Financial issues as retirement draws near During his 26 years as a pilot, Ted Tourtellott saw much of the United States but only from the air. Since retiring last December, Ted and his wife, Ginger, pilot s schedule hadn t allowed him to do. Says Ted, We decided there were things we wanted to do now, and not wait until I was 60. have traveled to San Diego, Florida, and Yellowstone National Park. It s great to see what things look like from the ground, he says. Ted, a resident of East Amherst, New York, retired at age 55. Until he met Certified Financial Planner Kevin Mahoney of Springville, New York, Ted assumed he d have to keep working until age 60, his former company s mandatory retirement age for pilots. Remain vigilant Many assume that with retirement, as with sailing, the greatest challenges lie mid-journey. It s true that keeping your investment plan afloat can be a struggle when you re facing those two great tidal waves mortgage payments and college bills. But good sailors know they must remain vigilant even when their port is in sight, and they re guiding the craft to shore. Kevin took a look at all the numbers, says Ted. After reviewing Ted s accumulated retirement benefits, Kevin presented us with all our options. Ted and Ginger looked at the retirement income they might have if Ted worked until age 60 and compared it with In fact, with investing for retirement, the biggest challenges may come when one s goal is within sight. Following are some of the issues you ll need to consider and steps you may want to take if you re approaching retirement. the income they could draw from their investments if Ted retired early. Eliminate credit card debt Joe Sgroi, a chartered financial consultant in West Ted also discovered an option he didn t know he had. Seneca, New York, advises his clients to get rid of all He wanted to roll his retirement plan money into an their debt before they retire. When asked if paying off Individual Retirement Account (IRA). But he knew debt would force someone to postpone retirement, withdrawals from IRAs before age 59 1 2 are ordinarily Sgroi stresses that eliminating debt can help people subject to a 10% penalty tax. retire sooner. Through Kevin, he learned about the 72(t) rule. When people retire, their income is generally not This rule enables people to make IRA withdrawals 100% of what it was before they retired, he says. before age 59 1 2 without penalty if they take their If you eliminate the cash flow that s necessary to money in a series of substantially equal payments pay off debt, you ll reduce the amount you ll need that are based on their life expectancy. to spend in retirement. And doing so will also minimize the amount you ll need to withdraw from your By taking advantage of the 72(t) rule, Ted has time investments. for travel, volunteer work, and house projects his NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE NOT A DEPOSIT NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
Financial issues as retirement draws near/2 Retirees need a substantial amount invested in order to keep their assets growing and to protect themselves against inflation. But if they re not having to withdraw extra amounts each month to pay debt, they won t need as much invested going into retirement. Develop an appropriate asset allocation strategy Traditionally, people believed that, as retirement approached, they should shift most of their money out of stocks and into bonds because bonds provide principal protection and pay current income. Today, with longer life expectancies, investment professionals generally recommend that people keep a good portion of their assets in stocks throughout retirement. People can draw income from stock mutual funds by establishing a Systematic Withdrawal Program. For retirees who elect this option, investment professionals will recommend an annual percentage rate for their withdrawals, such as 6%. If retirees stock holdings rise in value at a higher rate than their withdrawal percentage, retirees can continue to realize principal growth, even while using their stock investments for current income. If a husband and wife retire when he s 58 and she s 56, they have a joint life expectancy of about 30 years, says Sgroi. While every stock investor is worried about the next market downturn, he notes that over 30 years a couple could live through as many as five or six market cycles. For people retiring at that age, I don t recommend the traditional 60% stocks, 40% bonds split, he says. I usually suggest a heavier weighting in stocks. If they re conservative and worried about risk, I recommend conservative stock funds, such as utility funds and growth and income funds. Select the accounts that you will withdraw from first It s common wisdom that retirees should withdraw from their taxable accounts first. It s better to postpone distributions from tax-favored investments such as 401(k)s and IRAs the thinking goes so that retirees can continue to benefit from the deferral of taxes on their earnings. But that blanket advice is too simplistic to address the myriad issues people getting ready to retire have to consider, says Sgroi. People need to meet with their investment professionals and tax advisers to do some tax planning and to talk about what their goals are for leaving money to their children, says Sgroi. Some people, with their investment professional s help, might discover they ll be in only the 0% to 15% tax bracket when they retire. In 2002, if a husband and wife are both 65 or over, and if they don t itemize deductions on their tax return, they re in the 15% tax bracket if they have income of less than $60,850 per year. They re in the 10% tax bracket if they have annual income of less than $27,650. When couples withdraw money from 401(k)s and IRAs, their withdrawals are taxed at their ordinary income tax rate. Couples in the lower brackets, then, would pay no taxes or taxes of just 10% or 15% on their 401(k) and IRA withdrawals.
