Retirement Planning
Everyone wants a golden retirement. But saving for retirement is no
easy task. The baby boomer generation is graying. More and more people
are approaching retirement age. With Social Security's assets being
consumed and the number of workers that will support it shrinking, we
will have to rely more on our personal savings when it's time to retire.
Today, we have a myriad of options to help each of us prepare for the
golden years. Yet, without a specific plan of action, many people find
themselves falling short when it is time for them to live off of their
life's work.
Click below to learn about some of the most powerful retirement
strategies, including:
Take the time to review your options, and ensure that you're prepared
when it's your turn to retire. And when you're ready to speak with a
professional about saving for retirement, call us at 609 645 3900.
Annuities
Annuities are flexible insurance contracts designed to provide income
and help you achieve long-term savings goals. And these are not unused
financial vehicles.
Much like a CD is a contract between you and a bank, an annuity is a
long-term contract between you and an insurance company. In essence, the
same company that insures your home or protects your family may also
help you save for retirement.
After making a single lump-sum premium payment, or a series of
periodic payments, individuals can then receive regular annuity payments
from the insurance company. These payments can be made over a definite
period of time, or they can last a lifetime.
Payments to the annuity owner can also be tailored to begin after the
contract has been established for a number of years, or they can begin
immediately after the first premium payment is made.
Over time, insurance companies modified and enhanced both types of
annuities; however, their basic premise has always remained the same.
And because annuities are issued by an insurance company, Congress
allows them to grow tax-deferred under current tax laws.
A Myriad of Options
Tax-deferral is not the only reason why annuities have mushroomed in
popularity. While they typically have maturity dates of 5-7 years,
annuities require no medical exams, and can usually be opened by filling
out a basic annuity contract.
Today, there are hundreds of annuities to choose from, designed for
different retirement goals. When it comes to fixed annuities, insurance
companies sometimes offer higher intial rates to attract would-be
buyers, while other companies promise consistent interest rates
throughout the life of the annuity contract. Rates, maturity periods,
and death benefits are just some of the options to look for in a fixed
annuity.
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Annuity Flexibility
Annuities are one of the most flexible savings vehicles today. You
can use after-tax money to deposit into an annuity, or you can fund your
annuity by rolling-over qualified money.
For example, traditional IRA and 401(k) owners can transfer their
accounts into a qualified annuity, which maintains their tax-preferred
status. In some cases, annuities will offer fixed interest rates, added
death benefits, or other features from the insurance company that are
not available in a qualified retirement plan.
Non-qualified (or "after-tax") annuities are just as popular. Because
no rollover from another account is involved, non-qualified annuities
often require less time to establish. In addition, when you withdraw
funds, you'll only pay taxes on your accrued interest, since your
principal was already taxed once before (when you earned it).
Up until this point, we've focused primarily on options available
during the accumulation phase. But what about the payout phase, when the
annuity returns its value to you? Fortunately, annuities can also
provide incredible flexibility during the payout phase, as well.
When the payout phase begins, you can opt to receive your annuity's
value in one lump-sum, or you can elect to receive a steady stream of
payments in regular intervals (e.g. monthly, quarterly, etc.).
If you decide to opt for a regular stream of payments, many insurers
will allow you to have annuity payments last for a set amount of time
(such as 10 or 20 years). Many contracts also allow you to receive
payments for as long as you and your spouse live.
For many annuity owners, having indefinite payments for the rest of
your life provides a predictable source of income.
As a rule of thumb, the longer your payment period, the smaller your
payments will be. These conditions are clearly spelled out in the terms
of the annuity.
Want more flexibility? Some annuities are designed to be immediate
annuities. Immediate annuities have no accumulation phase whatsoever.
They begin paying you in regular increments the moment you purchase the
contract.
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Choices to Consider
When shopping for an annuity, there are several considerations that
must be weighed.
Immediate vs. Deferred Income
When it comes time to withdraw your money out of an annuity, you have
a variety of payment options to choose from. The insurance company can
pay you either in a lump sum, make periodic payments, or guarantee you a
lifetime of income on a tax-advantaged basis. Depending on the annuity
contract you purchase, the choice is yours.
Qualified vs. Non-Qualified
Annuities can accomodate qualified or non-qualified money. For
instance, suppose you are switching jobs and need to move over a 401(k).
However, you already have an IRA and are looking to diversify your
portfolio. You can reduce your portfolio exposure by rolling into an
annuity, and not be forced to lose your money's tax advantages.
In another scenario, suppose you receive an inheritance of $20,000.
If you don't need the money right away and want to build a long-term
nest egg, consider putting the inheritance into an annuity. You'll gain
the advantage of tax-deferral. Plus, when it comes time to withdraw from
your non-qualified annuity, you'll only be taxed on the accumulated
interest, not the principal itself.
