Retiring Safely

Are you investing in a 401(k) to save for your retirement?  If you’re planning on retiring anytime soon, then you’re probably concerned about future investment performance. 

Retirement savings, safely

Considering recent events, it should be no surprise over three quarters of 401k participants surveyed said they would like to guarantee their account, so it never decreases due to poor market performance. 

If you have been saving for your retirement in a 401k these statistics may come as no surprise to you.  What may surprise you is there is a guarantee feature now available.

A guarantee that you won’t lose money you’ve amassed in your 401k plan as you near retirement, is now available as an elective to the plan.  This option allows each participant to choose a suitable amount of protection, for a fee, to provide a base under a more aggressive exposure to equities that might not be attractive otherwise.

When an individual completes the wealth accumulation phase of life and nears the wealth distribution phase, the use of an investment management solution with downside protection should be considered.  This has traditionally been done with the use of risk management techniques, which may or may not work.   Now a concerned participant may consider the use of a risk transfer strategy to protect their retirement savings from loss. 

Risk transfer involves transferring the market risk to a third party, typically an insurance company, by utilizing products that provide some type of guarantee.  Applying the strategy, risk transfer allows participants to continue to seek higher returns in the market, but protects them from the risk of realizing sizable losses.  Losses can be especially harmful as the time to retire draws near, a time when these funds will be needed to generate retirement income.

According to a report from the Center for Retirement Research at Boston College, 63% of participants are relying solely on their 401k plan for retirement income outside of Social Security.  It’s no wonder a guaranteed income for life is the number one priority for those who are retired.  Because this feature offers a guaranteed payment for life, it may become an invaluable benefit to include in the retirement planning process.

TRADITIONAL DEDUCTIBLE                       

Tax Benefits:           

Tax-deductible contributions and tax-deferred earnings.

Eligibility:                       

Individual and non-working spouse must be under age 70 ½. 

Earned income subject to income limits:

If individual and spouse are not covered by a plan at work, full deduction regardless of income level.

Individual with a plan, deduction limits phased out for MAGI of:

                                    Single –             $55,000 to $65,000

                                    Joint –               $89,000 to $109,000

                                    Separate –         $0 to $10,000

Individual without plan and spouse with plan, deduction limits phased out for MAGI of:

                                   Joint –                 $166,000 to $176,000

Annual Contributions:

Lesser of 100% of earned income or $5,000 for each spouse. 

Aggregated with other IRA contributions, Traditional and Roth.

Catch-up contribution:

IRA owners age 50 and older may contribute additional $1,000

Mandatory Distributions:

Age 70 ½ or death

Rollover Contributions & Conversions:

Tax free transfer eligible distributions from another Traditional IRA, SEP IRA, 401(k), 403(b), & 457 qualified plans, or after two years a SIMPLE IRA

Taxes on Distributions:  

Taxed as ordinary income. 

Distributions before age 59 ½ assessed additional 10% income tax penalty

Substantial Equal Periodic Payments (SEPP)

Eligible medical expenses

Certain unemployed individuals’ health insurance premiums

Limited first time home buyer $10,000 lifetime maximum

Higher education expenses

Roth conversions

TRADITIONAL NON-DEDUCTIBLE                       

Tax Benefits:           

Tax-deferred earnings, contributions are not deductible

Eligibility:                       

Individual and non-working spouse must be under age 70 ½. 

Earned income regardless of plan participation status or income level

Annual Contributions:

Lesser of 100% of earned income or $5,000 for each spouse. 

Aggregated with other IRA contributions, Traditional and Roth.

Catch-up contribution:

 IRA owners age 50 and older may contribute additional $1,000

Mandatory Distributions:

Age 70 ½ or death

Rollover Contributions & Conversions:

Tax free transfer eligible distributions from another Traditional IRA, SEP IRA, 401(k), 403(b), & 457 qualified plans, or after two years a SIMPLE IRA

Taxes on Distributions:  

Each distribution is partially taxed as ordinary income. 

