Arizona University System Pre-Retiree White Paper 2013

Arizona University System Pre-Retiree White Paper 2013 By Eric Souders Accredited Wealth Management Advisor

When are you ready to retire? There are many questions to consider before making the leap into retirement; What will you do with all that free time? What passions have you put on hold while developing your successful career? What places would you like to visit? What experiences would you like to have? Who would you like to spend more time with? Then come the practical questions; do I have enough money saved to live a comfortable life in retirement? Will I be able to afford the health insurance that I need? How long will I live and will I have enough money to get me to my last day? There are also the pragmatic questions that people do not know to ask; how do I access my retirement money? How do I get my accumulated sick leave? How much do I want to spend and how much will I be able to spend in retirement? What will inflation do to my spending? How do I sign up for Medicare? Will Medicare pay for everything I need? When should I take social security? How will my investing affect my spending? How do my loved ones access my money after I die? Helping University Employees Retire Ascendant Financial Solutions has been working with university faculty and staff for over 20 years and during those years we have helped numerous individuals and families transition to successful retirements. There are many considerations, options, and hurdles that accompany a successful transition. The intention of this white paper is to identify the most common complexities and considerations that someone approaching retirement must face. The solutions to each of the issues depend solely on an individual s situation and desires and must be carefully calculated and planned. Expenses During Retirement For most people, basic living expenses change very little in retirement but over time increase due to inflation and increased medical expenses. There is no question that we are living longer. The current life expectancy is at 78.7 years in the US. According to the CDC s 2011 National Vital Statistics Report, mortality rates for those over 65 are decreasing at roughly 1% per year. At this rate, for every year you are alive you can add 1/10 of a year to your life expectancy.

Inflation Inflation is a powerful factor in our futures, and it is one of the most difficult pin down. Different kinds of expenses become more expensive at different rates over time. The Consumer Price Index is the Department of Labor s measure of inflation. This is the index on which Cost Of Living Adjustments (COLA) are made for Social Security and other government sponsored pensions. This index places a great amount of weight on static contracts such as mortgages and car payments which inherently creates a lower measurement of short term change in prices. http://www.bls.gov/cpi/ The American Institute for Economic Research Everyday Price Index is an index that uses the same categories of CPI, but excludes the static contractual prices. The EPI more accurately reflects the day to day price fluctuations we are actually experiencing on our basic living expenses. https://www.aier.org/article/7557-epi-reflects-basic-economic-change. When comparing the two indexes over the last 10 years the CPI has observed inflation at 2.2% per year while the EPI has observed inflation at 3% per year. For 2011 alone the CPI showed a 3.1% inflationary increase while the EPI recorded an annual inflation rate of 8%. According to the CPI, living expenses of $40,000 for example increased by $1280, while the EPI recorded a changed of $3200. It is important to know that Social Security Benefits are adjusted for inflation according the CPI numbers. http://www.ssa.gov/cola/2013/factsheet.htm Health Insurance To begin the Original Medicare enrollment process one must contact Medicare three months before one s 65 th birthday or within 8 months of retirement if still working. Missing this enrollment window will increase rates by up to 10% per year of delay. https://mymedicare.gov/ o Medicare Part A generally covers some of the costs for facility and nursing care, but there are significant limitations and co-pays that must be understood. The following types of care are covered under Part A: Hospital care Skilled nursing facility care up to 100 days. Hospice Some home health services o Medicare Part B covers medically necessary services and preventive services with limitations that must be understood. The following services are covered under part B: Clinical research Ambulance services Durable medical equipment Mental health Second opinions for surgery Limited outpatient prescription drugs

