee-to-trustee transfer method. The inherited IRA is required to be properly titled in accordance with IRS requirements, which state that inherited IRAs must be registered in the name of the decedent for the benefit of the beneficiary, and the transfer is nonreportable and nontaxable.
Separate RMD requirements for multiple beneficiaries
If an IRA is inherited by multiple beneficiaries, RMD requirements and excess accumulation penalties apply separately to each beneficiary, based on the beneficiary’s separate share of the inherited IRA. Each separate share is determined at the time of the IRA owner’s death, adjusted for gains and losses on a pro-rata basis until the transfers occur. Once the transfers are completed, gains and losses for each inherited IRA is based on the performance of the investments for each of those separate IRAs.
It’s a touchy subject, but a life expectancy analysis is the best way to ensure you will have enough money to live your later years in comfort and ease.
What do people fear the most in retirement? Outliving their income. And what variable has the largest impact on whether or not they will outlive their income? Life expectancy. Your ability to successfully plan for retirement is largely dependent on how well you can estimate your life span.
Longevity is the new buzzword in retirement planning, and rightfully so. It wasn’t that long ago when most people retired at 65 and maybe lived another five to 10 years if they were lucky. Those days are over, which makes current retirement planning a much more challenging endeavor. People are living much longer, and their retirement nest eggs must live much longer as well. Not only are life spans increasing, but statistics tell us that the longer people live, the longer they will live.
Longevity estimates According the Social Security Administration, a man who reaches the age of 65 today is estimated to live until he is 82.8 years old. A woman turning 65 today is expected to live, on average, until she is 85.4 years of age. In addition to that, 25% of all 65-year-olds will ive past 90 and 10% will live beyond 95. This dramatic increase in life spans is also expected to continue well into the future.Longevity planning is becoming a larger and larger component of successful retirement planning. In order to ensure you do not outlive your income, maintain a comfortable lifestyle, and have choices in retirement, you must be as accurate as possible in estimating your life expectancy.Unfortunately, estimating longevity is not even close to an exact science. The traditional approach for most advisors is to rely on actuarial tables for a best estimate. However, with life expectancies increasing practically every year, the mortality tables may no longer be enough.Overestimating life expectancy is almost as bad as underestimating it. You may think a safe response to the whole longevity question would be to simply assume death at the age of 105. While the former could result in you outliving your income, overestimating can affect your quality of life during retirement by being forced to spend less than you could.
Individual life expectancy analysis To increase the probability of success in estimating your life span, consider working with us to develop an individualized life expectancy analysis. Everything you do in planning for your retirement revolves around this number. Therefore, it is critical to the success of your retirement plan that you are able to estimate your life span as accurately as possible. Only then can you begin to develop a plan that will adequately provide for that life span. Areas you’ll want to consider when doing individualized life expectancy analysis are: medical history, family history, and lifestyle habits. The following are some questions you might want to think about.
Medical and family history
Have you ever had a heart attack or been diagnosed with any kind of heart disease?
Are you or have you ever been on cholesterol medication?
Have you ever been diagnosed with high blood pressure?
If so, are you on medication?
Have you or anyone in your immediate family—parents, grandparents, siblings—ever had a stroke?
Have you or anyone in your family ever had any type of cancer?
Are your parents still alive?
If not, what did they die of and how old were they when they passed away?
Are all your siblings still alive?
Have any of your siblings experienced any serious health problems?
On a scale of 1-10, with 10 being a health nut and 1 eating at McDonald’s every day, how would you rank your diet?
Do you exercise regularly?
How many times a week?
What kind of exercise?
Have you ever smoked?
Did either of your parents smoke?
How many days a week on average do you consume alcohol?
Do you always, sometimes, or never wear a seat belt?
On a scale of 1-10, with 10 being you could go postal any second and 1 you’re in a pleasant coma, how would you rank your daily stress levels?
Do you get enough sleep?
Do you participate in high-risk sports and other activities, i.e. football, skydiving, etc.?