Taxable distributions before age 59 ½ assessed additional 10% income tax penalty

Substantial Equal Periodic Payments (SEPP)

Eligible medical expenses

Certain unemployed individuals’ health insurance premiums

Limited first time home buyer $10,000 lifetime maximum

Higher education expenses

Roth conversions

ROTH                       

Tax Benefits:           

Tax-deferred earnings and qualified tax-free distributions

Eligibility:                       

Individual and non-working spouse may be of any age 

Regardless of plan participation, plan contributions are subject to income limits:

Contributions are phased out for MAGI of:

                                    Single –             $105,000 to $120,000

                                    Joint –               $166,000 to $176,000

                                    Separate –         $0 to $10,000

Annual Contributions:

Lesser of 100% of earned income or $5,000 for each spouse. 

Aggregated with other IRA contributions, Traditional and Roth.

Catch-up contribution:

IRA owners age 50 and older may contribute additional $1,000

Mandatory Distributions:

None during lifetime. 

Non-spouse beneficiary must begin the year following the IRA owner’s death           

Rollover Contributions & Conversions:

A Traditional IRA, SIMPLE IRA or after two years a SEP IRA owner may convert to a Roth IRA if:

MAGI is less than or equal to $100,000

Not married filing separately

Ordinary income tax on taxable distribution, but no 10% penalty

Eligible qualified plan distribution may be converted directly to Roth

May rollover from another Roth IRA

Taxes on Distributions:  

Qualified distributions are generally tax and penalty-free 

Distributions of earnings are tax-free and penalty-free after 5 years and age 59 ½

Earnings distributed earlier are subject to ordinary income tax and a 10% penalty

Eligible medical expenses

Certain unemployed individuals’ health insurance premiums

Limited first time home buyer $10,000 lifetime maximum

Higher education expenses

How do you decide which is the right IRA for you?

You should consider current and future income tax rates, your income and marital status, the availability of a company retirement plan at your place of work, and how you anticipate using your IRA funds in retirement.

In general:

If you anticipate being in a lower income tax bracket when you retire, then you may decide the Traditional Tax Deductible IRA is more appealing.

If you anticipate your income tax bracket to be the same or higher in retirement, then a Roth IRA would be more desirable.

A well functioning bankruptcy system, designed to make sure that division of assets is equitable in America, has lasted over the last two hundred years.  Thanks to Chrysler the system is now being undermined by our federal government.

Corporate bond covenants are very specific as to how assets are disbursed in the event of a bankruptcy.  Secured senior lenders have rights to the secured assets; unsecured, junior bondholders and loan holders follow; unions and employees are next in line; and equity investors get whatever is left. 

In the Chrysler deal, the banks were the first to walk away and give up their legal ownership.  At what price?  Obviously, banks have been the recipient of billions of dollars from the Fed.  Was this part of the deal?  Perhaps we’ll never know for sure.  Strange how banks would give up control of billions of dollars at a time they really needed the cash to support their balance sheets.  What’s the deal with this “stress test”?  I have yet to find a listing in my business texts.  It sure was good to know the banks passed the test.  As a result their stock prices rose, just at the time they all went to market to sell more stock to raise more money and now are repaying the Fed their TARP money.   What a fortunate set of coincidence!

Next on the list were the smaller loan holders.  These were referred to publicly as hedge funds and pension fund speculators.  In a smear tactic orchestrated by the White House, these investors were portrayed as endangering Chrysler’s future by refusing to sacrifice like everyone else.  Unfortunately, popular opinion won out and these loan holders dropped their claim.  Because of the outcome, it’s clear the UAW getting theirs was more important than the common investor, whose money was in these funds.  Oh, no one bothered to mention that?  We were lead to believe it was all those greedy devils on Wall Street who lost their money.

Politics aside, a very critical rule of law was breeched by such an event.  Ownership rights to a redistribution based on the provider’s place is a critical part of the foundation of our capital structure.  A bond investor makes certain assumptions of recovery based on the collateral and its place in the capital structure in the event of bankruptcy.  The less money they stand to lose, the lower the interest rate they expect to receive.  If the law had been followed for the Chrysler bondholders, investors would have recovered at least 70% of their value.  Because this precedent was broken and Chrysler was awarded to the UAW instead, bondholders realized less than 30% of the value.    

