More people are asking why people retire and how they enjoy it. One article reports that people in their 80’s who were surveyed said: when you retire is determined by how much you’ve saved. The same survey says that retirees found the first few years of retirement the happiest of their lives. But another survey says people pick a date when they want to retire, and do so regardless of how much money they have saved. The more likely view, in general, is that people decide when they want to retire and mold their retirement lifestyle to what they can do with what they have accumulated. My own survey, which is the result of asking many people I meet what they plan to do or what they have done, results in this conclusion: most people retire from full-time employment at an age they choose, and decide how much they will retire (whether they will work part-time, for example) based on what they have. And, perhaps most importantly, no one I have “surveyed” was not enjoying retirement or wished they could be back at work. The key takeaway from all of these surveys: retirement is generally a very positive experience, each retirement experience is unique, and retirement planning is a project that requires much thought and analysis.
For some people, it’s abundantly clear that setting up a Roth IRA, where you get no tax deduction for the contribution but have no taxable income when amounts are distributed, makes perfect sense. People just starting out on their working careers, who might be in a very low tax bracket, are probably better off using the Roth IRA because the tax savings from a traditional IRA deduction don’t help very much. If someone who has a traditional IRA has sufficient wealth that he or she will never need the IRA assets to live on, converting to a Roth IRA makes sense, because there are no required distributions at age 70 1/2, so the IRA funds can continue to build up for the owner’s entire lifetime; and the next generation can withdraw the funds over their life expectancy and will pay no federal income tax on the distributions: a powerful tax planning technique.
But most people aren’t in either of those situations: they’re well into their careers and in a higher tax bracket, and they are likely to need the IRA funds in retirement. In that situation, the question of Roth versus traditional IRA is more difficult to answer. It’s certainly wrong to say that Roth is always better. If an individual is likely to be in a lower federal income tax bracket after retirement, that’s a factor favoring a traditional IRA. But traditional IRA distributions add to adjusted gross income, which can affect taxation of Social Security benefits and could reduce itemized deductions. But most people will be taxed on 85% of Social Security (which is the highest level of inclusion) anyway. So it’s a matter of careful analysis to decide whether to continue with the traditional IRA or convert to a Roth IRA, which requires that you pay tax on the built-up income in the IRA; and whether to make current contributions to one or the other type of IRA.
Conversion from a traditional to a Roth IRA works best when you’re in a lower tax bracket, and when the potential gain on converting the traditional IRA is lower because the market value of the assets is down. So, market turndowns are a time to think about conversion. Some commentators suggest a partial conversion that will bring you to the top of a tax bracket but not push you into a higher one. Remember too that conversion before age 59 1/2 results in a 10% penalty, so that’s rarely a good idea. You’re better off paying the taxes on the conversion with assets outside the IRA, to get the most benefit from conversion. And, finally, remember that if you convert to a Roth IRA and the assets in the IRA then decline in value, there is a technique, recharacterization, by which you can undo the conversion, but not for long.
Think carefully about the Roth option, both contributions and conversions. It’s valuable for some people, a wash or somewhat disadvantageous for others.
President Obama has signed the Protecting Americans from Tax Hikes (PATH) Act, which makes permanent several provisions that were previously enacted year to year; which made any kind of careful tax planning very difficult. One provision that was revived and made permanent is the IRA charitable rollover provision. This provision permits individuals who have reached age 70 1/2 to make a direct transfer from their IRAs to certain kinds of charities (excluding donor advised funds, supporting organizations and private foundations). There is a $100,000 annual limit on such transfers. The amount transferred is not included in the IRA owner’s income, and there is no income tax deduction for the transfer. It’s a provision that applies only to those who have reached a certain age, and it’s really only a tax benefit to some taxpayers, as compared to taking a distribution and then donating it to charity. But for those who can benefit from it, it’s now permanently in the tax law.
The House of Representatives just passed a two year budget deal to avoid a default by the Treasury. Next stop will be the Senate. One provision of this deal is a change in Social Security rules. Specifically, the ability to use the file and suspend method to get extra benefits will be curtailed. This is a valuable benefit, and it will still be available to people of a certain age. We’ll write more about this change as details emerge, but it’s important, if you’re nearing Social Security eligibility, to know and perhaps act on all of the possible techniques to increase your benefits legitimately.