It’s probably best to go through these questions with us so we have all the necessary data directly from you. We will then review your answers together with the actuarial tables to determine the life expectancy you’ll be using when developing your retirement plan.
Once the expectancy tables have been reviewed, you can decide whether years should be added or subtracted from your life expectancy based on your answers to the questions above. A large number of “bad” answers, especially the parents’ age at death, would justify lowering your estimate, while a preponderance of “good” answers would suggest a higher estimate is appropriate.
The parents’ age at death is generally considered an anchoring data point for most longevity estimates, unless death occurred by other than natural causes.
While working, people generally have employer-sponsored insurance. Some 58% of people in the U.S. today get their health insurance through an employer, either their own, a spouse’s, or a parent’s, if they are under 26. Employers subsidize the premiums, so employees pay far less than the full cost of the insurance. Premiums for family coverage averaged $19,616 in 2018, according to the Kaiser Family Foundation 2018 Employer Health Benefits Survey, but employees paid just 29% of that, or $5,547 ($462 per month). The subsidy was even greater for single coverage: employees paid just 18% of the $6,896 annual premium, or $1,186 ($99 per month). These are averages, so any one situation could be different.
Retirement before age 65
If you retire before the Medicare-eligible age of 65, you may have several options:
Retiree insurance. Only 18% of large firms offered retiree insurance in 2018, compared to 66% in 1988, according to the Kaiser survey. Of those that do offer retiree insurance, it’s mainly for early retirees (91%), as opposed to Medicare-eligible retirees (67%). Because of the employer subsidy and quality of the coverage, retiree insurance is usually a good deal for those lucky enough to have access to it.
A spouse’s plan. If clients lose employer coverage due to retirement, and if their spouse is still working, they may be able to get onto the spouse’s plan. Again, the employer subsidy and quality of the coverage usually make this a good deal. If both retiree insurance and spousal coverage are available, compare the two. Consider premiums, deductibles, co-payments, and coinsurance to determine potential out-of-pocket costs under each plan.
Individual insurance. If employer insurance is not available, one can buy individual insurance on the exchanges. It won’t be cheap. The average unsubsidized premium for a silver plan for a 60-year-old is $1,140 per month. For a gold plan it’s $1,300.
Once early retirees turn 65, they become eligible for Medicare.
If you have chosen retiree insurance, you will enroll in Medicare Parts A and B at 65. If you can stay on the retiree plan, it will serve as supplemental insurance (plan terms will change now that Medicare becomes the primary payer). If a medical bill is incurred, Medicare will pay first according to its plan limits, and the retiree plan may fill in some of the gaps, such as the deductible and the 20% coinsurance. If the retiree plan also offers creditable prescription drug coverage, individuals may not need to enroll in Medicare Part D (the plan will let them know if Part D enrollment is necessary) and may get better coverage than Part D plans available on the open market. (But it never hurts to shop around to be sure.)
If you are on a spouse’s plan when you turn 65, and if the spouse is still working, they may remain on the employer plan. If the spousal plan covers 20 or more employees and is a good plan, with an employer subsidy and comprehensive coverage, you do not need to enroll in Medicare at age 65. you can stay on the employer plan and delay enrolling in Medicare until you go off that plan. However, once people turn 65, they can enroll in different parts of Medicare depending on how it rounds out (or replaces) the employer plan.
For example, they can enroll in Part A only, which is free and may offer better hospital coverage than the employer plan. They might even enroll in Part B and pay the $135.50 monthly premium, especially if the plan deductible is rather high. (The Medicare Part B deductible is only $185 in 2019.) Depending on their drug regimen, they might find a Part D drug plan on the open market that beats the employer’s drug coverage. (Note that if they enroll in Part D, they must also enroll in at least Part A.)