If bond or loan holders require a higher interest rate to recover accepting a higher risk of loss, which is only now a possibility due to government intervention with Chrysler, then interest rates will need to increase to attract investors.  If interest rates increase then borrowing costs rise for all companies, not good for a recovering economy. 

Changing the rules of law to suit a purpose is a dangerous activity, especially when the world is actively seeking safety and security to house their money.  Keep a close watch on the value of the dollar, as our foreign investors weigh in on this issue.  The Chrysler restructure may prove to be a bad move, made at a bad time, for the wrong reasons.

By T.Y. Khun

The 1986 Internal Revenue Code was amended to expand tax-free distributions from individual retirement accounts for charitable purposes.  Under current law an IRA Charitable donation is only available for individuals age 70 ½ or older.  A transfer of up to $100,000 may be transferred directly from IRAs and Roth IRAs without having to count the distribution as taxable income.  This provision is good for qualified charitable gifts made through December 31, 2009.  Gifts made to grant making foundations, donor advised funds or charitable gift annuities are excluded from these rules.

When you make a charitable donation from your IRA, you credit this amount toward satisfying any required minimum distribution (RMD) you might have from your IRA.  Use of this strategy may also lower your income and possible decrease the tax you pay on your Social Security income. 

Use of this tax legislation provides potential income tax advantages.  The primary intention is to financially support a favorite charitable organization.  IRA owners, who are over age 70 ½ are required to take minimum taxable distributions each year. 

The IRA owner who uses the standard deduction when calculating their income taxes may employ this strategy as a means of making a more tax efficient contribution.  A taxpayer who selects the standard deduction would not be able to claim a tax deduction when making a charitable donation.   Gifting to charity is a tax deduction for those who itemize and when a taxpayer selects to use the standard deduction, they are prohibited from itemizing their deductions.  Transferring money directly from a traditional IRA would eliminate the income taxes on the distribution.   

Taxpayers who itemize deductions may claim their charitable cash donations, but with limits.  Once the total cash donations to charity exceed 50% of adjustable gross income (AGI), any further charitable gift is not deductible in that year.  The excess deduction can be carried forward and taken within the next five years.  However, utilizing the IRA as the source of additional donations to charity will provide a means of increasing gifts, without exceeding the annual gift tax limits.

Social Security income may be taxable, depending on reportable income.  For these taxpayers, the additional income generated from RMD may actually push them into a situation where their SSC income is now taxable. Directing money from an IRA directly to charity may reduce or even eliminate required minimum distributions RMD and reduce or eliminate taxes on Social Security income. 

On April 22, 2009 the Public Good IRA Rollover Act was introduced in Congress.  This legislation would make the IRA Charitable Rollover permanent, remove the $100,000 annual limit on donations, provide IRA owners with a planned giving option starting at age 59 1/2 , and allow for distributions to supporting organizations, donor-advised funds, and private foundations.  This is only a proposal and not current law, so stay tuned for updates.                                                                                                 By T. Y. Khun

Maximum contributions for Traditional and Roth IRAs are $5,000 for 2009.  The “catch-up” contribution is $1,000 for those ages 50 or older by year-end, for a maximum contribution of $6,000.

An individual must have earned income, or compensation, on which to base their IRA contribution.  A non-working spouse may contribute based on the working spouses’ earned income when filing jointly.  Compensation included salaries, wages, tips, commissions, bonuses, alimony, royalties, and “earned income” in the case of self-employed individual.  Eligible compensation must be from personal services currently rendered. 

Compensation does not include any amount received as deferred compensation, pension, or annuity income, unemployment compensation, rental income, interest or dividend income, royalties from investments or any other amount not includible in gross income. 

Traditional and Roth IRAs may be established on behalf of an individual and contributions may be accepted for a particular year until the due date for filing the individual’s federal income taxes – NO EXTENSIONS.  April 15, 2010 is the last day to establish and fund IRA accounts for 2009.  Tax extensions apply to employer contributions to SEP and SIMPLE IRAs.

The 2009 contribution limit for a SEP IRA is $49,000 or 25% of compensation, whichever is less.

