Monthly Archives: August 2014
Posted by vanguard23
There are a lot of “important” dates to remember to stay out of hot water. There are dates that do not change (unless of course the event occurred on February 29th of a leap year), such as your spouse’s birthday, your wedding anniversary (and you must also know how long you’ve been married and not just the date), your kids’ birthdays and possibly your own birthday…oh yeah, Valentine’s Day is also important lest you find yourself spending time in the dog house for forgetting. In our family, our parents still celebrate their kids’ birthdays with family get-togethers, no matter how long the “kids” have flown the coop and started their own lives…so you have to remember your parents’ birthdays and your siblings’ birthdays as well. There are also dates that change every year but ones you “need” to keep track of, such as Mother’s Day…and possibly Father’s Day…although admittedly, Father’s Day is the “lesser” day and not as celebrated as Mother’s Day. I suppose social media with Facebook and such make “remembering” these dates easier with ubiquitous reminders obnoxiously announcing someone’s big day…but there are other dates just as important for financial planning that fails to garner much attention.
During one’s accumulation phase, there is little regard given to “important” dates for financial planning geared towards retirement. At age 25 or 35, age 50 seems like a long way away, let alone a full retirement age of 66 or 67, depending on when one was born. But certain dates or ages come with important decisions and actions requiring some thought and consideration to posture yourself for a better financial footing during retirement.
1. Age 50…the big FIVE-0. Not only is 50 the new 40 (or so I have heard…no doubt promoted by those pushing 50), but at age 50, employees can make catch-up contributions to their 401(k) plans or TSP as well as their IRAs. For 2014, the catch-up contribution for 401(k)s or TSP is $5,500, for a total annual contribution limit to one’s 401(k) plan or TSP at age 50 or older of $23,000. Consider this…just adding $5,500 annually to what you are already contributing to your 401(k) or TSP will amount to an additional $147,884.29 to your nest egg (assuming a modest 7% rate for an equity index fund over 15 years up to age 65)! At age 50, you can also contribute an additional $1,000 to your IRA (Roth or Traditional) for a total annual contribution of $6,500. That additional $1,000, compounded over 15 years at 7% rate, will add $26,888.05 to your nest egg.
2. Age 55. If you are 55 or over and you leave your job, you can take withdrawals from your 401(k) plan without paying the 10% early distribution penalty tax. Early withdrawals (i.e before age 59½), however, are still taxable as ordinary income…and are not recommended unless you absolutely, positively, have to make early withdrawals from your retirement accounts (i.e. one would ideally have an emergency fund to cover needs or if that has been depleted, consider cashing out taxable equity accounts that are hopefully taxed at a much lower long term capital gains tax). Taking early withdrawals from one’s tax-advantaged retirement accounts is like depriving your retirement sails of much needed wind…you might get to where you want to go, but it would take much longer. One way around this 10% penalty is to set up what’s called a Substantially Equal Periodic Payment (SEPP) (also known as 72(t) distribution – 72(t)(2)(A)(iv) to be exact – from its corresponding IRS Code Section) where the “funds are placed into an SEPP plan that pays the individual annual distributions for five years or until he or she turns 59.5, whichever comes last.” But SEPPs are beyond the scope of this modest blog.
Incidentally, contributions to Roth IRA accounts can be withdrawn penalty free. Note that this penalty-free withdrawal ONLY APPLIES TO CONTRIBUTIONS (i.e. not on any of the earnings).
3. Age 59.5 or typically 59½. At 59.5, you can withdraw funds from your 401(k), TSP, or IRAs without having to pay the 10% early distribution penalty. Withdrawals are taxed using your marginal tax rate or income tax rate. Since money contributed to your 401(k), Traditional TSP, and/or IRAs were before-tax dollars and income taxes were not garnished on those contributions, you would have to pay income taxes upon withdrawal.
4. Age 62. Age 62 is the age you can begin receiving Social Security benefits. The Social Security Administration (SSA) “calculates your average indexed monthly earnings during the 35 years in which you earned the most.” You can use the SSA’s Retirement Estimator tool to calculate how much you would expect to receive in Social Security benefits.
Deciding when to claim Social Security benefits is a highly personal one, and involves expected life expectancy, financial standing, etc. It is worth noting, however,that delaying claiming Social Security would lead to an increased benefit by about 6.7% to 8.25% year over year. Using the graph provided, one can clearly see that by delaying claiming Social Security from 62 to the full retirement age (FRA) of 66 or 67, one’s benefit increases by 33.3% (if FRA is 66) or 44% (if FRA is 67).