Each part should be looked at separately, and the employer plan compared to plans available on the open market. There are two caveats: (1) If the employer plan is paired with an HSA, once they enroll in Medicare, there can be no further HSA contributions. (Note: Because Medicare offers better coverage than the high-deductible plans that are usually paired with HSAs, it may be worth giving up the HSA to get Medicare.) (2) The Part B monthly premium may be more than $135.50 if joint income is over $170,000 and subject to the income-related monthly adjustment amount (IRMAA). Be sure to take these additional costs into account.
If you have individual health insurance when you turn 65, you will be ecstatic to go onto Medicare. You should apply for Parts A and B three months before your 65th birthday; Medicare will go into effect on the first day of your 65th birthday month. You should decide whether you want Original Medicare with a Medigap plan and standalone drug plan, or a Medicare Advantage plan; you must do the required shopping in time to enroll in the chosen plan(s) by the first of the month that you turn 65.
Retirement at or after age 65
If you are still working when you turn 65, you may stay on the employer plan if it covers 20 or more employees. It is illegal for employers with 20 or more employees to force age-65 employees onto Medicare by offering them a lesser plan than the one offered to younger employees. But now that Medicare is available, each person turning 65 should compare the employer plan to Medicare.
Whereas the employer plan is subsidized by the employer, Medicare is subsidized by the government. In most cases the health care itself—that is, where the client goes to seek health care services—need not change. What’s different is who pays and how much they pay. Actually, with health care pricing as crazy as it is, no one really knows how much insurance pays. That’s why our focus is on how much each person pays—that is, how much he will pay out-of-pocket for premiums, deductibles, copayments, coinsurance, and the full cost of noncovered services and drugs.
Note: If you are covered by a plan that covers fewer than 20 employees when you turn 65, you should enroll in Medicare. Plans that cover fewer than 20 pay secondary to Medicare, and the individual must be enrolled in Medicare in order for the plan to pay its share. In other words, if Medicare does not pay primary (because one is not enrolled in Medicare), the plan may not pay anything at all.
Some of these plans volunteer to pay in the absence of Medicare, but they are not required to do so, and they could back out of that agreement at any time. After enrolling in Medicare, you should check with the insurer to see if it offers a plan that can serve as Medicare supplement insurance, then compare that plan to what you can get on the open market.
Before going into the analysis between employer plans and Medicare, the first thing to check is the spouse’s coverage under either option. Is the spouse on the client’s plan? Does the client need to stay on the employer plan in order for the spouse to be covered? If you go off the employer plan and onto Medicare, does the spouse have other options, such as their own employer insurance?
The spouse may be able to go onto COBRA for as long as 36 months after you leave the plan to go onto Medicare, but this would require the spouse to pay the full, unsubsidized premium. Also, COBRA may not be available to the spouse if the employer plan covers fewer than 20 employees. If the spouse’s only option would be individual insurance under the ACA, those extra costs would need to be factored into the analysis.
Insurance vs. Medicare after 65
Employer insurance is generally considered to be more comprehensive than Medicare, and many simply assume they will stay on the employer plan after age 65 if they are still working. But it behooves everyone turning 65 to compare the employer plan to what they can get on the open market with Medicare.
For example, the average employer plan in the Kaiser survey has a cost-sharing premium (i.e., the employee’s share) of $99 per month and a deductible of $1,573. The average copayment is $25 to see a primary care physician and $40 to see a specialist. If outpatient surgery is needed, the average coinsurance rate is 19% and the average copayment is $151. If hospitalization is needed, the average coinsurance rate is 19%; the average copayment is $284 per hospital admission, and the average per diem charge is $327. For prescription drugs the average copayment is $11 for first-tier drugs, $33 for second-tier drugs, $59 for third-tier drugs, and $105 for fourth-tier drugs.
What makes employer insurance hard to analyze is that out-of-pocket costs will depend on how sick a person is. Someone healthy whose plan allows for no-cost screenings and checkups could conceivably pay no more than the monthly premiums—$1,188 per year, on average. At the other extreme might be a serious health event that pushes one into the plan’s out-of-pocket maximum of $7,350 (the maximum for nongrandfathered plans under the ACA).