The 2009 deferral limit for a 401(k), 430(b), or 457 Plan is $16,500.  The additional $5,500 catch-up contribution is available for those ages 50 and older by year-end for a maximum contribution of $22,000.

A SIMPLE IRA has $11,500 annual salary deferral limit in 2009.  The $2,500 catch-up brings the total contribution for those ages 50 and older by year-end to $14,000.

A qualified plan rollover or transfer refers to the process which allows you to take your retirement assets from your previous employer and move them to your IRA while the money continues to grow tax-deferred.  Careful consideration should be given before you choose, as the rules will vary depending on which method is used.  

Direct Rollover

A non-taxable distribution from a qualified pension plan, 401(k) plan, 403(b) plan or 457 plan that is sent directly to the trustee, custodian or issuer of the receiving IRA and is reported to the IRS as a rollover.  There is no limit to the number of direct rollovers that can occur in a year.  IRA owners will receive a Form 1099R to report the distribution and a Form 5498 to report the rollover.

Indirect Rollover

The employer-sponsored plan writes a check for the distribution, less a mandatory 20% withheld for taxes, to the employee who then deposits the check in their personal account.  The employee has 60 days to roll over all or a portion of the total amount received from the distribution to an IRA.  Any amount not rolled over, including the 20% withholding, will be considered a taxable distribution and you will owe income tax plus an additional 10% penalty tax if under age 59 ½.  To avoid any taxation or penalty, the recipient must deposit all of the distribution, plus come out of pocket the 20% withheld, within the 60 day period into an IRA.  An indirect rollover is allowed once every 365 days per IRA.

Trustee to Trustee IRA

You direct the custodian of your existing IRA to transfer your assets directly to an IRA held at another financial institution.  There is never a taxable event, as you are never in receipt of the funds.  You may make as many of these transfers as you want and there is no IRA reporting, so no IRS forms to file.

IRA to IRA Rollovers

An IRA owner can receive a distribution from an IRA and must roll it over to another IRA or to the same IRA within 60 days of receipt to avoid taxes and penalties on the distribution.  Partial rollovers are allowed.  The IRA owner is limited to one indirect rollover from a particular IRA in any 365 day period.  This limit is applied separately to each IRA owned.  IRA owners receive a Form 1099R to report eh distribution and a Form 5498 to report he rollover.  A direct rollover from a Qualified Plan to an IRA and a conversion from a Traditional IRA to a Roth IRA are exempt from the 365 day restriction.

Roth IRA Conversions

Technically, converting a Traditional IRA to a Roth IRA is a taxable distribution.  However, the account owner does not receive these funds as they are converted to a Roth IRA.  A Traditional IRA, SEP IRA or after two years from the first contribution a SIMPLE IRA may be converted into a Roth IRA.  Ordinary income taxes are paid on the amount converted in the year it is converted.  You may now convert from a Qualified Plan directly into a Roth IRA.   The 10% penalty tax does not apply to Roth IRA conversions.  A form 1099R is used to report the conversion.

IRA Divorce Transfer

If an interest in an IRA is transferred by a divorce decree or Separation Agreement, the interest in the IRA can be transferred to the former spouse’s IRA.  A Qualified Domestic Relations Order or QDRO is the document used to transfer assets from a divorcing party’s qualified plan to an IRA for the former spouse.  This is a direct transfer, so there is no reporting and this is not a taxable event to either party.   

We hope this information will help you correctly plan your IRA and qualified plan conversion and transfers.  If you have any questions, please send us an email.

Fund your IRA. 

The maximum contribution for 2009 is $5,000.  There is an additional $1,000 contribution catch-up provision for owners over age 50.

Fund your spousal IRA.

Couples who are married and file jointly can contribute up to the maximum amount to the non-working spouse, in their own individual retirement plan.

Carefully consider your beneficiary designations

Beneficiaries are specified as part of each IRA.  This allows for special consideration when planning how the owner wishes to divide their estate.  IRA owners are encouraged to work with an attorney, CPA or other financial professional, but generally avoid naming a trust or estate as the IRA beneficiary.

Most married IRA owners name their spouse the primary beneficiary.  At the death of the owner, the primary beneficiary surviving spouse may then make an IRA rollover into their name.  However, if the surviving spouse is younger than 59 ½, it may be more beneficial to establish an Inherited IRA. 

