Worcester Jewish Chronicle, March 23, 2006

How to have a long, happy retirement – Part 1

Procrastination.

It’s a word that most of us know all too well. While there are times when holding back can pay off; planning for your retirement is NOT one of them. There’s only one side to waiting and that’s the downside. It’s NEVER too early. But, while early is certainly preferable, it’s also NEVER too late.

Let me give you a few hard-to-ignore reasons to start saving for your retirement now.

•     Experts estimate that you will need 2/3 to 3/4 of your current income to lock in financial stability for your post-retirement years. On average, Social Security will only supply 40% or less of the income you’ll need in retirement.

•     You are likely to live a minimum of 20 or more years after you retire.  That’s good news – provided you have the money to afford this longevity.

•     If you start saving in your 20’s or 30’s, you can possibly be a millionaire by the time you reach retirement age.

•     Even a slight increase in contributions to your retirement savings plan.

•     1% or 2% – can reap huge benefits 15 or 20 years down the road.

•     If you stay the course, you are likely to maintain or improve your current standard of living in retirement.

Whether you’re a glass-is-half-full person, or a glass-is-half-empty one, the facts and figures just outlined hopefully have started you thinking about retirement saving and planning. But, as we all know, it’s really easy to fall into the “New Year’s resolution syndrome.” You know how it works. You get all fired up and then a few days or a few weeks later your resolve dissolves and you’re back to square one – or worse.

The strategies I am about to share will fight that natural, but dangerous, tendency because they will make it easy for you to stay on target and will also – pretty early on in the process – provide measurable results. In other words, you’ll have in your corner EASE and PROOF, two major psychological incentives for sticking with it.

In this series of articles, I am going to focus on the following 3-step program for successful retirement planning and saving:

STEP 1: Pinpoint Your Major Sources of Retirement Income

STEP 2: Take a Realistic Look at Your Retirement Costs and Goals

STEP 3: Close the Gap Between Income and Goals

Pinpoint Your Major Sources of Retirement Income

In this step you will basically inventory all of your anticipated sources of retirement income. As we walk through each of them, consider which ones you have, which ones you don’t, and which ones you should consider adding.

Let’s start with the one most Americans depend on – Social Security.  Social Security is a compulsory federal government insurance program that, in addition to retirement income, provides basic financial support for you and your family during disability and for your survivors following your death.

Each year, about two to three months before your birthday, you receive a statement from the Social Security Administration detailing the facts and figures surrounding your contributions and anticipated retirement benefits.

Review and keep this document. It’s a vital piece of information for your retirement planning. Especially relevant is the comparison of what benefit you can expect at various retirement ages. The longer you work, up until age 70, the greater your benefits.

You will need to consider these numbers to realistically assess when you can actually retire. For example, you should consider the ramifications of taking your Social Security benefits early and reinvesting that income in another vehicle that gives you a higher return than the increased benefits you could receive by waiting. In addition, you need to analyze the tax implications of receiving Social Security benefits while you are still working.  These are the kinds of questions that can be addressed in detail by a CPA or other financial planner.

You can obtain a copy of your Social Security Statement by contacting the Social Security Administration, either on their Website, www.sss.gov, or by phoning them at 800-772-1213. The Website also contains some very helpful information on all aspects of retirement. It’s worth a look.  One final note on Social Security. The system was never intended to provide complete financial independence at retirement by itself. Rather, Social Security is supposed to serve as a foundation for a comprehensive retirement plan, supplementing other sources of income. 

Another major source of retirement income is an Employer Pension Plan.

If you have a pension plan, you need to look at its provisions carefully and make sure you understand them fully. The most important thing to keep in mind is that your pension may be significantly reduced, or completely eliminated, if you are not with the company long enough to be fully vested.  Retiring even a few months too early (or leaving for another position in advance of vesting) could cost you tens of thousands of dollars over the course of your retirement.

For example, if your employer’s pension plan specifies that you must be with the company seven years before you become fully vested, and you’ve worked there only five, it may be wise to sit tight for another two years.  Also, don’t forget that the amount of your pension is often calculated using your final salary, so if you get raises in that period, you are also adding to your potential retirement income.

Employee Contribution Plans, with the most common being a 401(k) plan, are a highly effective approach to putting money away for retirement.  If your employer makes matching contributions, all the better. In addition to accruing retirement income, there are a number of other advantages to 401(k)s and other plans:

•     Your contributions are not subject to tax. If you put $5000 into a 401(k) and earned $50,000 that year, your taxable compensation would be $45,000.

•     Employers often offer a variety of investment options, so you can find the investment vehicle or vehicles that best suit your goals and your temperament.

•     Some plans allow you to borrow against your 401(k).

•    Should you leave your current employer, you can roll your 401(k) over into another tax-deferred retirement plan such as an IRA, or Individual Retirement Account

But far and away the best feature of employee contribution plans is that you build your retirement nest egg using pre-tax dollars that grow tax-free until you withdraw them.

IRAs are also tax-advantaged retirement vehicles that you can easily establish with your broker or banker. There are two types of IRAs –traditional IRAs and Roth IRAs. A traditional IRA contribution can be fully deductible, partially deductible, or totally non-deductible. This depends on whether you or your spouse has retirement coverage with your employer and on the amount of your adjusted gross income. Distributions from traditional IRAs are generally fully taxable and if made prior to age 59-½, are generally subject to a 10 percent penalty. Annual minimum distributions must begin when you reach age 70-½.Contributions to a Roth IRA are not deductible. However, distributions from a Roth IRA are generally tax-free if taken after (1) five years from the year of the contribution and (2) age 59-½. Unlike a traditional IRA, no annual minimum distributions are required after age 70-½. As a result, a Roth IRA can continue to grow tax-free. For 2004, the combined contribution limit for both traditional and Roth IRAs is $3,000 ($3,500 for individuals age 50 or older). For 2005, the contribution limit is increased to $4,000 for individuals under age 50, and $4,500 for individuals’ age 50 or older. Consulting a CPA or other financial adviser to learn more about which IRA is best for you could be a critical step in your retirement planning. 

More and more experts agree that, in order to afford retirement, you will also need to have private investments to supplement other sources of income. Here again, advice from an objective party who does not have an interest in promoting a particular investment can be invaluable. Many have been turning to their CPAs for that kind of advice. I’ll talk more about specific investment vehicles when we get to Step 3: How to Close the Gap.

Finally, as you assess where you will be getting retirement income, you may want to consider a second career. More and more Americans are doing that. Some out of necessity. Some because they feel they want to pursue a passion. Whatever your reasons for a retirement career, you should include it in your retirement scenario, and not just the projected income. You also need to look at the tax consequences. Will it affect your Social Security? Will it kick you up into a higher tax bracket? Will a part-time job or career generate enough income or will you have to consider working full time? These are the types of questions you need to be asking now.

You now have an idea where your retirement income will be coming from? In our next article we will be looking at Step 2 – Taking a Realistic Look at Your Retirement Costs and Goals.

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William E. Philbrick, CPA/ABV, MST, CVA is a Senior Vice President and Tax Director at Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached at wphilbrick@GRK&B.com.