Category Archives: Retirement

Retirement

Rethinking Retirement

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Over the years, I’ve thought a lot about the idea of retirement. When I was in my early 20′s, I accepted the traditional American notion of it, basically without question. However, as I have grown older, and have personally witnessed the change and uncertainty that life brings, I have changed my thinking considerably.

The fact is, the idea of retirement is a fairly new one when considered in the context of human history. Before the early 1900′s, there was really no thought of “retirement” as we think of it today. The idea really took hold in 1935, with the passage of the Social Security Act. However, at that time, life expectancy was 62, while the age picked for retirement by the new law was 65, leaving few people living long enough to enjoy retirement bliss.

Now, things have changed considerably. With improved health care, people are living longer. However, although many of these people have ostensibly worked all their lives to save for retirement, many of them do not have a large enough nest egg stashed away to last the thirty or forty years they plan to live in retirement. This has led to a greater number of people re-entering the workforce after age 65. (Please see the images below.)

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I recently read an article on the Forbes website written by Carolyn McClanahan that I believe gives great advice related to the idea of retirement. In the article, McClanahan gives two pieces of advice regarding retirement thinking: 1) Create a great life now; 2) Prepare for the uncertainty of the future.

The first point here is very important, I believe, because it can create a greater sense of happiness for people. Why spend the great majority of your life doing something you hate just to save for an uncertain future. If you do not love your work, then change, and do something that you do love, even if this means less money in the short-term. Doing this will most likely allow you to live and even earn longer, but enjoy the process as well.

The second point is equally important, because it takes into consideration the reality of life. The fact is, the only thing certain about the future is uncertainty, and this should be fully realized as part of the financial planning process. Learn to balance your “needs” versus your “wants.” This will allow you to save more toward an uncertain future. Additionally, it will point you toward personal growth and a balanced life, as you realize that the pursuit of material things alone does not lead to balance and fulfillment. However, a life filled with experiences with the people you care most about, while at the same time having your needs met, does lead to a balanced and fulfilled life.

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Tax Time!

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Well, it is that time of year when most folks are not only dealing with the last remnants of winter (hopefully!) and eagerly hoping for Spring, but also coping with the all-too-familiar obligation that comes every year, no matter what, in April: taxes. However, this time of year is certainly not all bad, as it may possibly offer an opportunity for some to put some of that tax refund to good use, in the form of an Individual Retirement Account (IRA).

For most people, there are two types of IRA’s to consider, the Traditional and the Roth. These two retirement vehicles are alike in some ways but different in others. Please take a look at the following chart from the IRS for a basic understanding of how the two accounts work:

 

Features Traditional IRA Roth IRA
Who can contribute? You can contribute if you (or your spouse if filing jointly) have taxable compensation but not after you are age 70½ or older. You can contribute at any age if you (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income is below certain amounts (see 2012 and 2013limits).
Are my contributions deductible? You can deduct your contributions if you qualify. Your contributions aren’t deductible.
How much can I contribute? The most you can contribute to all of your traditional and Roth IRAs is the smaller of:

  • for 2012, $5,000, or $6,000 if you’re age 50 or older by the end of the year ($5,500 or $6,500 for 2013); or
  • your taxable compensation for the year.
What is the deadline to make contributions? Your tax return filing deadline (not including extensions). For example, you have until April 15, 2013, to make your 2012 contribution.
When can I withdraw money? You can withdraw money anytime.
Do I have to take required minimum distributions? You must start taking distributions by April 1 following the year in which you turn age 70½ and by December 31 of later years. Not required if you are the original owner.
Are my withdrawals and distributions taxable? Any deductible contributions and earnings you withdraw or that are distributed from your traditional IRA are taxable. Also, if you are under age 59 ½ you may have to pay an additional 10% tax for early withdrawals unless you qualify for an exception. None if it’s a qualified distribution (or a withdrawal that is a qualified distribution). Otherwise, part of the distribution or withdrawal may be taxable. If you are under age 59 ½, you may also have to pay an additional 10% tax for early withdrawals unless you qualify for an exception.

 

The contribution limits to a Traditional or Roth IRA in 2014 are $5,500. However, People over the age of 50 can contribute another $1,000 to that amount as a “catch up” measure, bringing the total contribution limit for those folks to $6,500.

The great benefit with an IRA is that the money deposited is able to grow tax-deferred, which can allow for greater compounding over time than if it were taxed as it would be in a taxable account. The following chart is from First Investors, and shows how this can be a benefit to the investor over time:

This chart below compares a deductible Traditional IRA investment of $3,000 made at the beginning of each year with an annual non-deductible investment of $3,000 made into a taxable investment account at the beginning of each year. For both accounts, assume a hypothetical growth rate of 8 percent and a 28 percent federal tax rate.

Comparison of Traditional IRA to an annual taxable investment

More about the assumptions:

  • Your actual tax rate on the withdrawal of gains from a tax-deferred account could be more or less than 28%, depending upon the applicable tax rates that are then in effect, and whether you make your withdrawal in a lump sum or over time. Your effective tax rate on gains from a taxable account could also be more or less than 28%, depending upon your adjusted gross income and the nature of the gains. Currently, qualifying dividend income and long-term gains form a taxable account are taxed at an individual’s capital gains rate, which is 15% or lower. Capital gains taxation is not available for gains taken from a tax-deferred account. The differences between the tax-deferred and taxable returns shown in the example would therefore be smaller if (a) your effective federal tax rate on the gains from a taxable account were lower than 28% or (b) your federal tax rate on a withdrawal from a tax-deferred account were greater than 28%.
  • The hypothetical 8% investment return is compounded annually and assumes reinvestment of dividends and capital gains
  • The value of the Traditional IRA after a lump sum withdrawal taxed at 28% is $33,794 if taken after 10 years, $106,753 if taken after 20 years, and $264,267 if taken after 30 years.

So, as you consider what to do with discretionary funds during this time of the year, do consider investing some of it, possibly into an IRA. If you require help in understanding the investment maze, consult a financial professional, as a good one may prove invaluable in helping you put money to use for the long-term.