Medicare is designed for those with health issues
Medicare, when supplemented with additional insurance, is designed for people to be sick. The monthly premiums are higher, but when someone is fully covered, out-of-pocket costs are minimal. For $375 per month ($135.50 for Part B, $200 for Medigap Plan F and $40 for a drug plan), or $4,500 a year, pretty much all health care costs are covered, except for the things Medicare doesn’t cover, such as dental, vision, and hearing. It is possible to pay less with a Medicare Advantage plan—some plans have zero premiums but charge copayments or coinsurance if services are utilized. Medicare may cost more if the client is subject to the IRMAA.
What if the employer plan is an HSA paired with a high-deductible health plan (HDHP)? These plans are definitely designed for healthy people: the premiums are low, and if little or no health care costs are incurred, the money can stay in the HSA to keep growing tax-free. Under IRS rules, HSA contributions cannot be made for a person enrolled in Medicare. This means healthy individuals who love their HSAs should not enroll in Medicare.
However, once they start any kind of Social Security benefit, they are required to enroll in Part A and HSA contributions must stop. This means everyone age 70 or older—assuming they won’t want to leave Social Security money on the table—may not contribute to an HSA. Individuals who were born before January 2, 1954 and eligible to file a restricted application for spousal benefits when they turn full retirement age may also want to give up their HSAs in exchange for the Social Security income. They can keep the HSA and use it for qualified medical expenses; they just can’t contribute to it after starting Social Security and going onto Medicare.
Indiviuduals who have chosen to stay on their employer plan after age 65 should periodically re-evaluate the plan in light of Medicare availability. Worsening health, or a change in the employer plan, could subject one to hefty coinsurance amounts. People can switch to Medicare at any time after turning 65. They do not need to wait until they leave employment. Each year, when they are presented with their employer plan options, they should also look at Medicare to see how it compares.
Eventually, nearly everyone enrolls in Medicare—unless they keep working forever! As individuals prepare to retire, they should plan to have their Medicare start when the employer coverage ends so there are no gaps in coverage. This means enrolling in Medicare three months before they want it to start and lining up supplemental insurance and drug plan (or Medicare Advantage plan) so it starts at the same time.
Although terminating employees can take advantage of COBRA to maintain employer coverage for up to 18 months, this is not a good idea. For one, unsubsidized COBRA premiums are much higher than the government-subsidized Medicare premiums, even when supplemental insurance is added.
Also, the special enrollment period that allows people over 65 to delay enrollment in Medicare ends eight months after leaving employment. People who comes off COBRA after 18 months will be outside their special enrollment period and will need to wait until the next general enrollment period (January 1 to March 31) to enroll in Medicare, and coverage won’t start until the following July. HR people who are not aware of these rules often advise terminating employees to go onto COBRA; make sure you go onto Medicare instead.
Again, consider the spouse. If your spouse has been covered on your plan, and if you retire and go onto Medicare, your spouse will need to arrange for separate insurance. As noted above, spouses may have their own employer insurance. Or they may be over 65 and eligible for their own Medicare. Or they might go onto COBRA or buy their own health insurance in the marketplace. Just make sure your spouse gets their insurance lined up before you retire.
WOE!! to the taxpayer who runs afoul of the numerous and confusing IRA rules.
There are forms to file, contributions to make, distributions to take, and penalties to avoid. While corrections are possible, it’s best to avoid mistakes in the first place.
This post will help you understand IRAs.
They come with a lot of rules, especially when it comes to taxes. Failure to follow the rules can result in penalties, excise taxes, double taxation, and in a worst case scenario, the loss of your tax-deferred status. Here are a few tips that can help you avoid unnecessary— and costly—errors:
You must meet certain requirements in order to be eligible to make contributions to IRAs. Failure to meet these requirements can result in excess IRA contributions. Excess contributions that are not properly corrected can result in double taxation and excise tax being owed to the IRS. The following are some general eligibility requirements that must be met for IRA contributions.