o o Medicare Part C, the Medicare advantage plan, is an alternative to Original Medicare. Private insurers contracted with Medicare must offer all benefits provided by Medicare parts A and B. Price comparisons for plan providers in your area can be found at http://www.ehealthmedicare.com/find-coverage/ Medicare Part D adds drug coverage to Medicare plans. Each plan has its own its own list of drugs. One must select the plan that covers the prescriptions one is taking. Supplemental Policies or Medigap Policies may pay for health care costs not covered by Original Medicare such as copayments, coinsurance, and deductibles. One must sign up for a supplemental policy within six months of enrolling in Part B. This period gives one the guaranteed right to buy any available Medigap policy regardless of health status. If this period is missed, insurance companies may base rates on health status or deny coverage altogether. o AARP offers Medicare Supplemental insurance through United Health care. Plan F is the most comprehensive plan and costs approximately $1700 a year for an individual. https://www.golong.com/find-a-plan.html o Currently Arizona Board of Regents offers to all university retirees a group health insurance policy for those on Medicare through Blue Cross Blue Shield. This is an extension of the group policy through the university system and not a Medigap or Medicare Advantage plan. This policy takes second position to Original Medicare. In 2012 the price for an individual was $6516 a year. https://hr.nau.edu/node/10106 Long term care planning is a key part of a successful retirement. o When one is not able to clean, dress or feed oneself, someone will be taking care of those acts of daily living. Who that person is will depend on one s planning and resources. o A recent survey by Genworth showed that people over the age of 65 have a 70% chance of needing long term care. o A study by Metlife found that elder-care costs are increasing by 4-8%/year depending on the services provided. http://www.metlife.com/assets/cao/mmi/publications/studies/2011/mmi-marketsurvey-nursing-home-assisted-living-adult-day-services-costs.pdf o Currently the average cost for a home health aide in Arizona working four hours a day is $42,340/yr. http://www.disabled-world.com/disability/caregivers/home-care-costs.php o Currently the average cost for an assisted living facility in Arizona is $37,200/year. http://assistedlivingtoday.com/p/assisted-living/ o Currently the average cost of a private room in a nursing home facility in Arizona is $82,308/year. http://assistedlivingtoday.com/p/assisted-living/ o For eligibility in the state Medicaid program, Arizona Long Term Care System (ALTCS), one must have less than $2000 in assets and a gross income of not more than $25,128 for an individual. There is a five year look back period for assets that will be considered eligible as assets preventing ones enrollment. http://www.ltcfeds.com/documents/files/naic_shoppers_guide.pdf

Social Security Income Currently two people are paying into the system for every one retiree. This is not a sustainable system and will see some changes in the future, most likely in the way the benefits are taxed. Current taxation of SS benefits are as follows: o File a joint return with income more than $44,000 and 85% of Social Security income is taxable. File a joint return with income between $32,000 and $44,000 and up to 50% of the Social Security benefit may be taxable. o File a single return with income more than $34,000 and 85% of Social Security income is taxable. File a single return with income between $25,000 and $34,000 and up to 50% of Social Security income is taxable. Due to our expanding life expectancies, the Full Retirement Age (FRA) for benefits has been creeping upward for years. Your birth year determines your FRA so plan accordingly. o 1943-1954 = 66 o 1955 = 66 and 2 months o 1956 = 66 and 4 months o 1957 = 66 and 6 months o 1958 = 66 and 8 months o 1959 =66 and 10 months o 1960+= 67 One can file as early as age 62, however doing so will permanently reduce the benefit by a maximum of 25%. Upon reaching Full Retirement Age one can opt to file and suspend. This has the result of increasing the benefit by 8% each year that it is suspended until age 70. A spouse has the option of choosing between his or her own benefit or the spousal benefit which is 50% of the spouses FRA benefit. A surviving spouse is entitled to 100% of the higher of either their own or their spouses benefit. More information on social security can be found at: http://www.ssa.gov Optional Retirement Plan Phased Retirement The ORP Phased Retirement program is currently available for those over the age of 62 who are vested in the ORP Plan Phased Retirement allows for a lower work load down to 50% FTE for up to three years. Contributions to the ORP will reflect the salary reduction. http://hr.nau.edu/benefits/phased_retirement According to the plan, unlimited access to ORP retirement accounts is available upon entering the phased retirement program.

