The Answers to 46 Frequently Asked Questions about Retirement

1.  Where will my retirement income come from?

According to the Social Security Administration, many retirees receive income from four main sources:

1) Personal Savings and Investments

2) Earned Income

3) Company Pension Benefits

4) Social Security Income

2.  How much will my income need to increase to keep up with the cost of living?

The cost of living (as measured by the Consumer Price Index) has fluctuated, but has averaged between 4% and 5% per year over the past 20 years.  While recent inflation has declined to 2% to 3% annually, it is recommended that retirees compensate for inflation when preparing retirement income projections.

3.  If inflation averages 5%, how much will I need in the future?

Assume you retire at age 60 and need $4,000 per month retirement income.  Assuming 5% inflation, at age 65 you will need $5,105 to buy the same goods and services.  At age 70, this amount will rise to $6,515.  At age 75, you will need $8,315 to maintain the same purchasing power as $4,000, 15 years earlier.

4.  What percentage of my final working earnings will I need in retirement income?

Retirement planning resources suggest 66% to 75% of final earnings as a “rule of thumb.”  However, many people have to adjust to a 1/4 to 1/3 drop in their income.  We recommend that as you near retirement, you make a monthly “needs” budget based on past spending (review your check register for the last year) and combine that with a “wants” list.... items like travel, golf, entertainment, gifts, etc....so that you have a carefully considered income goal, rather than just an estimate based on your final year’s salary.

5. before I retire, is there a way for me to project my retirement income?

With today’s technology, there are many financial planning computer programs that are reasonably accurate.  For more detailed planning as you approach retirement, seek the advice of a professional experienced in retirement planning and wealth management.

6. Where can I go to find answers to questions about Social Security Benefits?

We have found Social Security Administration offices in our area to be quite helpful.  A call to the local Social Security office any time you have a specific question will probably be welcomed.  Also, a number of books that describe Social Security benefits are available at most bookstores or the public library.

7.  When should I file for my Social Security?  What will I need when I file for Social Security?

Normally, you should file for Social Security three months before you plan to receive benefits.  You will need:

1) Your Social Security card

2) Proof of your age

3) Tax forms from the previous year

4) Marriage certificate/divorce documents, if any

5) Death certificate, if applying for survivor benefits

8.  What is the maximum Social Security I can be paid if I retire this year at age 65?

A worker retiring at age 65 could receive up to approximately $2000 per month, depending on past contributions to the system. 

9.  What’s the best way to get an accurate estimate of my Social Security benefits?

Request a “Personal Earnings and Benefit Estimate Statement” form from the Social Security office, complete and send it in, and you will receive a record of your wage history and an estimated retirement benefits statement.  You can also request a Social Security Statement through the Internet at www.ssa.gov/SSA_home.html.

10.  Will Social Security keep up with the cost of living?

Although Social Security has had cost of living adjustments in the past, because of well-known changes in demographics, we do not recommend relying on Cost of Living Adjustments (COLAs) to increase benefits at the rate of inflation in the future.

11.  If I decide to retire before my normal retirement age, should I file for Social Security early at the reduced rate?  What is the reduction?

For individuals born in 1937 and prior, normal retirement (the age at which recipients are entitled to 100% of his or her SSI benefits) is 65 years of age.  For each month you choose to collect social security income before the “normal” retirement age, your payment is reduced by .5556%.  The earliest you can collect is age 62 and the benefit would be 80% of your “normal” SSI.

For individuals born after 1937 the reduced benefit is 70% at age 62, and the normal retirement age increases from 65 and 2 months to 67 years of age, depending on the year of birth. 

12.  How much income can I earn from employment without affecting Social Security payments?

This is an important consideration, because many retirees choose to work during retirement.  Under age 65, a worker can earn $10,680 with a reduction of $1 in benefits for every $2 earned over the $10,680 limit. Social Security recipients 65-69 no longer have earnings limits.

13. Will my Social Security be taxed?

For couples filing a joint tax return:

If your “income” is less than $32,000, your benefits are not taxable.

Above $32,000, 50% of your Social Security is included in taxable income.

Above $44,000, 85% of Social Security is taxable.

For single taxpayers: 

If your “income” is less than $25,000, your benefits are not taxable.

Above $25,000, 50% of Social Security is included in taxable income.

Above $34,000, 85% of Social Security is taxable.

See your tax advisor for complete details, including the definition of “income” as it relates to the taxability of Social Security income.

14. Is there a way to reduce the “Social Security Tax?”

One way is to continue to defer income not needed, through investments such as IRAs or single-premium tax-deferred annuities.

15. What kind of investments do you recommend for retirees?

Investments should be coordinated with an investor’s individual need for income, growth of income, safety of principal and liquidity.  Only after careful planning should investments be recommended to a retiree.

In general, however, many retirees have the need for three kinds of investments:  Short term investments like Money Market Funds, CDs and Treasury Bills are useful in meeting needs for cash within the short term.  Fixed income investments like municipal and government bonds can meet intermediate need for income, for periods beyond a year but not more than 8 to 10 years.  Long-term investments like real estate, stocks, and stock mutual funds can be used to potentially increase a portfolio and the income it produces in years to come.