Insurance Company
The quality of the insurance company is important, especially when
purchasing a fixed annuity. Working with a respected, highly-rated
insurer can help eliminate default risk, and ensure a retirement income
when you need it most.
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Common Benefits
All annuities, share several common benefits. Here's a summary
of what annuities can bring to your retirement portfolio:
- Ideal for Estate Planning: Proceeds from annuities pass
directly to your beneficiaries without the delay, expense, and
publicity of probate in most states. If you've ever had a loved one's
estate go through this time-consuming legal process, you know just
what kind of advantage this is.
- The Power of Tax Deferral: Because you do not pay taxes on
earnings every year, your annuity is able to work harder thanks to
tax-deferral. You will have to pay taxes on earnings when you withdraw
your annuity's gains, but at least you can decide when that happens.
- No Contribution Limits: ontributions to other retirement
savings vehicles, like 401(k)s and Individual Retirement Accounts, are
strictly limited. Annuities, however, offer tremendous flexibility.
You can contribute as much as you want, up to the limits imposed by
the insurer.
- Flexible Payment Options: Unlike 401(k)s and IRAs, which
require that you begin making withdrawals at age 70 1/2, you may be
able to wait much longer with annuities. When you do decide to begin
receiving payments, you can usually select one of the following
methods:Lump Sum distribution (a one-time payment)Periodic
distributions (you can take money only when you need it). Systematic
distributions; Annuitization (fixed or variable payments,
guaranteed by the insurer for the rest of your life).
- Tax Control: The money inside your annuity is made up of
two components -- principal and earnings. Assuming your annuity was
opened with after-tax dollars, you're only taxed on your earnings.
Different distribution methods behave differently when it comes to
taxes; for instance, Lump Sum, Periodic, and Systematic distributions
exhaust all earnings (which are taxable) before tapping principal.
Under annuitization, each payment consists of both principal and
interest, spreading your tax liability evenly among payments. Through
these distribution options, you have complete control over when you
will pay taxes on your earnings. Annuities are not perfect when it
comes to tax control. If you should pass away while your annuity is
accumulating, all deferred taxes on your growth will become due,
reducing your annuity's value.
- Easy To Start and Maintain: Usually, a simple application,
a check, and your signature begins your annuity. And, at the end of
each year, you will not receive a 1099 for income earned within your
annuity contract. That's one less thing to worry about when April 15th
rolls around.
- Other Features: Annuities also do not offset Social
Security benefits like bond, CD, and other investment income does.
Annuities are easy to establish and often come with a "free look
period." Your state of residence or the annuity contract will define a
length of time (usually 30 days) where can cancel your contract if you
decide it's not right for you. You can even exchange older,
non-performing annuities into a newer fixed annuity with no tax
consequences, thanks to Section 1035 of the Internal Revenue Code.
If you are a conservative investor looking for a consistent way to
build your retirement savings, then fixed annuities may be the answer
for you. However, if you are financially savvy and believe you can do
better choosing your annuity's direction, variable annuities offer you
much greater flexibility and control.
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Modified Endowment Contracts (MECs)
For nearly two decades, tax-deferred annuities have enjoyed
remarkable popularity. Most tax-deferred annuities require a single
premium payment in the beginning, which then accumulates on a
tax-deferred basis.
However, annuities are not perfect. For instance, if you should pass
away while your annuity is accumulating, all deferred taxes on your
growth suddenly become due. Annuities with substantial growth could be
reduced significantly, and your children and grandchildren could end up
with a fraction of your annuity's value after taxes.
For retirement savers looking to preserve a little more wealth for
their family, there may be a solution: a type of life insurance policy
known as a Modified Endowment Contract (MEC).
In financial circles, MECs are often compared to annuities because of
their similarities. In fact, MECs are technically life insurance
contracts that have many of the benefits of accumulation found in
annuities... but if anything happens to you, your loved ones will
usually receive more than your initial premium, not less.
The Basics of MECs
The same insurance companies that issue annuities also underwrite
Modified Endowment Contracts. MECs are very similar to annuities in
terms of tax-deferred accumulation of your initial premium.
However, the tax code is not very favorable, particularly if the
owner passes away during the annuity's accumulation stage. If that
happens, all deferred income taxes on growth become due.
MECs are able to overcome this by including an insurance "rider" in
the contract, designed to pass the entire account value to your
beneficiaries income tax-free. While specific features will vary by
company, MECs offer several distinct advantages over deferred annuities
and other wealth-accumulation vehicles:
- MECs avoid income taxes during the accumulation stage of your
account
- MECs do not force you to make distributions by a particular age,
like some IRAs and 401(k)s
- MECs allow you to make withdrawals or loans in cases of emergency
- MECs give you the flexibility to choose between fixed and variable
account options
- MECs provide a lump sum payment to heirs that is tax-free
- Unlike annuities, MECs can be owned by certain types of trusts
without losing their tax-advantaged status
MECs can provide a retirement income for you, while preserving your
legacy for your loved ones.
