Jan 12, 2016
Major Retirement Income Sources
1. Social Security
2. Employer-sponsored retirement plans
3. Personal savings
4. Work (wage income)
Income Sources: High-Income Retiree
0
10000
20000
30000
40000
50000
60000
70000
Work SS andRetirement
Plans
InvestmentIncome
$ Amount
Average Income: $116,596Source: Bureau of Labor Statistics, 2001-2002
Income Sources: Average-Income Retiree
02000400060008000
1000012000140001600018000
Work SS andRetirement
Plans
InvestmentIncome
$Amount
Average Income: $28,638Source: Bureau of Labor Statistics
Source #1: Optimizing Social Security
• Adjusted annually for inflation – Based on the lesser of the CPI or average wage
index
• Lifetime guaranteed income benefit– Can be viewed as a government bond position in
the retiree’s portfolio
• Personal earnings benefit statement
• Main decision: when to start
The Goldin’s SS Benefit
AgeAnnual Benefit
Amount
65 (normal retirement age)
$9,750
62 (early retirement) $7,800
64 (early retirement) $9,100
70 (delayed retirement) $12,188
When to Start SS Benefits
• Health and longevity– Breakeven for early
benefits = 15 years
• Need for cash to meet budget needs now– Can always start
whenever needed– Once begun, can’t
stop
• Survivor benefits• Employment
– may reduce SS benefits until FRA
• Potential taxation of SS benefits due to earnings
SS Breakeven Example
• Bob Brown: CPA, age 62• Can afford to retire or keep working • Father, 2 uncles, and grandfather died of
heart attack ~ 75• Wife has health problems that will worsen
What to do?? Take SS now or postpone?
Source #2: Employer-Sponsored Plans
• Defined benefit or pension plans
• Defined contribution plans
• Nonqualified employer plans
Defined Benefit Plans
• Benefit based on a formula
• Annuitization may be only distribution option
• Keeping track of plan benefits from the working years
Defined Contribution Plans
• Benefit based on contribution
• May be able to purchase an annuity, leave assets in the plan, or rollover to another plan/IRA
• Differences in public versus private sector plans
Non-Qualified Employer-Sponsored Plans
• aka Non-qualified deferred comp (NQDC)
• NQDC doesn’t meet tax and ERISA requirements for qualified plans
• Assets not protected by a trust
• Often used to recruit and retain executive level talent
Source #3: Personal Savings
• Annuities– Fixed– Variable
• IRAs– Traditional– Roth
• Home
• Other– Cash value life
insurance– Taxable investments– Business interests– Investment real
estate– Expected inheritance
Annuities
• Deferred for the accumulation years
• Immediate for the payout years
• Can eliminate longevity risk
• Both immediate and deferred annuities offer tax-deferred growth
• No step up in basis at death
Fixed & Variable Annuities
• Fixed may be subject to purchasing power risk– May offer COLA features
• Variable offers wide range of investment choices– Subject to market risk– But may keep up with inflation
Variable Annuity Guarantees
• Guaranteed minimum income benefit– Costs 30 to 75 basis points– 7 to 10 year waiting period
• Guaranteed minimum accumulation benefit– Costs 25 to 100 basis points
• Guaranteed minimum withdrawal benefit– Costs 30 to 40 basis points
Individual Retirement Accounts
• All provide tax-deferred growth• Wide variety of investment choices
– Subject to market risk
• Traditional IRA• Roth IRA offers tax-free income• Stretch IRA
– Passes IRA down several generations– Can maximize bequests
• No step up in basis for estate tax
Home
• Four ways to tap equity:– Home equity loan– Line of credit– Selling the home and downsizing– Reverse mortgage (RM)
Home Equity as Percent of Assets
Higher Income Retiree Average Retiree
Ages 65-74 Ages 65-74Home Equity43%Net
Financial Assets57%
Home Equity75%
Net Financial Assets
25%
Cash Value Life Insurance
• Policy loan
• Advantages– Relatively low interest rate– May not need to repay interest
• Disadvantages– Reduced death benefit– Potential policy collapse, triggering taxes– Loan interest not deductible
Taxable Savings and Investments
• Taxable account investments– Low turnover
funds– Long-term capital
gain stocks– High dividend
stocks– Tax-free income
• Tax-deferred accounts– High turnover
funds– Short-term capital
gain stocks– Bonds– REITs
Other Types of Personal Savings
• Business interests
• Investment real estate
• Inheritances
4. Work in Retirement
• Ability to work• Availability of work
For retirees age 65 and over, work generates about 1/3 to 1/2 of total income for households with income of $40,000 or
more
Taxation of SS Benefits• Up to 85% of benefits may be taxable,
depending on total income
• Amount subject to income tax is the lesser of– ½ of the retiree’s SS benefits, or– ½ of the amount by which AGI + tax-exempt
interest + ½ of SS benefits exceed• $25,000 filing single• $32,000 married filing joint
Reduction of SS Benefits
• Over normal retirement age (NRA), no reduction in benefits for earnings
• Excess earnings test– Under NRA: $1 reduction for every $2 of
excess earnings– Year of NRA: $1 reduction for every $3 of
excess earnings
Annual Exempt AmountsYear Age 65-69 Under Age 65
1996 $12,500 $8,280
1997 $13,500 $8,640
1998 $14,500 $9,120
1999 $15,000 $9,600
Normal Retirement Age Under NRA
2000 $17,000 $10,080
2001 $25,000 $10,680
2002 $30,000 $11,280
2003 $30,720 $11,520
Social Security Reduction
Example #1: Dr. Smith, who partially retired in 2002 at age 62, practices for four months in 2003 and earns $32,000.
Question:
How much will his SS benefit be reduced?
Social Security Example
Answer: $10,240.
Dr. Smith’s benefit will be reduced by $1 for each $2 of earnings over $11,520:
$32,000 – 11,520 = $20,480
½ x $20,480 = $10,240
Social Security Reduction
Example #2: Mr. Martin is 66 years old, past his normal retirement age and has not retired. He earns $35,000/year. Mr. Martin receives a Social Security retirement benefit of $700/month.
Question:How much will his SS benefit be reduced?
Social Security Example
Answer: No reduction
Since he is over the normal retirement age, Mr. Martin loses none of his benefits by working.
Coordinating the Four Sources of Income
• Determine when to start Social Security• Coordinate wage earnings with Social
Security benefit timing• Identify all potential sources of income. • Preserve opportunities for tax-deferred asset
growth when possible• Structure allocation of personal savings and
work earnings to minimize taxation
Now, Where Were We with the Goldins . . .
• $20,000 Social Security benefits
• $10,000 per year pension benefit
• No work income
• $1.1 million combined IRA (50/50 stocks/bonds)
• $700,000 home
What’s New: Taxable Savings,Investments and Income
• $35,000 in a checking account
• $125,000 ski condo
• $300,000 in a stock portfolio (growth)
• $100,000 in tax-exempt bonds (AA)
• $85,000 in a DC plan
• Mr. Goldin is thinking of working part-time for 18 months at $3k/month