Retiree Accumulated Sick Leave (RASL) Employees who have accumulated more than 500 hours of sick leave will be eligible for the RASL pay out of up to $30,000 spread over three annual lump sum payments. Eligibility begins once a termination date is established. http://www.gao.az.gov/rasl/ A systematic withdrawal from an ORP account must be initiated and maintained for the duration of the RASL payout. RASL pay outs are taxable. o The university payroll system will assume that the payout is a payroll check and calculate withholdings based on your W-4 information while working. A $10,000 check will be taxed as if your annual income would be $260,000, thereby taxing it much more than your effective tax rate. o Submitting a new W-4 each calendar year that shows you as exempt from payroll withholdings will allow you to collect the total payout now and pay the correct amount of taxes for it when you file. Required Minimum Distributions The year one turns 70.5, one must begin taking Required Minimum Distributions from all pretax saving plans (ORP, 403(b) supplemental savings accounts, and IRAs) per IRS rules. The first year s distribution rate is 3.65% of the prior December 31 balance. This distribution rate increases by approximately.01% each year. http://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf If one is still working at age 70.5, any account associated with the university of employment will be exempt from the RMD requirements. Penalties for missing a Required Minimum Distribution are 50% of the amount not distributed. http://www.irs.gov/retirement-plans/plan-participant,-employee/retirement-topics--- Required-Minimum-Distributions-(RMDs) Accessing Money in ORP and Supplemental Savings Accounts. ORP and Supplemental savings accounts are sponsored by the university of employment. As the money is inside the university s plan there are certain processes one must utilize in order to access the money. The university system places no restrictions on how much can be accessed. The money can be taken in lump sums or systematic withdrawals. o Any money in TIAA fixed annuity accounts will be restricted to a distribution rate of 10% per year even if rolling to an IRA. Insurance companies often encourage annuitization for a guaranteed lifetime income. In the process of annuitizing the company looks at one s life expectancy and according to actuary tables, will decide how much one will receive every month for as long as one is alive. These are irrevocable contracts.

o o The company risks the annuitant outliving their life expectancy The annuitant risks Loss of assets to beneficiaries if life expectancy is not met Inflation is typically not factored into annuity payments Fixed incomes do not allow for financial flexibility In order to access ORP or 403(b) money one must o 1: Request the proper distribution paperwork from the account carrier. o 2: Request verification from a university human resources plan administrator of termination by signing the carrier distribution forms. o 3: Send forms to the account carrier for processing. The above process must be completed for each lump sum withdrawal or change of the systematic withdrawal amount. It is not uncommon that the forms get lost at the carrier or Human Resources. Often the forms will be returned because they have been improperly completed or forms have changed. This process can take three to six weeks before a check will arrive. Before 1986 the ORP plan received after tax contributions and held the earnings tax deferred. The after tax contributions can be withdrawn separately and without taxation. Beneficiaries All retirement accounts must have beneficiaries named in order for assets to transfer free of probate after one s death. Required Minimum Distribution rules will apply to beneficiaries o Based on the beneficiaries age if the owner dies before reaching age 70.5 o Based on the owner s age if the owner dies after age 70.5 and RMD has begun The spouse is generally the primary beneficiary; the first one to receive the benefit if still alive at the owners death. The contingent beneficiary will receive the benefits if the primary beneficiary is deceased. Any individual, organization, or trust can be named as the primary or contingent beneficiary. o A trust or organization will be required to pay taxes on the amount received in the year of the owner s death, where an individual may defer the taxes until they withdraw the money. Estate Planning A properly written will o Leaves your property to your chosen beneficiaries o Names a guardian to care for your minor child when you can not o Names someone to manage property you leave to your minor children o Names the person with the authority to carry out the terms of your will

Will substitute is any property that has a clearly defined recipient through such designations as contract beneficiaries (retirement accounts and life insurance policies as explained above), joint ownership with right of survivorship, transfer on death, marital agreements, and trusts that have been funded prior to death. o Community property states such as Arizona specify that property acquired during the marriage belongs one half to each spouse no matter whose name is on the title. Probate is the process of administering a decedent s property that is not held in a recognized will substitute form at death. If there is a will, it is validated and interpreted by a judge. The process of probate court to transfer property to surviving heirs can be an expensive process. Trusts are a form of property ownership by a trustee for the benefit of one or more beneficiaries. o Trusts eliminate the need for property to pass through probate since it is an independent and separate legal entity. o Trusts can be used to manage assets for legally, mentally or financially incapacitated beneficiaries, accumulate income for later distribution to beneficiaries, create life time income or lump sum distributions for beneficiaries, and provide income, gift and estate tax savings. Durable Power of Attorney allows one person, the agent, to act on the behalf of another, the principal, during incapacity. o A Springing Durable Power of Attorney authorizes the designated agent to act on behalf of an individual at the onset of incapacitation, and ceases power at death. o A Durable Power of Attorney for Health Care authorizes another person to make healthcare decisions on one s behalf when the principal is unable to give informed consent. o A Living Will allows a person to state in advance what life-sustaining measures are to be used in the event that that person is unable to give informed consent. Managing Savings for the Next 20 to 30 or More Years With interest rates currently at a 40 year low, rising interest rates in the future may change the pattern of stability of fixed income investments. Increasing market volatility and increasing correlations between low and high risk asset classes may change the risk/return profiles of standard portfolio allocations. Global economic recovery and growth may be hampered by the large debt burdens of the US and other developed nations. Changing demographics may affect markets over time both negatively and positively. Geopolitical instability in oil rich nations may greatly affect inflation.

