Major Retirement Income
Sources
1.
2.
3.
4.
Social Security
Employer-sponsored retirement plans
Personal savings
Work (wage income)
Income Sources: High-Income
Retiree
70000
60000
50000
40000
30000
$ Amount
20000
10000
0
Work
SS and
Investment
Retirement
Income
Plans
Average Income: $116,596
Source: Bureau of Labor Statistics, 2001-2002
Income Sources: Average-Income
Retiree
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
$Amount
Work
SS and
Investment
Retirement
Income
Plans
Average Income: $28,638
Source: 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
Age
Annual 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: EmployerSponsored 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 EmployerSponsored 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
Ages 65-74
Net
Financial
Assets
57%
Home
Equity
43%
Average Retiree
Ages 65-74
Net
Financial
Assets
25%
Home
Equity
75%
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 Amounts
Year
1996
1997
1998
1999
2000
2001
2002
2003
Age 65-69
$12,500
$13,500
$14,500
$15,000
Normal Retirement Age
$17,000
$25,000
$30,000
$30,720
Under Age 65
$8,280
$8,640
$9,120
$9,600
Under NRA
$10,080
$10,680
$11,280
$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 parttime for 18 months at $3k/month