Retirement Planning

The main goal of retirement planning is to make sure that you have enough money when you retire to maintain your standard of living. How much is enough depends on when you wish to retire, what your anticipated living expenses will be, what rate of return you can expect on your savings, and whether you will continue to work at all after retirement.

The anticipated date of your retirement affects two important factors: how much time you will have to save up for retirement and the number of years you can expect to live after you retire. A qualified financial advisor can help you sketch out your retirement plans in terms of timing and lifestyle. Once you put these down on paper, she can help you calculate how much money you need to set aside to meet your goals and how it should be invested. Unfortunately, one likely answer will be that “You’ll probably need more money than you think.” Americans are living longer than ever before and inflation inevitably eats away at the value of dollars saved.

Many Web sites now offer free tools and information to assist with retirement planning, including so-called “retirement calculators”. By providing a few details about yourself and your finances, these calculators can predict how much you need to save to achieve your retirement objectives. You can find links to a number of different calculators by clicking on the Calculators button of the Resources section of this site.

Making the Most of Your Retirement Plan

One of the most critical and frequently overlooked issues in retirement planning comes after most people have retired. Beginning on the April 1 occurring after you reach age 70 ½, you must begin taking minimum distributions from your retirement plan. How you structure these distributions can have a profound effect on your own retirement and even more on what you leave your heirs. However, as the result of new proposed rules issued by the Internal Revenue Service (IRS), the requirements regarding minimum distributions are much simpler than they used to be, giving you greater flexibility in your decisions.

There are some basic steps you can take to get the most out of your retirement plan. Failing to follow these basic strategies could wind up costing you and your heirs many thousands of dollars in unnecessary taxes. A case study of how poor retirement planning can cost one’s heirs appears at the end of this section.

Calculating Your Minimum Distribution

Congress created the rules governing the minimum distribution of retirement plan funds to encourage saving for retirement and to allow retirement assets to build up tax-free during the plan owner’s working years. You do not pay tax on income you put into a retirement plan when earned or on investment income on the account itself. However, the funds you withdraw upon retirement are treated as taxable income in the year you take the distribution. And if your children withdraw the funds that they inherit from you, they will be taxed on such distributions at their income tax rates.

Since the idea of retirement plans is to encourage taxpayers to save for retirement, lawmakers imposed a penalty for early withdrawal – before age 59 ½ — and a penalty for failure to withdraw once the owner reaches retirement age — after age 70 ½. Until recently, there was also a penalty for excess withdrawals — in other words, for those who saved more than they need for retirement — but that penalty has been repealed. These penalties apply to all tax-advantaged retirement plans, including Individual Retirement Accounts (IRAs), Keogh accounts, 401(k) plans, and pensions.

The withdrawal penalties are in the form of excise taxes. Early withdrawals, those taking place before you reach age 59 ½, are subject to a 10 percent excise tax (with limited exceptions). In other words, you pay the government 10 percent of the amount withdrawn in addition to the taxes that would normally be due upon withdrawal. As for late withdrawals, you must begin taking distributions by the April 1 occurring after you reach age 70 ½ (known as the required beginning date), or pay a whopping 50 percent excise tax on the amount that should have been distributed but was not.

The IRS’s New Rules

The old rules governing minimum distributions from retirement plans required you to make a number of often difficult choices:

      • which of several life expectancy tables to use;
      • whether to employ the “fixed” or “recalculation” method for determining your life expectancy; and
      • who to name as your beneficiary.

Once you made these choices, changing your mind later was not an option.

Under the new rules, beginning with required 2001 distributions, you can consult a simple chart to determine your required distributions (see below). Unless you name a spouse as beneficiary who is more than 10 years younger than you, the beneficiary of your account has no impact on your minimum distributions. This change in the rules will reduce almost every account owner’s lifetime minimum distributions. This will allow you to accumulate more money in your retirement accounts, tax-deferred. (If you name a spouse as beneficiary who is more than 10 years younger than you, your minimum distributions can be reduced even further by consulting a separate joint-and-survivor table.)

New Minimum Lifetime Distribution Chart
Note: Chart extends from age 101 to “115 and older,” for which the distribution period is 1.9 years.

Age of Account Owner
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
Distribution Period
27.4
26.5
25.6
24.7
23.8
22.9
22.0
21.2
20.3
19.5
18.7
17.9
17.1
16.3
15.5
14.8
Age of Account Owner
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
Distribution Period
14.1
13.4
12.7
12.0
11.4
10.8
10.2
9.6
9.1
8.6
8.1
7.6
7.1
6.7
6.3

To calculate your required minimum distribution for a given year using the chart, find the distribution period for your age as of December 31 of the prior year and then divide that figure into your prior year-end retirement account balance. So, for example, if you had $100,000 in a retirement account on December 31 of last year and you were 73 as of that date, you would have to withdraw $4,049 from the account by the end of this year ($100,000 divided by your distribution period of 24.7 years).

Retirement account owners whose spouses are more than 10 years younger than they are should consult the “Joint Life and Last Survivor Expectancy” table in the Appendix of the IRS’s Publication 590. To see this publication, go to: www.irs.gov/publications/p590/ch01.html

The Designated Beneficiary

It used to be that the first rule of retirement plans was to always designate a beneficiary. While it is still important to designate a person or institution to inherit your retirement accounts, the choice of beneficiary is not nearly as critical a decision as it once was.

First, as explained above, your choice of beneficiary generally won’t have an impact on your required minimum distributions. Second, the new rules permit you to change your beneficiary down the road. In fact, your beneficiary can even be changed after your death by the executor of your estate. The old rules required that you name a designated beneficiary by the date you are required to begin making distributions. The new rules postpone the date for determining designated beneficiaries until September 30 of the year following the year of your death.

All this means that your designation of a beneficiary (or failure to name one) will rarely result in the kinds of tax-planning disasters that were common under the old rules. For example, under the old rules, without a designated beneficiary, the heirs had to take distribution of the entire retirement plan within five years and pay income taxes on those distributions. Under the new rules, in most cases, your heirs will be able to take steps that will ensure deferral of taxes on retirement accounts over their lifetimes. But these changes also mean that it is doubly important that your heirs consult with a qualified elder law or tax attorney to ensure that they are making the best decisions regarding beneficiaries from a tax-planning standpoint.

Recalculation: Forget You Ever Heard the Word

Another fateful choice that had to be made under the old rules was whether to elect the “fixed” or “recalculation” method of determining your minimum distributions. With the use of the new simplified chart, this choice no longer needs to be made.

Designating a Trust As the Plan Beneficiary

For tax planning purposes, many couples with estates larger than $1.5 million set up “A and B” trusts to take advantage of the unified credit of the first spouse to pass away. Where a large portion of the estate consists of retirement plans, it often makes sense to have them payable to the trust rather than to the surviving spouse. Unless the trust is properly drafted, however, it won’t be considered a designated beneficiary and the surviving spouse will have to withdraw all the retirement plan monies within five years. Making sure the trust is carefully drafted is complicated and requires the services of an attorney experienced in such matters.

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