Social Security benefits, for most retirees, are the main source of “income” during retirement (which can last 25, 30 years, or even 40 years for those retiring at FRA) and considerable thought and planning need to be devoted to the decision involved with when to receive benefits. It is important to consider, that about a third of 65-year-olds make it to age 90 and more than 1 in 7 make it to 95 years old…so one has to plan for a longer lifetime during retirement and develop a cogent plan to maximize those benefits.
IMPORTANT NOTE: If you are still working and elect to receive your benefits prior to your FRA, part of your benefits might be held by the SSA. There are also online tools (and some fee-based organizations would do this as well) that will assist you in maximizing your Social Security benefits…with strategies such as file and suspend and strategies for married couples for claiming spousal benefits. It would behoove soon-to-be retirees to fully educate themselves (don’t even rely on SSA employees to do this for you) on all the options available to them to ensure they are maximizing their Social Security benefits.
For government workers who are eligible for or are receiving a pension, there are certain rules that might apply affecting your benefits, since a different formula is applied to your average indexed monthly earnings. To find out how the Windfall Elimination Provision (WEP) and/or Government Pension Offset (GPO) affect your benefits, go to the SSA’s WEP calculator or the GPO calculator.
5. Age 65. Three months before you turn 65, and three months after the month you turn 65, you can sign up for Medicare Part A (Hospital Insurance) and/or Part B (Medical Insurance), if you are eligible. Your coverage starts the first day of your birthday month, unless your birthday is on the first day of the month, in which case, your coverage starts the first day of the previous month. If you fail to sign up for Medicare during the 7-month initial enrollment window, you can sign up during the General Enrollment Period between January 1–March 31 each year. According to the Medicare website, “if you’re covered under a group health plan based on current employment, you have a Special Enrollment Period to sign up for Part A and/or Part B any time as long as you or your spouse (or family member if you’re disabled) is working, and you’re covered by a group health plan through the employer or union based on that work.”
To find out if you are eligible for Medicare, use the following link: http://medicare.gov/eligibilitypremiumcalc/.
6. Age 66 or 67. Full Retirement Age (FRA), also known as “normal retirement age” is the age at which a person may first become entitled to full or unreduced retirement benefits. Your FRA is 66 if you were born between 1943 and 1954. If you were born in 1955, your FRA is 66 years and 2 months. Your FRA increases by 2-month increments every year until you reach 66 years and 10 months for those born in 1959. If these calculations seem confusing, you can just use the SSA’s Retirement Age Calculator.
If you were born in 1960 or later, you FRA is 67. Once you reach your FRA, you can work and collect Social Security benefits at the same time without your SS benefits being reduced.
7. Age 70. At age 70 is when one can claim the largest Social Security benefit. There are no increases to your Social Security benefits, except for the annual Cost of Living Adjustment (COLA), after the age of 70.
8. Age 70 1/2. If you have a 401(k), TSP (Traditional or Roth), and/or a Traditional IRA, you must take Required Minimum Distributions (RMD) when you reach 70.5 years of age as you cannot maintain your funds in these accounts indefinitely. There are provisions allowing you to delay this somewhat until after you stop working. In general, you must begin withdrawing money from the above-mentioned accounts by April 1st of the year following the year you turn 70½. RMD is the minimum amount you must withdraw from your account each year. Failure to take RMDs, or if the distributions are not large enough, can result in the IRS requiring you pay a 50% excise tax on the amount not distributed as required.
Note that RMD only applies to Traditional IRAs, 410(k)s, Traditional TSP as well as the Roth TSP. RMDs are not required for Roth IRA accounts. Some retirees opt to rollover their 401(k)s or TSP into Roth IRA accounts to avoid RMDs, but this is a decision not to be taken lightly. There have been numerous concerns about 401(k) providers encouraging retiring employees to rollover their 401(k) into their firm’s IRAs despite this move not being in the best interest of the employee. Possible fees and increased expense ratios could be lurking. According to a Money magazine article in July 2014, “as long as an employee is in a 401(k), their investments are overseen by a fiduciary” – i.e. looking after the employee’s best interest. Increasingly, however, those advocating a rollover into IRAs are not acting as fiduciaries but applying the “suitable” investment standard. Regulators have taken notice and intend to make this a priority when examining financial firms this year.