Reducing Taxes
The Internal Revenue Code provides tax advantages for MECs,
regardless of whether you choose a fixed MEC or a variable MEC.
Insurance products have always received very favorable treatment by
Congress, and MECs are no exception. Unlike stocks and mutual funds,
which are taxed every year, any earnings within your MEC remain untaxed
as long as they stay within the MEC account. You choose when to pay
taxes, since income taxes on the growth of your MEC are due only upon
withdrawal. Over the long haul, this tax-free accumulation can produce
dramatic advantages.
Tax-deferral provides this added value, because of the time value of
money. Compare the accumulation of a jumbo CD and a MEC, and let's
assume both are earning 7%. The CD is taxed on the earnings, reducing
your net interest rate. If you're in the 27% tax bracket, you're
actually earning 5.11%.
However, for the MEC, it's a different story. Since income taxes are
deferred, the MEC is credited with the full 7%.
Of course, CDs have much shorter maturities than MECs, and they're
offered by banks (not insurance companies). CDs are also FDIC-insured,
while MECs are not. Plus, remember that when funds are finally withdrawn
from the MEC, income taxes will be due. However, your MEC money will
have worked harder for you, thanks to the time value of money on your
side.
Long-Term Strategy
Tax-deferral is wonderful, but there is a small price to be paid in
terms of liquidity. MECs are able to grow without annual income taxes
being paid, because they are designed for retirement.
Like annuities and traditional IRAs, money placed inside a MEC must
remain there past age 59 1/2. If you make a withdrawal from the MEC
before that age, the IRS will slap a 10% penalty on any withdrawals
made. For this reason, they are not liquid, and should remain in there
until you're ready to draw money in the form of retirement income.
It's important to make a distinction between "liquidity" and
"flexibility." Because MEC money must remain inside the retirement
account past 59 1/2 does not mean you don't have options. To the
contrary, many fixed MECs offer a wide variety of payout options to suit
your needs.
Variable MECs go one step further, allowing you to choose from
several variable accounts. These "variable accounts" are often run by
the same professional money managers who run mutual funds. And if you
have a favorite mutual fund, chances are the mutual fund manager also
runs variable accounts for use in variable MECs.
Let's not forget that as long as your account is accumulating and no
withdrawals are made, no Form 1099s reporting income will be generated.
At the very least, this maintains a degree of privacy. And, in many
states, MECs also offer asset protection from creditors. If anything
happens to you, your MEC also avoids probate. Resembling an annuity once
more, MECs pass probate-free to your named heirs. This probate bypass
will spare your family the time, expense and public exposure that
probate can bring.
When purchasing a MEC, it's important to look at the quality of the
issuer. If you were buying an annuity or life insurance policy, you'd
want a highly-rated insurance company behind your purchase. MECs are no
different, since the same insurance companies that offer traditional
life insurance and annuities also offer Modified Endowment Contracts.
If you're concerned about your MEC issuer's stability, there are many
safeguards already in place by law. For instance, in a variable MEC,
each variable account is in a separate custodial trust. Your money is
invested with the separate portfolio managers, and is not commingled
with the issuer's general accounts.
Once you purchase a MEC, you don't have to keep it forever. Section
1035 of the Internal Revenue Code allows you to switch from one MEC to
another without incurring taxes on the growth of your MEC. However, if
you switch to another MEC before your guarantee or "maturity" period has
expired, you may incur company-imposed surrender charges. Always check
those charges carefully before choosing your MEC.
Plus, MEC's usually have a death benefit higher than the actual cash
value. This feature is especially useful for variable MECs, since your
family may be guaranteed a death benefit greater than the payments you
made, no matter what happens with the performance of your variable
accounts.
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Roth IRA
Roth IRAs, unlike traditional IRAs, have a simple premise: you pay
income tax going in, rather than when you pull out.
Named for Sen. William V. Roth from Delaware, the Roth IRA represents
an enhanced level of flexibility for people saving for their retirement.
The Roth IRA is a type of account that you establish through a
qualified broker. Beginning in 2002, you can contribute up to $3,000
annually to your Roth IRA. Any contributions that you make to your Roth
IRA are considered "after-tax," and cannot be deducted from your tax
return. However, when it is time for you to draw money from your
account, you will not pay income taxes on the growth of your account. If
you're in a high tax bracket, that can amount to tremendous savings.
