Where Do You Start?

Providing for a comfortable retirement requires comprehensive planning, taking into account cash flow, income taxes, available assets, retirement plan distributions, and preferred lifestyle. The goal is to match expected expenditures to projected retirement income cash flow and provide for contingencies (such as extended illness, rapid inflation, and investment losses).

Most individuals share similar concerns when they consider their retirement years. These concerns include having enough income to live comfortably, providing security for a spouse or children, minimizing income and transfer taxes, accounting for inflation, and outliving assets.

Take a serious look ahead to determine how much income you will need to maintain your current lifestyle when you retire. When you estimate how much income you will need, take into account inflation, future tax rates, and the investment returns on your retirement savings. Most retirement planning advisers say that you will need 60% to 80% of your pre-retirement income to maintain your current standard of living


Determining Your Retirement Income Needs

By completing the Calculating future income needs worksheet below, you can assess your financial position in terms of future retirement income. This assessment will help you determine a realistic investment goal. To evaluate future income sources, start with Social Security. The Social Security Administration website has a retirement benefit estimator that can determine your maximum benefit at your normal retirement age (generally age 66–68) and your maximum benefit at age 70.

Individual Retirement Planning
Individual Retirement Planning

Next, consider retirement distributions you can expect from your company’s qualified retirement plan (See Retirement savings through an employer’s plan, below). Talk to your HR person or plan administrator to get an estimate of future distributions at different retirement ages.

Year Max Salary Employer Match Highly Compensated Employee

Note: If your annual income from your employer exceeds the amounts listed in above table for years indicated, the compensation over those amounts is not included when your employer contributes on your behalf to your company’s qualified retirement plan. As an example, if your employer matches up to 3% of income, the match is capped at 3% of the maximum compensation listed above for the years indicated.

If you are a highly compensated employee making more that the amounts listed above for a highely compensated employee, you may be able to negotiate deferred compensation in a nonqualified plan to increase your retirement savings (see Nonqualified deferred compensation, below).

If you are a self-employed individual who is not a partner in a partnership, you can set up your own SEP, SIMPLE, or qualified retirement plan .

Beyond these types of retirement income, you will have to develop resources on your own through other savings and investment strategies. Most people have to provide for at least 40% of their retirement income from other sources.

Other retirement instruments, such as annuities, enable tax-deferred accumulation of earnings but without the contribution restrictions of an individual retirement account. An annuity allows you to choose guaranteed life income payments or payments for a predetermined period of time, usually beginning at retirement.

A comprehensive investment program is an integral part of retirement planning, with periodic adjustment of strategies to fit your objectives as you progress toward retirement.Nugent & Associates can help you determine your retirement needs and develop a feasible retirement savings plan.

Should You Have an Individual Retirement Account?

Traditional individual retirement accounts (IRAs) were first introduced to encourage taxpayers to save for retirement even if their employers did not offer retirement savings plans.

Many working Americans qualify for at least a partial income tax deduction for retirement savings. You may make a deductible IRA contribution, provided neither you nor your spouse is an active participant in an employer-sponsored retirement plan and you are younger than age 70½ at the end of the year.

IRA contributions are taxable as ordinary income on distribution. Distributions before age 59½ may be subject to an early withdrawal penalty. At age 70½, you would have to start receiving minimum required distributions from the IRA.

Individual Retirement Planning

Roth IRAs

A Roth IRA is an IRA with a special tax structure. Contributions to a Roth IRA are not deductible, but the eventual distributions are not included in income (and thus earnings are distributed tax-free). In addition, a Roth IRA is not subject to the required minimum distribution requirements that apply to an IRA, so the amounts can be left in the Roth IRA until needed. Special penalties apply to distributions from a Roth IRA before the Roth IRA has been in existence for five years and before you reach age 59½. Married individuals and single taxpayers, regardless of the adjusted gross income (AGI) are allowed to convert a traditional IRA into a Roth IRA. On conversion, all taxable amounts in all of the individual’s aggregate IRAs are used to determine the taxable and nontaxable portions of the conversion amount.

Example A: Sarah has a nondeductible traditional IRA with $10,000 of contributions and $2,000 of earnings (and has no other IRAs). She converts the IRA to a Roth IRA. The $10,000 of after-tax contributions is treated as basis and is not taxed again on conversion, but the $2,000 of earnings is taxable as ordinary income when it is contributed to the Roth IRA.

Example B: Michael has two IRAs, one a non-deductible traditional IRA with $10,000 of contributions and $2,000 of earnings, and one an old rollover IRA with $20,000 that has never been taxed (such as from a 401(k) rollover). Michael wants to convert the $12,000 traditional IRA to a Roth IRA. On conversion, he has an aggregate IRA balance of $32,000 ($12,000 plus $20,000) and a total nondeductible balance of $10,000.

