Major Retirement Income Sources 1.Social Security 2.Employer-sponsored retirement plans 3.Personal...

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Transcript of Major Retirement Income Sources 1.Social Security 2.Employer-sponsored retirement plans 3.Personal...

Major Retirement Income Sources

1. Social Security

2. Employer-sponsored retirement plans

3. Personal savings

4. Work (wage income)

Income Sources: High-Income Retiree

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Work SS andRetirement

Plans

InvestmentIncome

$ Amount

Average Income: $116,596Source: Bureau of Labor Statistics, 2001-2002

Income Sources: Average-Income Retiree

02000400060008000

1000012000140001600018000

Work SS andRetirement

Plans

InvestmentIncome

$Amount

Average Income: $28,638Source: Bureau of Labor Statistics

Source #1: Optimizing Social Security

• Adjusted annually for inflation – Based on the lesser of the CPI or average wage

index

• Lifetime guaranteed income benefit– Can be viewed as a government bond position in

the retiree’s portfolio

• Personal earnings benefit statement

• Main decision: when to start

The Goldin’s SS Benefit

AgeAnnual Benefit

Amount

65 (normal retirement age)

$9,750

62 (early retirement) $7,800

64 (early retirement) $9,100

70 (delayed retirement) $12,188

When to Start SS Benefits

• Health and longevity– Breakeven for early

benefits = 15 years

• Need for cash to meet budget needs now– Can always start

whenever needed– Once begun, can’t

stop

• Survivor benefits• Employment

– may reduce SS benefits until FRA

• Potential taxation of SS benefits due to earnings

SS Breakeven Example

• Bob Brown: CPA, age 62• Can afford to retire or keep working • Father, 2 uncles, and grandfather died of

heart attack ~ 75• Wife has health problems that will worsen

What to do?? Take SS now or postpone?

Source #2: Employer-Sponsored Plans

• Defined benefit or pension plans

• Defined contribution plans

• Nonqualified employer plans

Defined Benefit Plans

• Benefit based on a formula

• Annuitization may be only distribution option

• Keeping track of plan benefits from the working years

Defined Contribution Plans

• Benefit based on contribution

• May be able to purchase an annuity, leave assets in the plan, or rollover to another plan/IRA

• Differences in public versus private sector plans

Non-Qualified Employer-Sponsored Plans

• aka Non-qualified deferred comp (NQDC)

• NQDC doesn’t meet tax and ERISA requirements for qualified plans

• Assets not protected by a trust

• Often used to recruit and retain executive level talent

Source #3: Personal Savings

• Annuities– Fixed– Variable

• IRAs– Traditional– Roth

• Home

• Other– Cash value life

insurance– Taxable investments– Business interests– Investment real

estate– Expected inheritance

Annuities

• Deferred for the accumulation years

• Immediate for the payout years

• Can eliminate longevity risk

• Both immediate and deferred annuities offer tax-deferred growth

• No step up in basis at death

Fixed & Variable Annuities

• Fixed may be subject to purchasing power risk– May offer COLA features

• Variable offers wide range of investment choices– Subject to market risk– But may keep up with inflation

Variable Annuity Guarantees

• Guaranteed minimum income benefit– Costs 30 to 75 basis points– 7 to 10 year waiting period

• Guaranteed minimum accumulation benefit– Costs 25 to 100 basis points

• Guaranteed minimum withdrawal benefit– Costs 30 to 40 basis points

Individual Retirement Accounts

• All provide tax-deferred growth• Wide variety of investment choices

– Subject to market risk

• Traditional IRA• Roth IRA offers tax-free income• Stretch IRA

– Passes IRA down several generations– Can maximize bequests

• No step up in basis for estate tax

Home

• Four ways to tap equity:– Home equity loan– Line of credit– Selling the home and downsizing– Reverse mortgage (RM)

Home Equity as Percent of Assets

Higher Income Retiree Average Retiree

Ages 65-74 Ages 65-74Home Equity43%Net

Financial Assets57%

Home Equity75%

Net Financial Assets

25%

Cash Value Life Insurance

• Policy loan

• Advantages– Relatively low interest rate– May not need to repay interest

• Disadvantages– Reduced death benefit– Potential policy collapse, triggering taxes– Loan interest not deductible

Taxable Savings and Investments

• Taxable account investments– Low turnover

funds– Long-term capital

gain stocks– High dividend

stocks– Tax-free income

• Tax-deferred accounts– High turnover

funds– Short-term capital

gain stocks– Bonds– REITs

Other Types of Personal Savings

• Business interests

• Investment real estate

• Inheritances

4. Work in Retirement

• Ability to work• Availability of work

For retirees age 65 and over, work generates about 1/3 to 1/2 of total income for households with income of $40,000 or

more

Taxation of SS Benefits• Up to 85% of benefits may be taxable,

depending on total income

• Amount subject to income tax is the lesser of– ½ of the retiree’s SS benefits, or– ½ of the amount by which AGI + tax-exempt

interest + ½ of SS benefits exceed• $25,000 filing single• $32,000 married filing joint

Reduction of SS Benefits

• Over normal retirement age (NRA), no reduction in benefits for earnings

• Excess earnings test– Under NRA: $1 reduction for every $2 of

excess earnings– Year of NRA: $1 reduction for every $3 of

excess earnings

Annual Exempt AmountsYear Age 65-69 Under Age 65

1996 $12,500 $8,280

1997 $13,500 $8,640

1998 $14,500 $9,120

1999 $15,000 $9,600

Normal Retirement Age Under NRA

2000 $17,000 $10,080

2001 $25,000 $10,680

2002 $30,000 $11,280

2003 $30,720 $11,520

Social Security Reduction

Example #1: Dr. Smith, who partially retired in 2002 at age 62, practices for four months in 2003 and earns $32,000.

Question:

How much will his SS benefit be reduced?

Social Security Example

Answer: $10,240.

Dr. Smith’s benefit will be reduced by $1 for each $2 of earnings over $11,520:

$32,000 – 11,520 = $20,480

½ x $20,480 = $10,240

Social Security Reduction

Example #2: Mr. Martin is 66 years old, past his normal retirement age and has not retired. He earns $35,000/year. Mr. Martin receives a Social Security retirement benefit of $700/month.

Question:How much will his SS benefit be reduced?

Social Security Example

Answer: No reduction

Since he is over the normal retirement age, Mr. Martin loses none of his benefits by working.

Coordinating the Four Sources of Income

• Determine when to start Social Security• Coordinate wage earnings with Social

Security benefit timing• Identify all potential sources of income. • Preserve opportunities for tax-deferred asset

growth when possible• Structure allocation of personal savings and

work earnings to minimize taxation

Now, Where Were We with the Goldins . . .

• $20,000 Social Security benefits

• $10,000 per year pension benefit

• No work income

• $1.1 million combined IRA (50/50 stocks/bonds)

• $700,000 home

What’s New: Taxable Savings,Investments and Income

• $35,000 in a checking account

• $125,000 ski condo

• $300,000 in a stock portfolio (growth)

• $100,000 in tax-exempt bonds (AA)

• $85,000 in a DC plan

• Mr. Goldin is thinking of working part-time for 18 months at $3k/month