retirement planning

Retirement Planning in 2014

Planning for retirement is one of the most important aspects in the financial planning process. However, only 64% of us actually takes the time to plan and save for retirement. There’s no doubt that planning for retirement can be a daunting endeavor, however not having enough resources to live comfortably during retirement is a far worse alternative. Many of us postpone retirement planning due to the perception that we will have plenty of time in the future. This is not usually the case as many retirees wish they started to save for their retirement sooner. As we start or adjust our retirement plans in 2014, it’s important to remember that we control our ability to plan and save for retirement.

Despite the fact that we can control some aspects of our retirement, there are a few that we can’t. This includes elements such as economic growth, inflation and retirement plan contribution laws. These limits can change year to year as they are dictated by Congress. In 2014 ensure that you consider the following limits in your retirement plan and adjust if necessary.

Contribution Retirement Plans Limits in 2014

Contribution retirement plans are employer sponsored investment accounts. These accounts are funded through automatic paycheck deductions. In these plans a employer sets a matching contribution policy in which they will invest a percentage of an employee's income as a retirement plan investment.

If your employer offers a contribution retirement plan, it is in your best interest to participate. Not only do these plan offer you a quick and easy way to build your portfolio, it also provides great tax advantages. Your personal retirement account contribution is deducted from your paycheck before taxes are calculated. This helps you reduce your annual tax bill.

In order to limit the amount of tax that is deductible from these retirement plans, Congress caps the amount in which can be contributed to these accounts on an annual basis. In 2014 you will be able to contribute up to $17,500 in your 401(k), 403(b) and most 457 plans. In addition if you are 50 years or older you qualify for a retirement “catch up” contribution of $5,500. This will set your total contribution limit at $23,000 a year.

Individual Retirement Plans Limits in 2014

Individual Retirement Plans or IRAs, are tax advantaged investment accounts. These common retirement plans are usually managed by the individual and can be opened at most financial and brokerage firms. While IRAs have a few advantages over contributions plans, such as investment flexibility, they do not include an employer contribution.

Individuals can contribute up to $5,500 to their IRA in 2014 and if over the age of 50 they qualify for the additional $1,000 “catch up” contribution. While the contribution limits to IRAs are limited, maxing out your contribution to your IRA is better than not having any retirement savings at all.

In addition to the limits for IRA contributions, the tax advantages are also capped by your Adjusted Gross Income or AGI. In 2014 the traditional IRA tax deduction is phased out for single taxpayers with a retirement plan at work when their incomes are between $60,000 and $70,000. However this limit is raised for married couples when their combined incomes are between $96,000 and $116,000.

If you do not have a retirement plan for 2014, it’s never too late to start. Many put off saving for retirement for a variety of reasons. Retirement is enviable and postponing preparing for it makes it more difficult.

Financial Planning Assumptions - Part 2

As mentioned in Financial Planning Assumptions - Part 1, in-order to create a financial plan you will need to rely on a variety of assumptions. These assumptions will be required to forecast and estimate your future financial situation. In addition to estimating investment rates of return and inflation, you will also need to estimate the following assumptions for inclusion in your comprehensive financial plan.

Assuming Life Expectancy

A financial plan should include a lifelong cash flow forecast. This will ensure that you understand about how much money you will need though all phases of your life. The best case scenario is that you will have enough money to live comfortably in your golden years. To ensure that you do not run out of money during retirement, you will have to use an estimate of your life expectancy in your cash flow analysis.

Two of the most common methods of estimating life expectancy includes using an actuarial life table and planning to 100 years old. Using an actuarial table provides an estimated life span based on year of birth. The U.S. Social Security Administration provides actuarial tables on their website.

Despite the mathematical savvy of the actuarial table, I prefer to estimate all life spans to 100 years of age. This method reduces the risk of running out of money in retirement.

Retirement Planning Assumptions

Looking into the future, it is difficult to determine what your life and career will look like at certain date or age. Due to this difficulty, you will need to make a few assumptions concerning your eventual retirement.

The assumptions that you will need to place in your retirement plan include: date of retirement, income needs during retirement, amount of monthly Social Security benefit and the value of your investment accounts upon retirement.