The dollar limit for IRA contributions is the lesser of (a) $5,500, plus $1,000 if you are age 50 or older by the end of the year, or (b) 100% of the eligible compensation you receive for the year. As a result, if you earned only $3,000 for the year, the maximum amount that can be contributed to your IRA for the year is $3,000.
Regular IRA contributions must be made from eligible compensation, such as W-2 wages and/or salary, commissions, self-employment income, nontaxable combat pay, and other amounts earned from working.
If a wife, for example, does not earn income from working outside the home but is married to someone who does, her IRA contribution can be based on her working spouse’s income. In such cases, the couple must file a joint federal tax return.
Contributions cannot be made to Roth IRAs if your modified adjusted gross income (MAGI) exceeds a certain amount. Roth IRA contribution limits are phased out if the MAGI falls within a certain range.
Contributions cannot be made to your traditional IRA for the year your reach age 70½ and after. This limitation does not apply to Roth IRA contributions.
IRA contributions must be made by your tax filing due date, which generally is April 18 for calendar-year tax filers. Tax filing extensions do not apply. If you make any contributions between Jan. 1 and April 18 for the previous year, you must clearly designate which year contributions apply. Failure to include that information may result in the IRA custodian applying the contribution to the current year.
If you made IRA contributions and did not meet the income and age requirements where applicable, the contributions must be corrected under the “return of excess contributions” procedures. Under these procedures, excess contributions must be removed by your tax filing due date plus extensions, and must be accompanied by any net income attributable (NIA) to the contributions. NIA can be earnings or losses, and are determined using an IRS provided formula. If the IRA custodian will not perform the calculation, the formula—which can be found in IRS Publication 590, Individual Retirement Arrangements (IRAs)—can be used. As always, we recommend to talk with your financial advisor if you have any doubts.
Funding a 30-year retirement will take financial planning prowess as you juggle the effects of inflation, distributions, taxes, asset allocation, and expenditures. Are you up to the task?
George Forman, the boxer-turned-spokesman for portable grills, may have best summed up the retirement conundrum facing baby boomers: “The question isn’t at what age I want to retire; it’s at what income.” The amount you’ll need each year to maintain your desired standard of living is the most critical variable to identify in the retirement planning process. No rule of thumb will suffice. If you are like many boomers, your spending will not drop significantly at retirement. In the beginning, you’ll be fulfilling the many dreams and desires you postponed during your career and child-rearing years. Later on, the cost of health care will become a significant factor in determining your income needs.
How long will you need it?
Longevity is perhaps the greatest challenge for boomer retirement planning. Most boomers seriously underestimate their life expectancy. Perhaps this is due to a misunderstanding of what mortality age really means. In fact, half the population will outlive their life expectancy.
When the mortality table tells us that a 65-year-old man has a mortality age of 82, it means that half of all men who are 65 today will die before age 82, and the other half will still be alive. The mortality tables also include the entire population, not just those who receive the level of nutrition and health care that you probably enjoy.
Another frequent misunderstanding about mortality age is the statistical increase in mortality age that occurs when calculating joint mortality. A male age 65 has a 50% chance of living to age 82. A female age 65 has a 50% chance of living to 85, but as a couple, they have a 50% chance of one of them living to age 92. In fact, as a couple, they have a 25% chance that one of them will still be alive at age 97. A worker retiring early at age 55 may need to generate more than 50 years of retirement income. This is the basis for the new definition of long-range planning.
The double bite of inflation
The increased longevity that boomers can expect contributes to the serious risk of inflation, which is the long-term tendency for money to lose purchasing power. This has two negative effects on retirement income planning. It increases the future costs of goods and services that retirees must buy, and it potentially erodes the value of their savings and investments set aside to meet those expenses. Even at a modest inflation assumption of 3% annually, the effects of inflation over a half century of retirement could be devastating.