Financial issues as retirement draws near/3 After looking at their projected income and tax brackets, couples in the lower brackets might decide to withdraw money from their tax-deferred accounts first, says Sgroi. Reduce taxes for children. Even people in the higher ordinary income tax brackets might want to withdraw from their tax-deferred accounts first if they wish to reduce the taxes their children will pay when they inherit the parents assets, he says. When children inherit pension, IRA, or 401(k) money from their parents, the children are required to take distributions from the accounts and pay ordinary income taxes on those distributions. Money that parents held in taxable accounts, outside of retirement plans, benefits from a separate tax rule when it passes from parents to children. The rule is called the step-up in basis. Here s how it works. Remember that when you sell shares of taxable accounts, such as stock funds, you pay capital gain, rather than ordinary income, taxes. When someone dies, the cost basis used to determine the capital gain on inherited assets steps up or rises to the value of the assets on the date the person died. If parents bought a stock for $5, for example, their cost basis is $5. If they sold the stock during their lifetime when it was valued at $20, they d owe a capital gains tax on their gain of $15. If the parents bequeathed the stock to children, the children s cost basis would step up to the value of the stock when the parents died. If the stock was worth $25 when the parents died, the children s cost basis is $25. If they sell the stock shortly thereafter, before it appreciates any further, the children won t owe a capital gains tax on the sale. Their selling price is $25. Their cost basis is $25. Consequently, their capital gain is zero, and the children don t owe a capital gains tax. Note that in 2010 when estate tax reaches repeal, the step up in basis is replaced by a carry-over-basis regime whereby the child would inherit assets at the parents cost basis. Find the best way to take pension payouts Defined contribution plans, such as 401(k)s, have become popular in recent years. But many people retiring today still have the more traditional pensions, known as defined benefit plans. Unlike 401(k)s, the traditional pensions offer retirees a guaranteed monthly benefit that is usually based on their years of service and final salary. When their retirement date draws near, people with traditional pensions must decide how they want to take their plan s benefits. A few defined benefit plans allow retirees to take lump-sum payments. Retirees can take the money as cash and pay taxes immediately, or roll the money into an IRA. Lump-sum payments are a popular choice among the plans that offer them because they give retirees more freedom in how to handle their money. But many defined benefit plans don t allow lump-sum payments. Instead, they require retirees to annuitize their benefits. When annuitized, the pensions convert to a guaranteed monthly payment usually for the remainder of the retiree s life or for the remainder of the retiree s and his or her beneficiary s life.