STRETCH IRA

A STRETCH IRA is a plan design strategy for IRA owners who may not need this money in retirement.  Carefully structuring IRA beneficiaries will result in continued tax deferral and compounding over as many as two generations.  As a result, the STRETCH IRA can be a strategy employed to increase family wealth.     

Non-Spousal Beneficiary

The Pension Protection Act of 2006 offers non-spouse beneficiaries of qualified retirement plans the ability to request a direct transfer of these assets to an Inherited IRA, if the qualified plan provides this option.

Transferring a retirement plan form an ex-employer to your IRA enables your non-spouse beneficiaries, upon your death, to establish an Inherited IRA and stretch out the life of the IRA assets.  This is another wealth building technique, retaining the continued tax deferred compounding for the beneficiaries.

Take RMD   

Required Minimum Distributions must be taken from Traditional IRA, SEP IRA and SIMPLE IRAs by April 1, following the year when the owner reaches age 70 ½ of age.  After the first year, RMD must be taken before December 31 of that year.  Failure to take these distributions may result in a tax penalty of 50% of the amount not taken.

Note:  RMD was suspended for the year 2009 by the Worker, Retiree and Employer Recovery Act of 2008.  RMD will be reinstated again in 2010.

Rule 72(t) for Pre 59 ½ Distributions

Taxable IRA withdrawals taken prior to the owners age 59 ½ must pay an additional 10% early distribution tax penalty, unless utilizing IRC 72(t).  One exception to the penalty is for a series of Substantially Equal Periodic Payments (SEPP) for the longer of five years or until reaching age 59 ½.  If there are any modification to the 72(t) SEPP schedule of equal payments prior to the completion of the required time frame, a 10% penalty will be applied to all distributions, retroactively and with interest.

Understand Income in Respect of a Decedent (IRD)

At the death of the owner, the value of all IRAs are included in the total taxable estate for federal estate tax purposes.  This estate tax liability will be in addition to the ordinary income tax due for distributions made to a named beneficiary from a pre-tax IRA.  IRAs are considered “Income in Respect of a Decedent” or IRD in accordance with IRC Section 691(c).  This code allows an income tax deduction for any federal estate taxed paid on the IRA.  Employing IRD strategy will limit the amount of double taxation on inherited IRA assets.

Please send us an email, requesting additional information, if you have any questions regarding any of these IRA strategies.  

REQUIRED MINIMUM DISTRIBUTIONS

(RMD)

Owners of Traditional, SEP or SIMPLE IRAs are required to begin minimum distributions when the reach the age of 70 ½. Roth IRA distributions are not subject to the required minimum distribution rules.

The following are some frequently asked questions pertaining to and individuals RMD:

When must I actually take distributions from my IRA?

In the year you turn age 70 ½ you may take your first distribution by December 31.  Or you may delay taking your first distribution until April 1 in the year following your reaching age 70 ½. 

Any distribution is taxable at ordinary income tax rates in the year the withdrawal is taken.  If you choose to wait to take your first RMD distributions until April 1 of the following year after you turn 70 ½ of age, you must make another taxable distribution by December 31 of the same year.  This may or may not be advantageous to your tax rate.

May I take a distribution of more than required?

Yes, Excess distributions do not offset the RMD percentage to be taken in future years.  Excess withdrawals will reduce the total amount of the IRA and to that extent the future RMD calculated may be less.

What happens if I don’t take my required minimum distribution?

You may be subject to a 50% IRS penalty tax on the difference between the RMD and the amount you actually took as a withdrawal.

How is each years RMD determined?

Your minimum distribution is calculated by dividing the total value of your IRA balance on December 31 of the previous year by the IRS appropriate life expectancy factor.

What happens if I have more than one IRA?

The RMD is calculated on the sum of all IRAs, but the withdrawal may be taken from any of them.

What if I still have another type of retirement plan, like a 401(k) or 403(b)?

You must take your RMD from your IRAs separately than from your other retirement plans. This is another good reason to consolidate your retirement plans into an IRA once you have retired form active employment.