The Economic Growth and Tax Relief Reconciliation Act of 2001, signed
into law by President Bush, increased the annual amount you can
contribute from $2,000 to $3,000 ($3,500 if age 50 or over). Plus, in
2005, the annual amount increases to $4,000. And in 2008, the maximum
annual contribution rises once again to $5,000.
Just like a traditional IRA, Roth IRA accounts can hold stocks,
mutual funds, and other types of investments. Retirement-minded
investors, looking to build their nest egg, can open a Roth IRA
brokerage account and invest it like they would any other account.
However, unlike other types of brokerage accouts, your broker will
usually ask you to pick a designated beneficiary for your Roth IRA
funds, should you pass away with the account open.
People who are still working and are eligible to contribute more have
to think about what kind of IRA they should contribute to. This is
especially true if you have already accumulated a large IRA, perhaps
from the rollover of a retirement plan, and if you want to know whether
you should convert that pot of money into a Roth IRA.
If you have accumulated a large traditional IRA, you can elect to
convert the entire account to a Roth IRA. Upon conversion, you must
declare the entire IRA taxable balance as taxable income and pay taxes
on it in the year of conversion. From that point on, the IRA is federal
income tax-free during compounding, and federal income tax-free when you
pull money from it (if you have held the Roth IRA for at least five
years, you are age 59 1/2, or meet other requirements).
If you are a mature American with a large IRA, you have a big
decision. Should you convert your nest egg to a Roth IRA? In many cases,
it makes sense. If you qualify for a conversion, you may save thousands
of dollars for both yourself and your heirs.
Better to Pay Now or Later?
Are you better off waiting to pay taxes, or paying them now? For
many, paying your taxes owed now is the smart thing to do. Forget the
math... just know that politicians like to spend other people's money.
After all, Uncle Sam could collect his pound of flesh later, or just a
few ounces now. Traditionally, the U.S. Government prefers to collect
its money now, even if the long-term goal is more reduction of the
budget deficit.
In this era of budget balancing, politicians need collections today
to show that they are working hard to keep the budget balanced.
Looking long-term, Congress may have problems later, but only after
our hard-working politicians are probably long-gone. Congress'
short-term outlook can be turned around to work for you. Even if you
already own a traditional IRA, you can convert it to a Roth IRA. For
existing IRA owners, there are restrictions on conversions. For
instance, you can convert only if your AGI (Adjusted Gross Income) is no
more than $100,000 in the year you make the switch, assuming you're
single or married filing jointly.
Who should not convert their existing IRA to Roth? If your tax
bracket is higher now than your heirs' tax bracket will be when the
money is spent. Also, be very careful if you aren't sure about falling
under the $100,000 ceiling. Converting and then discovering later that
your income was higher could blow up in your face, creating significant
tax penalties.
From an estate planning standpoint, if your main goal is to
accumulate as much as you can and leave it for your heirs, conversion
can make a lot of sense. Traditional IRA owners must begin taking
distributions by age 70 1/2. However, Roth IRAs require no minimum
distributions each year during the life of the IRA owner, nor on the
life of the IRA owner's spouse. If you want to keep your money growing
on a tax-preferred basis longer, then the Roth IRA may hold your
solution.
A Look at the Numbers
Suppose you own $20,000 of growth stocks in a qualified IRA, and you
believe that you it will be worth $60,000 by the time you spend it.
For simplicity, you are in a 36% tax bracket now, and expect to be in
the same bracket in the future.
If your assumptions are correct and you leave your IRA alone, the IRA
will grow to $60,000. After paying $21,600 in taxes, you will have
$38,400 of spendable cash after taxes.
But suppose, in the beginning, you made the conversion to a Roth IRA.
You convert, using $7,200 from the account itself to pay the immediate
tax bill. The remaining $13,600 triples to $38,400.
The two outcomes are identical. In this scenario, there's no
difference between the two... unless you were under age 59 1/2, in which
case money taken from the Roth IRA account to pay tax would also be
subject to a 10% early withdrawal penalty.
However, there is another option. Suppose you convert to a Roth IRA
in the beginning, and come up with the $7,200 in initial taxes from some
other source of cash that would not have qualified for tax-deferred
compounding.
Assuming the same growth rate, your Roth IRA would have tripled in
value to $60,000 (a full $21,600 more). Best of all, the entire amount
would be income tax-free when you needed to make withdrawals... plus,
there would not have been a 10% tax penalty on money taken from the
account if you were under age 59 1/2.
Sure, you're missing that $7,200 from your outside account, and that
money could have grown. However, its growth would've been stunted by the
fact you were paying taxes on the income all along.
Remember: in this case, the "time value of money" is definitely on
your side. The Roth trade is a bad one for Uncle Sam, and a good one for
you.
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