Your anticipated date of retirement is highly contingent on your cash flow needs and preferred lifestyle. In the absence of any additional data, estimating a retirement age of 62 - 67 is appropriate. Your income needs during retirement can be estimated by creating a budget or using a few common rules of thumb.

Many of us will rely on Social Security benefits for a portion of our retirement income. This amount will have to be assumed due to the probability that Congress will lower these benefits in the future. To estimate these benefits at retirement I like to use the models on the Social Security Administration's website. Finally, you should take a look at your investment plan and forecast the value of your portfolio at your retirement age.

Guessing Future Tax Rates

The last major assumption you will have to incorporate into your financial plan concerns tax rates. Tax rates are as difficult to estimate as Social Security benefits due to the politics that influence them. This is why I rather refer to tax rate forecasting as "guessing".

There are three main tax rates that influences the outcome of your financial plan. These rates includes taxes on income (salary), capital gains (investments) and estates (property transfers).

Due to the uncertainty of these rates, many financial analysts keep them constant (place current rates into the financial plan) when estimating future cash flow. However for a robust comprehensive financial plan, I recommend performing a "what-if" analysis to see how a change in rates effects your long-term financial success.

When developing a financial plan you will be required to include a few assumptions into your analysis. These assumptions can have a significant impact the outcome of your plan, thus your best effort should go into their accuracy.

Creating a Portfolio for Retirement

As we approach retirement it’s critical that we ensure our portfolios will provide a reliable and steady stream of income as we transition from the workforce. A few years ago many retirees learned this lesson the hard way when the financial markets all but collapsed.

If you are approaching retirement it's a good idea to take a few minutes and analyze your portfolio’s holdings. At this point in your life you should be seeking to reduce the volatility of your asset accounts. This will help protect against large losses that could severely impact your quality of life during retirement.

Retirement Portfolio Allocation

Many individual investors have a large percentage of their portfolios allocated to stocks. While this is not optimal, I understand the attraction to stocks as they have more growth potential than other, less risky assets like Bonds and Certificates of Deposits. However, having a large allocation to stocks during a bear market can wreak havoc on a retiree’s lifestyle, thus it’s imperative that we allocate a higher percentage of our portfolios to fixed-income investments.

Fixed-income investments include assets such as Treasury Notes and Bills, Bonds and Certificates of Deposit. While these assets do not promise high returns their safety, especially to retired investors, is priceless.

The Right Mix of Retirement Assets

Finding the perfect portfolio is a fools errand. This is due to the fact that there are too many lifestyle variables to consider. However, there are portfolio allocations that are better than others and this is the key to successful investing during retirement.

With that said, in a general sense a good retirement portfolio includes no more than 50% of its allocation to stocks. The remaining portion of the portfolio should be dedicated to fixed-income investments. However I would normally suggest a much higher allocation of 75%-85% of a portfolio to fixed-income assets. A retirement portfolio with these allocations would provide financial security and a little hedge against inflation. Both of these factors are an important part of retirement planning.

A Model Retirement Portfolio

As an investor myself, I am partial to ETFs and Mutual Funds for my retirement accounts. This is due to the ease of allocation and portfolio management. In addition these funds provide easy diversification. So with that in mind you can use the following model retirement portfolio as a start when determining your portfolio’s allocation.

  • 10% - Cash/ Savings Account
  • 25% - TIPS Bond
  • 20% - Long-term Government Bond
  • 20% - Short-term Government Bond
  • 15% - S&P 500
  • 10% - International Stock

To ensure that you protect your retirement assets and income stream reallocate your holdings to less volatile assets. Fixed-income might not offer high returns, however their safety will help protect your lifestyle during retirement.

The Rules and Limits of Traditional IRAs

When looking at all of the different investment and retirement planning tools available, its easy to become overwhelmed. However, the Individual Retirement Account (IRA) is one of the most popular and widely use retirement accounts.

The rules that govern the application and management of IRAs change slightly from year to year. This is due to the changes Congress makes in tax laws (the following figures are for 2012).

Traditional IRA Eligibility Rules

To be eligible to invest in an IRA, you only need to have earned income for the year in the amount of the contribution. This includes both self-employment and part-time income as well. As with many tax advantaged accounts, there are restrictions to investing in an IRA which include the participation in a tax-qualified retirement plan and if your income is above certain thresholds.

