Planning for retirement, whether you are 25 or 65, is so very important and tricky. If it is done right, you should have many options later in life. If you’ve waited to fund adequate retirement, it still may not be too late, albeit, you may not have as many options. Some of our clients have had to put offretirement longer than expected, but happily, still enjoy their work and remain healthy. Others have had to make choices that are not nearly as appealing as they’d prefer.
This article addresses several issues around the retirement funding challenge. Having a blend of different assets capable of producing income by the time you retire, both taxable and tax-deferred, is optimum in order to avoid remaining in a high tax bracket upon retirement. Besides aggressively funding any deductible and/or tax-deferred vehicle available to you, additionally, using a regular investment account has many advantages as well. For those of you who have a dual goal of both passing money onto your heirs and funding retirement, a regular investment account has the advantage of both providing ways to use capital gains and other more efficient forms of cash distributions as well as providing a step-up in cost basis upon death, thus maximizing your assets for your heirs.
Many factors affect investment and retirement assets.
Reverse Dollar Cost Averaging
This occurs when you begin making withdrawals from your assets. Investments are sold on a regular basis regardless of the price per share. If share values are low, the strategy sells more shares to get your predetermined withdrawal amount than when share values are high. Withdrawing money on a regular basis during volatile and negative markets has a compounded negative impact on the portfolio, forcing the investor to save more than originally planned during the accumulation phase.
According to financial planning guidelines, the new paradigm for retirement funds withdrawal rates have significantly decreased. For investors early in their retirement, recommended withdrawal rates has been reduced from 4-5% to a more modest 2-3% annually due to historical low interest rates and prevailing equity dividend distribution rates.
Most investors have a high probability of living longer than expected, even more so when the household includes a spouse or significant other. At age 66, one or both retirees may live well into their 80s or 90s. That requires another 20-30 years of needed cash flow from the portfolio. Therefore, keeping an important component of your investment in growth vehicles as well as cash flow positions is imperative.
Budget and Lifestyle
At the time of the important life transition to your retirement, it is important to comprehensively review your spending budget and lifestyle. Too many retirees fail to adjust their spending to match the cash flow capable of being produced by their retirement assets and get into serious financial trouble. This can result in being forced to make unwanted drastic changes in spending and lifestyle.
If you wish to retire before the age of 59 ½ and have done a good job of deferring income into retirement plans, and now you need a stream of income from your IRA, you normally would have to pay a penalty in addition to taxes; however, the IRS has a special provision allowing a withdrawal of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary before 59 ½ through their Code §72(t)(1)72T. IRS Rev. Rul. 2002-62 lists three methods you may use in determining what are substantially equal periodic payments: the required minimum distribution method, the amortization method, and the annuitization method. Once you choose the method, you must continue to take the income for five years or until age 59 ½, whichever comes later.
Additional Savings Vehicles
For employees that have retirement plans such as a 401(k) SIMPLE IRA, Simplified Employee Pensions, etc., you can supplement your firm’s plan by adding a non-deductible IRA, a brokerage account or an annuity. Savings on a non-deductible IRA can grow tax-deferred. Further, if converted to a Roth IRA, you won’t owe taxes on the original nondeductible contributions, although the earnings on those contributions, along with any other pre-tax amounts (e.g. deductible contributions) will be taxable as ordinary income. Additionally, if you have an existing balance in any traditional IRA that you hold as owner, those balances must be taken into account when performing the calculations to determine the taxable portion of your conversion, using the pro-rata rule. Under the pro-rata rule, your distributions (including conversions) are treated as including a pro-rated portion of the taxable (i.e., pre-tax amounts) and nontaxable (i.e., aft er-tax amounts, such as non-deductible contributions) in your non-Roth IRAs. We recommend you contact your CPA to assist in making those decisions.
Roth IRAs can be particularly attractive savings vehicles because they provide flexibility for contributions and withdrawals: holding a potentially tax-free account like a Roth IRA, in addition to a taxable and tax-deferred account, provides the flexibility to take income from different sources and to potentially keep taxes low in retirement. Further, aft er age 70 ½, you can contribute to a Roth, providing earned income requirements are met. An attractive feature of the Roth is there is no requirement to take a distribution, unlike a traditional IRA.
If your employer does not offer a retirement plan, it is well worth an investigation as to how you can provide retirement funding for yourself. If you’ve waited until mid-life and you own, or are partners of, a small firm, and you have adequate income, there are strategies to put money into retirement plans through utilizing retirement programs such as SEP, 401(k) and a defined benefit/profit sharing plan. In some cases, as much as several hundred thousand dollars can be contributed. It is worth a discussion with your CPA.
Living long is not for the faint of heart. Having adequate resources to navigate the increasing challenges during that time is instrumental to achieving many of your retirement goals.
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC (“Morgan Stanley”), its affiliates and Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except as otherwise provided in writing by Morgan Stanley. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account. The Harbor Financial Group at Morgan Stanley is a financial advisory team with the Wealth Management division of Morgan Stanley in Boca Raton, FL. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Investing involves risks and there is always the potential of losing money when you invest. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member SIPC, or its affiliates. CRC1688499 02/17