A recent article reminds us of a scam that is still being tried: telephone callers saying they are from the IRS and demanding immediate payment to avoid arrest and imprisonment. If you won’t pay on the spot, your Social Security number is demanded. But, as the IRS frequently tells us, they don’t call people on the telephone demanding payment. So it’s a scam and you should hang up. Similar ploys involve school loan payments, and nearly all of them want your identifying numbers so they can be stolen. Never give out Social Security or bank account numbers to people who call you. Here’s a question: are there people who get up in the morning and say “today at work I’m going to try to cheat innocent people by scaring them with phony IRS demands.” Apparently there are.
An online report about retirement issues included the statement from one participant that 401(k) plans and IRAs were the worst ideas ever. Why? Because they are voluntary and it’s easy to put off contributing to them. The result, obviously, is too little saved for retirement. In an earlier era, which featured more defined benefit pension plans, employees were often, in effect, forced to save for retirement, which was in the form of a monthly check at retirement. The other problem with these plans is that the investment of these funds is left to the individual, usually someone who is not an investment expert. Again, in the earlier era, investments of pension plans were managed by investment professionals. The so-called freedom given to 401(k) and IRA participants to manage their own futures just resulted, in too many cases, in poor investment results that then resulted in inadequate retirement income. As the individual who spoke suggested, if the pipes in your home burst, would you call a plumber or try to fix them yourself?
I saw a discussion online today about trying to measure retirement income readiness. There was discussion of Black Rock’s CORI retirement index, which tells you how many dollars you need to save to produce a dollar of income at retirement. It’s a helpful number to know, even if it’s possibly a depressing one. Of course, knowing whether you have saved enough for retirement starts with knowing how much income you need in retirement, which is a process in itself: how much income for a basic retirement or a more “robust” one. One you know these numbers, which obviously differ greatly from person to person, you can determine what benefits you have to offset your income needs, such as from Social Security or pensions. What’s left is the number for which you have to save. If your income need is $75,000 per year and you have Social Security and pensions of $50,000, you have to save enough to produce the additional $25,000. The online report indicated that about $18 would be needed to produce $1 of retirement income, at today’s rates, so to produce $25,000 you would need $450,000 in retirement savings.
Some other publication has just come out with its list of the top 10 places in the country for retirement, based on criteria such as availability of health care, activities for seniors, climate, etc. I believe all 10 were fairly small towns in less populated areas. There are magazines as well that focus solely on where retirees should go. OK, it’s an idea, but it’s not ideal for everyone. One of my colleagues just mentioned a reason to stay where you are: having children nearby. These decisions should be based on the individual’s own interests. Not everyone wants to live in a small town in Kansas, although some do. One criterion that seemed to be missing from the survey was proximity to large cities and the cultural activities they offer, or living near a college campus with the opportunities that offers. The point is, retirees should start with what they want to do and whether there is family they want to stay near. Health care availability is also important, and recreational activities (although they seem to be available just about everywhere). If you’re living in a place you like, think carefully before “pulling up stakes” and moving to another part of the country just because it doesn’t snow there.
For many people who reach the customary retirement age of 65, it’s not time to sit on the porch in a rocking chair. Because of advances in health care and greater attention to developing good habits, people at 65 are physically and mentally able to do more. Call it the second season or whatever, there is a desire to remain active. It could be a second career or something related to the prior career. Or it could be charitable work or greater attention to a hobby. Studies, as well as common sense, prove that staying active is a key to a longer and more satisfying retirement.
But there is also some important personal planning to do, to ensure a successful retirement. We’ve written before about decisions relating to Social Security and Medicare, and those continue to be crucial. Planning how far your retirement income will stretch will tell you whether you can maintain your pre-retirement lifestyle or must downsize. As unpleasant as it might be to consider, it’s necessary to think about your living arrangements if you begin to experience a physical decline. Many issues to consider, but starting early and getting advice from impartial experts will go far toward making the retirement years more successful.
Numerous articles discuss the ongoing march of baby boomers to retirement, and part of that process involves succession planning for businesses. There are several steps to the planning process, and the process itself should begin at least 3-5 years before the planned sale and its aftermath. No business should be sold or transferred to family members until there has been detailed estate and tax planning, and some of that should take place years before the event. There are many things to decide, and the failure to go through a decision-making process before, during and after the succession events could mean that the business owner will waste some portion of the value he or she has built up a long wealth-building career.