Case Study Pat and Charlie, both age 66, have reached their Social Security full retirement age after working long and satisfying careers at a university in Arizona. In their final year of work, their salaries were $70,000 each, giving them a net spendable income of about $98,000 a year. They methodically put an average of $872 a month into pretax savings for 30 years and achieved an annual average of return of 8%. They paid off their mortgage the year before they retired and have decided to post pone their Social Security income until age 70 for the maximum benefit. They purchased long term care insurance several years ago. They have signed up for Original Medicare parts A, B and D, and have purchased a Medigap policy to cover what Medicare will not. Longevity runs in both of their families so they expect to live until their mid 90 s. Assumptions Both age 66 Although we do not know what will really happen in anyone s life, we will plan for both living until age 96. Nursing home care will be required for one at age 93 for three years. $1,300,000, in pretax savings with a post retirement annual average growth rate of 6% Combined Social Security Income at age 70 estimate: $60,000 Average annual inflation: 5% Tax brackets will remain at 2013 levels for 30 years. $40,000 a year in living expenses includes: food, utilities, transportation, property taxes, property insurance, travel and entertainment. Additional annual healthcare expenses: o Original Medicare for two: $13,200 o Medicare plan D for two: $2400 o Medigap Policy for two: $3400 o Long Term Care insurance for two: $5000/yr Total living expenses: $64,000 Estimated State and Federal taxes: $11,200 Estimated annual spending: $75,000 Retirement year Spending Goal Withdrawal Social security Taxes on withdrawal LTC Benefits End of year savings balance 1 $63,992 $63,992 0 $11,227 $1,286,408 5 $80,290 $39,480 $54,384 $6967 $1,216,630 10 $101,092 $49,335 $63,046 $8,706 $1,367,499 15 $127,640 $60,091 $73,088 $10,604 $1,430,400 20 $161,523 $76,795 $84,728 $12,505 $1,389,176 25 $204,768 $108,586 98,224 $13,923 $1,181,375 27* $716,271 $254,098 $104,205 $19,741 $109,954 $1,112,885 28 $752,085 $234,022 $107,332 $41,298 $150,317 $803,285 29 $789,689 $407,661 $110,551 $71,940 $271,476 $554,363 *This is the year one goes into a nursing home.

This is a worst and best case scenario. Worst in that average inflation is high, and they live well into their 90s. It is best case in that they are prepared with savings, a modest lifestyle and long term care insurance which only one of them needs. They have paid in approximately $165,000 in LTC insurance premiums, and received over $500,000 in benefits. At the end of their lives there is a small legacy of savings, the house and other tangible assets they might own at the time. This information is hypothetical and is meant as an illustration only. It is not indicative of specific return or yield on any particular investment. The performance data quoted represents past performance, the investment return and principal value of an investment will fluctuate so that an investor s share, when redeemed may be worth more or less than their original cost Conclusion For future retirees, every year presents different issues to solve. Markets, taxation, IRS rules, university policy and personal priorities will change over time. With one opportunity to retire, the decisions made at retirement can affect the lifestyle, the security and the confidence of the retiree and his or her surviving family for a very long time. We at Ascendant Financial Solutions want you to make informed and productive decisions for your future. With over 20 years of experience helping university employees through the retirement process and beyond, we make a significant and positive impact on the lives of our clients and their families. Call me, let s begin your transition from a successful career to a successful retirement. Eric Souders Accredited Wealth Management Advisor Ascendant Financial Solutions 809 W Riordan St 104 Flagstaff AZ 86001 928-774-9598 Disclosures: Please consult your tax or legal advisors before taking any action that may have tax consequences. Securities offered through Geneos Wealth Management, Inc. (Member FINRA/SIPC). Advisory Services offered through Geneos Wealth Management, Inc. and Ascendant Financial Solutions.