Michael calculates the nontaxable part of the conversion as ($10,000/$32,000) × $12,000, or $3,750. The remaining $8,250 is taxable income on conversion. If Michael rolls his old rollover IRA into his current employer’s 401(k) plan, and later converts the remaining IRA to a Roth IRA, he would include in income only the $2,000 of earnings above the after-tax contributions in income.

Roth(k) contributions

A section 401(k) plan can be designed to allow plan participants to elect to defer amounts as pre-tax contributions (normal 401(k) elective contributions) or as post-tax Roth contributions. Post-tax Roth contributions (sometimes called Roth(k) contributions) are treated the same way as the pre-tax contributions (subject to FICA on contributions and subject to the same dollar restrictions). An employee can choose to contribute partly pre-tax and partly through Roth(k) contributions. Between the pre-tax contributions and the post-tax Roth(k) contributions, the employee cannot contribute more than $19,000 (or $25,000 if the participant is at least age 50). Your employer can match your elective contributions, whether they are 401(k) elective contributions or Roth(k) contributions.

Like Roth IRA contributions, Roth(k) contributions are taxable as made, but the accrued earnings on the contributions are not taxable on distribution, so long as the Roth rules are satisfied at the time of distribution. Thus, the first Roth(k) contribution starts the 5-year Roth holding period. The amounts in a Roth(k) account can be rolled over to a Roth IRA if all of the requirements are satisfied.

In-plan Roth conversions

Some plans now also allow “conversion” of pre-tax contributions (such as 401(k) elective contributions) into Roth accounts within the same plan. This is a fairly new feature. On conversion, the pre-tax amounts are not distributed to the individual and remain in the same plan, but the amounts converted are subject to ordinary tax in the year of the conversion. Once in the Roth account, the earnings accrue under the Roth rules and can eventually be rolled over to a Roth IRA if all of the Roth rules are satisfied at the time of distribution. As with other Roth accounts, there is a 5-year holding period on converted amounts. There is no withholding within the plan on these conversions, so you would have to be prepared to pay the tax on the amount converted from other sources of cash

Other IRA and Roth IRA issues

Contributions to an IRA in excess of the limits are subject to an annual 6% penalty. Also, money generally cannot be withdrawn from an IRA without a 10% penalty tax—except in substantially equal payments over your life expectancy (or the joint life expectancy of you and a designated beneficiary) or after you are at least age 59½, disabled, or deceased.

Retirement Savings Through an Employer’s Plan

Many employers have established 401(k) plans (or 403(b) plans for certain tax-exempt organizations—because 401(k) and 403(b) plans have similar rules, they will be discussed together). If you are enrolled in a 401(k) or 403(b) plan, you can reduce your salary by making pre-tax plan contributions (which are still subject to Social Security taxes)

Some 401(k)/403(b) plans permit Roth(k) contributions as well as pre-tax contributions. Roth(k) contributions are includible in taxable income, but distributions are not. Your employer may match a portion of your pre-tax or Roth(k) contributions.

Year Limit Catchup for 50yo +

The amount you can contribute to a 401(k) or 403(b) plan in years indicated above is limited, but may be less depending on participation in the plan by other employees. If you inadvertently elect to defer more than a total of allowed in the respective year to all 401(k) and 403(b) plans in which you participate, you must notify your employer and have excess amounts returned to you by April 15, {}. You will owe income tax on any excess deferrals and on income earned on the funds. No penalty will apply to this amount. However, if excess deferrals are not paid to you by April 15, {}, you must include the excess deferral as income both in the year of contribution and in the year of distribution. Additionally, the 10% early withdrawal penalty applies to the amount distributed from the plan.

Some plans allow additional after-tax contributions. These funds accumulate tax-deferred, and you pay tax only on the earnings when you receive distributions at retirement or later.

Nonqualified Deferred Compensation

If you are a highly compensated employee, your employer may provide additional retirement savings for you by establishing a nonqualified deferred compensation plan. Such plans have no contribution limits, and employers generally may use their discretion as to who will participate. Because the amounts are contributed pre-tax, you get the immediate increase in savings as compared to after-tax savings, because the amount you would have paid as tax is available for savings and generates returns throughout the saving period. As with all deferred compensation (other than Roth IRAs and Roth 401(k) accounts), you receive compensation (taxed at ordinary income rates) on amounts deferred once the plan provides for distributions. Your employer cannot deduct the promised compensation until the year in which you include the amount as income.