If you are eligible or participate in a company sponsored retirement plan, the tax advantages of Traditional IRAs are limited. The tax deductions of investments in Traditional IRAs are phased out for single filers that make adjusted gross income (AGI) between $58,000 and $68,000. In addition, married couple’s IRA tax deductions are phased out between AGI of $92,000 and $112,000.

Traditional IRA Contribution Limits

Depending on your contribution eligibility, individuals will be able to contribute up to $5,000 per year up to age 49 and $6,000 if you are 50 or older. The additional $1,000 for individuals over 50 years of age is referred to as a “catch up” contribution. Lastly, you will not be able to contribute to an IRA past the age of 70 1/2 years old.

If you are not eligible for the tax deductions of a Traditional IRA, you will still be able to contribute. The advantage of contributing to a non-tax deferred IRA is that your earnings (through investments) will not be taxed until you make a withdraw. This avoids the short and long-term capital gains tax of your Traditional IRA investments. This can grow to be a significant amount over long time periods.

Traditional IRA Income Distribution

During retirement, Traditional IRA distributions can provide a decent source of income. However, due to the tax advantages provided for this retirement account there are some restrictions concerning when you can withdraw your cash.

Traditional IRA holders can begin to withdraw from their account without penalty at the age of 59 1/2. If a withdraw is needed before this time, your account might incur a 10% penalty. However an account is exempt from these penalties in cases of permanent disability or death. Account holders over the age of 70 1/2 must begin to take the minimum distribution.

Traditional IRAs are a good investment and should be included in most retirement and financial plans. The tax deductions and tax avoidance is worth the hassle of opening a new investment account.

Fundamentals of Retirement Income Planning

Properly timing the distribution of income during retirement is critically important to living a financially secure in your golden years.

There are two main risks of not timing your income distributions correctly. These risks include running out of money too soon and not living the lifestyle you could have afforded. Neither of these situations are optimal, thus we need to carefully plan for the distribution of assets during retirement.

Goals of Retirement Income Distribution

As stated above, its critical that you create a robust income distribution plan. In order to accomplish this, you will need to determine all of your sources of retirement income and their available distribution options.

Once that is complete you can begin to determine what retirement income distribution strategies are available to you. This will help optimize your income situation so you can live your desired lifestyle during retirement.

Types of Retirement Income Distribution

Depending on what type of asset and retirement accounts you have, you will probably be constrained to a few common income distribution scenarios.

Lump Sum - Lump sum distributions are taken all at once. This option provides you with funding flexibility in the event that your expenses become unpredictable or vary widely from month to month.

Systematic Withdraws - In contrast to the lump sum payment options, some asset and retirement accounts will allow you to take systematic withdraws. These withdraws will be taken in the same amount every month or payment period. This option provides less flexibility, but more financial security.

Required Distributions - Finally, some asset accounts will require you to take distributions at a certain point in time. These distributions are usually age based, such as Social Security. In this plan you will have to being to withdraw benefits at age 70.

Retirement Income Distribution Strategy

Since the point of developing a retirement plan is to ensure that you use your retirement income wisely, start your strategy by timing your cash flows. Since everyone has a different retirement situation, I have provided the following objectives to help guide your retirement income distribution strategy.

Create a Strong Foundation - I like to being a retirement cash flow plan by determining a client's fixed costs during retirement. This helps me determine how much money will be absolutely needed every month. If at all possible, I also like to have monthly systematic withdraws cover all monthly fixed costs (mortgage, food, clothing, etc.). This helps secure my client’s financial future.

Increase Flexibility as Needed - Hopefully you have enough annuity or systematic income options to cover fixed expense. If this is true, you can then use your lump sum income options for flexible expenses such as vacations, entertainment and other discretionary expenses. However, if you do not have enough systematic income to cover your fixed expenses, you may need to tap into your lump sum accounts to help supplement your fixed monthly income.

Retirement income planning can quickly become a complicated matter. This is due to the constraints that many retirement plans place on our ability to withdraw benefits when we need them. By taking the time and developing a solid income distribution strategy, you can increase your financial security and live the best retirement that you can.