Do I always use the IRS Uniform Table to determine my RMD factor?

Yes, with one exception.  When the IRA owners spouse is the sole primary beneficiary and that spouse is more than 10 years younger, the factor is found by using the Joint Life with Recalculation Table.

Am I required to take my RMD in cash each year?

No.  Cash and/or securities can be withdrawn from your IRA.  Typically, securities would be transferred into the owners individual brokerage account.

May I continue to make contributions to my IRA when I am older than 70 ½?

If you are still working and have earned income, you may continue making annual contributions to a SEP IRA, SIMPLE IRA or Roth IRA, but you may NOT make any additional contributions to a Traditional IRA.

RMD

ENTIRE INTEREST REGULATIONS

Individuals age 70 ½ and over with annuities in their IRA, 403(b), qualified plan, government 457, Keogh, Inherited IRA or Inherited TSA may be affected by a new IRS ruling. 

Beginning January, 2006 the actuarial present value of an annuity’s “additional benefits” will be added to the end of year account value for determining required minimum distributions RMD.  This new value is known as the “entire interest.”  This would require a greater RMD than would have been required if only the account value was used in the calculation.  Benefits that may be included in this IRS ruling include living benefits and death benefits.

The IRS ruling includes death benefits, excluding premium guarantee death benefits, on contracts with a death benefit feature, on a dollar for dollar basis for withdrawals, where the actuarial present value of the guarantee is 20% greater than the contract value.  The actuarial present value of the benefit will be added to the account value for purposes of calculating the RMD.  Contracts with a living benefit feature are included on a dollar-for-dollar basis for distributions, where the actuarial present value of the guarantee is 20% greater than the contract value.  Death benefits that guarantee a return of premium, benefits (death or living) that adjust on a pro-rata basis when a withdrawal is taken, or benefits that have an actuarial present value of less than 20 percent of contract value are not included for purpose of this calculation.    

If the benefit is a return of premium death benefit, the impact will be minimal.  However, if the living or death benefit is disproportionately higher than the account fair market value the impact will be much greater.

If you have an unanswered question regarding your RMD please send us an email.

As attempts are made to pull the U.S. economy out of  recession, the federal government is now expecting their deficit to be close to $2 trillion.  This is particularly sobering news when you also consider that very soon the government will also have to fund Social Security out of general revenues.  Unfortunately, their need to spend more money does not end there.  Not only are Medicare and Medicaid going to cost more as our population ages, but the government is now looking to pass a health-care bill which will surely add additional trillions of dollars to the debit balance. 

If it hasn’t crossed you mind yet, relax a moment, take a deep breath and ask yourself how is our government expecting to pay for all this and how is this likely to play out?  

What about consumer spending as a solution?  Increased consumer spending would stimulate corporate earnings and personal employment income, which would also increase tax receipts.  Let’s get more people to work, there’s the solution.  But wait, our unemployment rate is increasing.  Businesses have cut payrolls because of a reduction in earnings. As a result, layoffs or fear of layoffs has caused the American consumer to stop spending money.  Instead they are saving or better yet, paying down their debt.  Businesses are not going to add employees until they see some sign of consumer confidence returning.  With the amount of existing consumer debt, don’t look for the consumer to spend us out of this recession anytime soon.

How about eliminating the tax cuts?  Nice start, but no where near enough to make a difference.  How about controlling costs?  One sure way to control cost is to ration benefits.  How about Social Security, Medicare or health care, especially at the older ages when the costs are much more expensive?  How does rationing those benefits strike you?

The other thing that happens when you incur debt is you have to pay interest.  Paying the interest on such a large amount is going to create an immediate and continual need for the government to raise additional capital.  They do this buy selling bonds.  The way you attract investors to buy more bonds is you raise interest rates.  But the government is not the only entity needing to borrow money, don’t we need businesses to start growing and hirer again?  Business also issue bonds to attract growth capital.  So they will all be competing to raise money and all this competition will force them to pay higher interest rate to get it.  As a result, interest rates should rise.

The fed recently published their long-term budgetary trend reports.  For anyone who could find these and read them it is clear we are on a path to higher taxes What is the one sure way our government can raise revenue?  Raise taxes.