Remember, however, that you are a general creditor of the corporation with regard to this deferred compensation; therefore, in bankruptcy, the corporation’s secured creditors will be paid before you. In many cases, there is nothing left with which to pay the nonqualified deferred compensation. Another disadvantage of a nonqualified deferred compensation plan is that distributions will be taxed as ordinary income

Planning for Retirement Distributions

Retirement planning involves determining future needs and how your resources will satisfy those needs. As discussed above, penalty taxes apply to early distributions, late distributions, excess distributions, and distributions of less than the required minimums. You also must consider the effect penalties will have on undistributed retirement plan balances that are part of your estate. To avoid incurring these penalties you should review your retirement plans to determine the optimum method of taking distributions.

The most advantageous way to receive retirement distributions from an employer’s plan or an IRA depends not only on penalty taxes and your need for income, but also on the tax treatment of the distribution.

Minimum Annual Distributions

You generally are required to take minimum annual distributions from most retirement plans no later than April 1 of the year following the year in which you reach age 70½ or once you retire, if you are not at least a 5% owner. Distributions for subsequent years must be made by December 31 of each year. For example, if you reach age 70½ in {}, you must begin receiving distributions by April 1, {}. However, delaying the required {} distribution until {} will force you to include in your {} taxable income required distributions for both {} and {}.

The minimum annual distribution amounts are determined by calculating the amount necessary to distribute the retirement plan interest over your life, or over your life and that of a designated beneficiary. The minimum annual distribution rules allow you to avoid depletion of your retirement savings through annual recalculation of your life expectancy (and the life expectancy of your designated beneficiary if that person is your spouse).

If minimum distributions are required, the amounts must be taken out timely. Otherwise, you will be subject to a penalty totaling half the amount you should have withdrawn.

Taxation of distributions

A 10% penalty tax generally applies if you receive tax-deferred retirement savings from your 401(k) or broader pension plan or your IRA before you reach age 59½, die, or become disabled. The penalty does not apply if you roll over amounts to an IRA or another qualified plan. However, distributions in substantially equal payments over your life expectancy (or the joint lives of you and your beneficiary) are also exempt from the penalty. If the payment schedule is modified for reasons other than death or disability, the tax will be applied retroactively if you are not age 59½ and have not been receiving payments for at least five years.

Several techniques are available to defer or reduce tax on distributions:

  • You can defer taxes on a lump-sum distribution and certain partial distributions by rolling the distribution amounts into an IRA or, when permitted, to another qualified plan. The plan administrator can usually do a “direct rollover” to another plan or IRA. Otherwise, you need to move the money within 60 days (see Withholding requirement below)
  • If you receive your distributions as payments over a life annuity payment, you will pay tax in the year in which you receive each payment.

Withholding Requirement

If you do not elect to have your qualified plan (401(k), 403(b) or deferred benefit plan) distribution transferred or rolled over directly to an IRA or another qualified plan, you will receive only 80% of your distribution. The remaining 20% will be withheld to pay income taxes. This is the case even if you plan to roll the funds into an IRA within 60 days of receiving the distribution. Of course, you will not owe tax on the amount you roll over. But if you only receive 80% of your distribution and only roll over that 80%, you will be taxed on the 20% withheld. Also remember that any portion of the distribution not rolled over may be subject to the 10% penalty on early distributions in addition to ordinary income taxes, if you are under age 59½ and do not meet certain other exceptions.

Social Security Benefits

If you are under your normal retirement age (between age 65 and age 67, depending on your birth year) and are still employed but are taking Social Security benefits, your Social Security benefits will be reduced if your current earnings exceed a prescribed limit.

You should review the Social Security Administration (SSA) report on earnings and confirm that it is a correct record of your earnings.

To correct an error, you must notify the SSA within three years, three months, and 15 days after you discover the discrepancy.

You can check the Social Security website (www.ssa.gov) to obtain this information and model payments at various ages.

At Nugent & Associates, we're not just number crunchers. We bring over 3 decades of invaluable certified public accounting and tax expertise to your company – serving as business and financial strategists who can offer such services as tax and financial planning, investment advice, diligent financial records, and help with estate planning.

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Take advantage of our FREE and no obligation business checkup.

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At Nugent & Associates, we're not just number crunchers. Our people bring decades of invaluable certified public accounting and financial and tax expertise to you – offering tax and financial strategies to individuals such as yourself. If you have any questions or concerns about your own tax, financial or investment matters, please do not hesitate to contact us.

Experienced tax and financial experts are not just for the super rich. At a reasonable fee you too can maximize your wealth and receive professional guidance for retirement, and/or any tax issues you may be facing, no matter your situation, with a tax and financial expert as your consultant.

Contact Nugent & Associates today. We don't charge for phone calls. You may just find you found an ally in your quest to have a great financial future.

After all, at Nugent & Associates, we succeed when you succeed!



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