In prior generations, inflation was not such a worry, since retirees were not expected to live much more than five or 10 years past the age of 65. In fact, when the Social Security retirement age of 65 was enacted in 1935, the average mortality age for a man was 64.
The planning process
Explore any and all sources of guaranteed income available when retirement begins. Social Security, pensions, and any other income sources must be quantified as to how much, from what source, and for how long. Pay careful attention to whether benefits index with inflation or continue to a surviving spouse, since survivor planning is an important part of retirement income planning. Develop three cash-flow models — both spouses living, husband dies, wife dies — to identify any gaps in cash flow that need to be addressed by additional savings or insurance.
Next, inventory all assets that will be used to generate retirement income. This is where the traditional financial planning tools are needed to project future values and income streams from various types of assets. Be alert to the differences in taxation during distribution among various types of assets. Retirement accounts will generate less spendable income than investment accounts, because of the taxes due on distributions from retirement plans.
Be cautious about considering your primary residence as an investment asset. You may be thinking of downsizing later, but experience tells us that people are often reluctant to leave a familiar home in their advanced age. Be zip-code flexible when making your retirement plans. Many areas of the country have low to no income tax, and there can be significant differences in the cost of housing and health care.
The risks involved
Health insurance, disability insurance, life insurance, and long-term care insurance should also be evaluated as part of any retirement plan. These policies can be expensive, and some of them may not be necessary if you have significant assets. However, they can provide an important safety net in the absence of such assets, so ask your advisor to review your insurance needs.
If you work in a professional field, litigation is a very real risk to your retirement assets, and professional liability insurance is a must. Divorce is another landmine that can blow up even the best retirement plans, but to date there is no insurance policy available to reduce this risk other than a well-drafted prenuptial agreement.
Asset allocation: Between a rock and a hard place
The double whammy of longevity and inflation creates an asset allocation dilemma for boomers. The old adage of subtracting a person’s age from 100 to obtain the optimal percentage of equities just doesn’t hold for a five-decade retirement portfolio. Invest too conservatively, and your money may not grow enough to last your lifetime considering the erosion of long term inflation. Invest too aggressively, and you run the increasing risk of outright capital loss without adding significant years to your plan under average market conditions.
Working with your advisor, determine an appropriate exposure to equities, then design an allocation within those equities to ensure meaningful diversification among asset classes and investment styles. Cash and fixed income will play a larger role in retirement portfolios, since provisions must be made for the orderly withdrawal of assets.
Have your advisor set up regular portfolio transfers to your bank account to enable you to manage your income just as you did when paychecks were funding your expenses. This tends to dampen overspending by imposing some discipline on the withdrawal process.
Otherwise the portfolio could easily become an ATM machine.
Setting a realistic withdrawal rate
Most of the evidence seems to point to 4% as being about right for a sustainable withdrawal rate for
decades of retirement. The withdrawal rate is the one variable over which you have the most control — not your mortality, not your health, not your investment returns, not inflation — just your withdrawal rate. You must understand that this is the lever you will need to pull when things don’t go
as planned. Being realistic about what you can spend and keeping a sufficient contingency reserve fund will ease the pressure that withdrawals put on retirement portfolios.
The challenges facing boomer retirees are significant, but not insurmountable with some realistic and prudent planning. You will need to consider what you own, what you owe, what you will make, and where it will go in order to develop a workable retirement income plan. A financial advisor can help you to plan ahead!
Whether you are managing debt, investing assets, or developing an estate plan, changes in interest rates represent an excellent opportunity to review your financial plan and consider new strategies designed to capitalize on changing conditions. If you talk with your financial advisors, they will tell you too.
Calling the direction of interest rates has always been an iffy proposition. In many cases, even the experts disagree. But when the economy is in recovery and rates are inching up, it may be time to plan a new strategy. Here are some ways you can tweak your financial plans to take advantage of—or lessen the sting of—higher interest rates.