Financial issues as retirement draws near/4 Joint-and-survivor annuities. By law, the only Scrutinize choices payout option traditional pensions are required to While the single-life annuity pays the highest monthly offer is a 50% joint-and-survivor annuity in which a benefit, most retirees first instinct is to select a joint retiree receives a certain amount each month for annuity because they want to protect their spouses, the remainder of his or her life, and the spouse, especially when the spouses don t have their own after the retiree dies, receives half of that amount pension, says Sgroi. Still, Sgroi recommends that (50%) for the remainder of his or her life. people carefully review their options with their adviser before making a decision. If the reduction Some plans choose to offer more options. For in the monthly benefit, from the single-life to the example, some plans offer a 100% joint-and-survivor joint annuity is too great, someone might do better annuity in which the monthly payment to the spouse by taking the single-life annuity and using the isn t reduced after the retiree dies. This option difference to buy a life insurance policy, he says. provides more money for the spouse after the retiree dies, but the monthly payment with the 100% option A man retiring, for example, might have the option of may be less because it offers the spouse a greater taking a single-life annuity that would pay a $4,000 guarantee. The 50% option, with a lower amount monthly benefit for the remainder of his life. The 50% guaranteed for the spouse, could offer the retiree joint-and-survivor available from his plan might offer a a higher monthly payment while the retiree is alive $3,000 monthly payment while he was alive and a and collecting benefits. $1,500 monthly payment to his wife after he died. Single-life annuities. Some plans also offer In that case, Sgroi might recommend the retiree take single-life annuities. With these, the monthly benefit the single-life annuity of $4,000 per month, live on is guaranteed for the retiree s lifetime only. With a $3,000 per month, and use $1,000 a month to pay shorter guarantee period, this option usually provides the premiums for a substantial life insurance policy. retirees with the highest monthly payment. But, with a As he explains, That way the spouse will be protected single-life annuity, the spouse won t collect any when the retiree dies. The spouse won t get any more benefit after the retiree dies. money from the pension, but the spouse will receive the proceeds of the life insurance policy. The spouse Periods certain. Both single-life and joint annuities could invest the tax-free proceeds in mutual funds. are sometimes offered with a period certain, which If it were a substantial enough policy, she could guarantees payments for a specified number of years. withdraw from her investment an amount that would A retiree might select a joint annuity with a 10-year give her income each year equal to the amount she period certain, for example. If both the retiree and would have received from the joint annuity. spouse died within six years, benefit payments would continue for another four years to a beneficiary, such as a child.
Financial issues as retirement draws near/5 Living off the investments might even enable the spouse to increase her monthly withdrawals each year to keep pace with inflation. With the annuitized benefits, that s not possible because the monthly payment stays the same throughout the retiree s and spouse s lifetimes, notes Sgroi. If the money invested from the policy grows faster than the spouse s annual withdrawal rate, the principal would continue to grow. There could then be something to leave for the couple s children. When the spouse dies with a joint annuity that doesn t have a period certain, benefits stop and the children don t receive anything. But this strategy taking the single-life annuity and buying insurance is worth considering, notes Sgroi, only when there s a substantial difference in the monthly benefits paid under the single-life and joint-annuity options. It s also a strategy available only to those who are healthy. Those with a major physical illness may not be able to buy life insurance, or a policy could be prohibitively expensive. Investments in mutual funds and variable annuities will fluctuate, and your investment, when redeemed, may be worth more or less than its original cost. Past performance is no guarantee of future results. This material is not intended to replace the advice of a qualified attorney, tax adviser, investment professional, or insurance agent. Before making any financial commitment regarding the issues discussed here, consult with the appropriate professional. The testimonials provided by the investors in this article may not be representative of the experience of other clients. These testimonials are not indicative of the future performance or success of any MFS mutual fund. Know your options Discovering all the money issues you ll have to consider as retirement nears may feel overwhelming. But these are issues investment professionals deal with routinely. With my long-term clients, whose needs I know well, I can recommend a payout option after about 15 minutes of number crunching, says Sgroi. In fact, he adds, many of the choices retirees face can be reduced to simple math. When clients see the numbers, their choices often become obvious. If you chart the right course with your advisers, then you may be able to step onto the long-sought-after shores of retirement with grace and ease. Resources for further information Holzer, Bambi and Floyd, Elaine. Set for Life: Financial Peace for People over 50. John Wiley & Sons, 1999, 240 p., $24.95. Malaspina, Margaret A. Don t Die Broke: How to Turn Your Retirement Savings into Lasting Income. Bloomberg Press, 1999, 284 pages, $21.95. Contact your investment professional for more information or to construct a personalized Heritage Planning SM Profile to help your parents, your children, or yourself. 2002 MFS Investment Management. MFS investment products are offered through MFS Fund Distributors, Inc., 500 Boylston Street, Boston, MA 02116. H1080502.pdf