Active planning and saving is critical for a successful and happy retirement. Social Security alone isn’t adequate as increasing life expectancies extend retirement years. No matter what stage of life you are in, understanding your options and the different types of available income will make your retirement goals much more attainable.
Maximize Employer Benefits
One of the first questions to ask when saving money for retirement is whether your employer offers a retirement savings plan. This may be a 401(k), 403(b), SIMPLE IRA, or SEP IRA plan. While these plans are similar in some respects, they can differ greatly in terms of eligibility, investment options, and how they are administered. Perhaps the most important question is whether the employer offers to match your contributions to the plan. If so, even for those that are risk-averse, this is an easy way to earn a 100% return on contributions. For example, if your employer matches every dollar you contribute up to 4% of your annual income, then your 4% contribution will be doubled each year with a total of 8% of your annual income.
Supplement Employer-Sponsored Savings with IRAs
If you are already maximizing contributions to an employer plan and would like to save additional funds, or if your employer does not offer a plan, you can contribute to a Traditional IRA or Roth IRA, depending on your level of household income. Anyone with earned income can contribute to a Traditional IRA, however the amount will only be tax deductible under specific household income limits. If your income is below specified limits (under $196,000 in 2017 for married couple filing jointly), you are eligible to contribute to a Roth IRA. Contributions to a Roth IRA are made with post-tax income and the entire amount of a qualified distribution from a Roth IRA is non-taxable, including accumulated earnings on contributions. Unlike a Traditional IRA that requires minimum distributions be taken after age 70 ½, withdrawals are not required to be taken from a Roth IRA during the owner’s lifetime. Thus, a Roth IRA provides tax and planning advantages over a Traditional IRA. (For more information on income limitations and IRA contribution deductibility, please see a Wealth Management representative or visit IRS.gov for the most current deduction limits).
Understanding Social Security
Social Security is a benefit paid to individuals once they are qualified to receive payments and have attained the age required for the payments to commence. Social Security has undergone changes in the last few years in response to demographic shifts – more retirees with longer life expectancies collecting Social Security compared to the amount of workers currently paying into the system. In order to qualify for Social Security, an individual must have worked at least 10 years, earning at least $1,260 per quarter. The amount of benefits paid is based on the individual’s highest earning 35 years adjusted for inflation. An individual worker contributes to Social Security through payroll deductions on income up to $127,200 in 2017. Income beyond this amount is not subject to tax deductions for Social Security and does not factor into an individual’s subsequent Social Security benefit calculation.
One of the most difficult decisions facing those nearing retirement is when to start taking Social Security. If you elect to take Social Security prior to full retirement age (age 66 for people born 1943-1954), Social Security benefits will be reduced. This reduction is permanent. Additional reductions may apply if you continue working during retirement. In 2017, Social Security will deduct $1 in benefits for every $2 an individual earned over $16,920 annually ($1,410/month). A potential solution to this problem is to defer claiming Social Security until full retirement age and take distributions if needed from an IRA to supplement earned income. However, this requires careful planning to make sure the added benefit from deferring Social Security outweighs the tax impact and forfeited investment growth of the IRA. Another solution may be a deferred compensation arrangement with an employer that delays recognition of earned income until after full retirement age. Once full retirement age is attained, earned income no longer reduces Social Security benefits, no matter how much you earn.
You can defer Social Security even after reaching full retirement age and further increase your benefits by 8% per year up to age 70. After the age of 70, it no longer makes sense to defer Social Security. Coincidentally, you will also be required to start taking minimum distributions from any Traditional IRA or 401(k) after age 70 ½. For individuals who do not need additional income, these required minimum distributions can be an unnecessary tax burden. Those retirees may consider having their required minimum distributions (up to $100,000) paid directly to charity, allowing them to avoid counting the distribution as taxable income. Another way to reduce future taxation of IRA distributions is to convert a Traditional IRA to a Roth IRA. This requires a one-time payment of previously untaxed gains in the IRA, but if done at a time when there is a slump in the market value of investments, future appreciation is untaxed. Additionally, a Roth IRA does not require minimum annual distributions during the owner’s lifetime, giving the owner more flexibility in planning.
Review Goals Regularly
Once retirement plans and goals are in place, they should be reviewed on a regular basis to ensure they remain feasible. Each individual’s plan is different, and for some that may mean waiting to collect Social Security and avoiding minimum distributions from retirement savings. For others, the solution may be a blend of IRA distributions in addition to Social Security payments. If you have questions or would like more information concerning planning for retirement needs, please contact a Wealth Management representative.