Because debt is the area most directly and most negatively affected by a rise in interest rates, start by reviewing any debt portfolios. Look at credit card debt, mortgage debt (on one or two properties), home equity loans or lines of credit, and auto loans. Check to see if any adjustments need to be made to either pay down debt or switch to a less costly form of debt.
Credit card debt. According to Bankrate, variable-rate cards tied to the prime rate move in direct response to Fed interest rate action. Fixed-rate cards are less volatile, but they are not a haven from higher rates because issuers can—and will—raise the rate.
•Check your credit card bills to see what interest rate you are being charged and how much the debt is costing you each month in dollars and cents. Options for lowering credit card costs include negotiating for a lower rate or paying off the debt with available assets or with proceeds from another loan, such as a home equity loan, a lower-interest credit card, or even a loan from family members.
•Home mortgage. If you have a fixed mortgage, you can sit tight and keep making your regular mortgage payments. Although accelerating payments to pay off the mortgage faster may fit with your personal financial goals, this is generally a declining-rate strategy, not one undertaken in anticipation of rising rates.
•If you have an adjustable-rate mortgage (ARM), on the other hand, you have a decision to make: Should you switch to a fixed-rate mortgage before rates go higher, or stick with their ARM (depending on what the spread is)? The ARM can be a better deal if you don’t plan to stay in the home for more than a few years.
•Home equity loans and lines of credit. Here you’re dealing with the fixed vs. adjustable question again. If you have a fixed-rate home equity loan you can sit tight. If you have small, short-term loans or lines of credit tied to the prime rate, you may want to lock in a fixed-rate loan before rates go much higher or you plan to pay off the loan fairly soon.
•Auto loans and leases. According to Bankrate, auto loans typically reflect rate increases before the Fed’s move, responding to yields on Treasury securities. If you are thinking of buying a car, you may want to do it when financing incentives offered by dealers are most attractive.
•401(k) loans. Rates on 401(k) loans are usually tied to the prime rate, so it is not possible to lock in a rate on these loans. Better to pay them off, perhaps taking out a fixed-rate home equity loan to do so.
Savers typically rejoice at the prospect of rising interest rates, but use caution if you are thinking of locking in higher yields while rates are still rising.
Laddering CDs or short-term fixed-income securities is a classic strategy when rates are in flux and you don’t want to commit too much of your portfolio to one particular scenario. If rates jump, you’ve always got something coming due that can be reinvested at the higher rate. When rates are rising, you want to keep the ladder fairly short—say, up to three years—gradually lengthening the ladder as rates continue to rise.
Believe it or not, some bonds hold their value when interest rates go up. This can happen when something other than interest rates exerts a greater influence on the bond’s price, such as when a bond’s credit quality improves.
By searching out special situations (or finding professional money managers who have the time and resources to thoroughly analyze the bond market), you may be able to achieve long-term yields with minimal interest-rate risk, but since this strategy involves buying bonds of lower quality in the hope that the fortunes of the issuer improve, there’s still a good deal of risk involved. Definitely discuss a special situations strategy with an investment professional.
Certain estate planning strategies are worth more if they are implemented when rates are low and the strategies are appropriate for your situation. It is also a good idea to check with your financial advisor before making any irrevocable decisions:
Grantor-retained annuity trust (GRAT). A GRAT is used to shift assets to family members before they appreciate in value. The grantor places assets in trust and receives a portion of the assets each year in the form of an annuity. A gift tax is triggered at the time the assets are transferred into the trust, with the value of the gift being the fair market value of the assets minus the grantor’s retained interest, which is the present value of all of the annuity payments over the term of the trust.
Both the annuity payments and the present-value calculation are tied to the 7520 rate, which changes every month based on Treasury bond yields. The lower the 7520 rate, the less income the grantor is forced to accept, which means more assets remain in the trust for heirs.
Also, the lower the initial interest rate when the present value of the income stream is established, the higher the grantor’s retained interest will be, thus lowering the value of the gift for gift-tax purposes.