16.  What has been the long-term return of stocks?

Since 1940, the average return of the largest companies, the Standard and Poor’s 500 Index, is around 13%.  From 1940 to 2000, the S&P 500 has increased in value 47 years out of 61 years, and decreased in value 14 years.  In other words, about three out of four years the market rises. Moreover, in the 46 “up” years, the average return was a gain of around 20%.  The 14 “down” years the average loss was about 9 1/2%.  Because of these historical facts, most financial planners and advisors recommend that investors with a long-term perspective consider substantial investments in stocks or stock mutual funds.  Source:  Salomon Smith Barney Consulting Group

17.  Why do some people I know say they never made money investing in stocks?  Are stocks really good retirement investments?

Some investors maintain a short-term perspective, buying only on good news (when the share prices are high) and quickly selling on bad news (when prices are low).  There are no guarantees with stock ownership.  Yet many patient investors have enjoyed very attractive returns over 10- and 20-year holding periods.  Because most retirees have at least 10 or 20 years to leave a portion of their money invested, stocks are an excellent investment for a portion of their retirement investments.

18.  In general, how would you arrange my investments to meet my need for income and growth?

Following basic wealth management principles:

First, we determine a cash reserve amount and set that aside for use in the next 12 months and to meet emergency expenses.  Next, we arrange fixed-income investments to produce income for a period of, say, eight years.  The balance could be positioned in several growth investments, each employing different approaches to investing, thereby diversifying the portfolio.  Using this strategy, we expect that income will be available each year for a number of years and that unguaranteed but higher potential growth investments can be left untouched for eight years or longer.

19. Aren’t bank Certificates of Deposit (CDs) better than investments in stocks for retired investors?

Fixed-dollar investments with short maturities, such as CDs, do offer stability of principal and should be one component of nearly every retired investor’s portfolio.  The income, however, can and does fluctuate widely from year to year.  According to the Federal Reserve Board, during the latest 10 year period, the highest average interest paid on 6-month CDs was 6.7%; the lowest was 1.3%.  So while the principal may be stable, it is not really safe to rely on the interest for steady retirement income.

20. I’ve always liked real estate as an investment.  Should I own real estate?

Real estate investments may be appropriate because of their growing income and appreciation potential.  But real estate properties are illiquid and may require hands-on management, which can grow into an unwelcome chore during retirement years.

Many investors choose to participate in real estate investments called Real Estate Investment Trust (REITs).  REITS offer exposure to real estate investments for growth and income, and are liquid because they are actively traded like stocks. 

21. Now that I’m going to stop working, won’t my taxes be lower?

Many retired workers are surprised to learn that they will still be paying income taxes, often with little or no reduction in tax payments from their working years.  You need to plan carefully, and you should consider using some tax-advantaged strategies.  Start by determining your taxable retirement income and your marginal tax bracket.

22. Is there a way for me to safely and legally reduce my income taxes during retirement?

Most investors should consider a number of alternatives including:

*  Municipal bonds that pay tax-exempt interest

*  Proper planning with IRAs, Roth IRAs, and annuities can offer tax deferral of earnings and tax advantaged income

*  Quality common stocks that appreciate with tax deferred growth

23. What are my options for the money that is in my 401(k) or other pension plan?

Usually there are four broad choices, each with different advantages and disadvantages:

1) Leave it invested in the company plan

2) Annuitize and receive an income for life

3) Withdraw the account balance, pay taxes and then invest the funds

                       *4) Rollover to an IRA, paying no taxes and continue to defer the income tax.

*This is usually the best option.

24. Why should I rollover my 401k to an IRA?

The many rules and complications in this IRS Notice remind us all of the reasons to always take your 401k when you leave a company, and roll those funds into an IRA as soon as you have the opportunity to do so. You always want to stay in control of your assets, and leaving them in an old companies 401k hinders that all the way from accumulation (you will have superior investment opportunities with a roll-over) through distribution which will allow non-spouse beneficiaries, such as children, grandchildren, trust beneficiaries, partners or friends to be able to stretch distributions over their lifetimes from the inherited IRA without all the bumps in the road that can occur when funds are left in the plan. 

25. Should I rollover to an IRA when I can leave my pension or 401(k) balance in my plan and not pay any expenses?

While many investors do leave pension balances in a company sponsored plan, many individuals prefer an IRA for a number of reasons.

First, the choices in the company plan are usually limited to a handful of investment accounts while an IRA offers an almost unlimited number of alternatives and the ability to make changes frequently and easily. 

Second, many retired investors find the service from a former employer or from a voice menu reached via a toll free number to be less than adequate service.

Perhaps the most important reason retired investors choose an IRA is the personal attention and advice offered by a Wealth Management Advisor that is knowledgeable about the investment markets, financial planning, and the needs of the retiree.

26. When am I required to withdraw money from my IRA?

By the end of the first quarter of the year following the year that you become 70 ½ years of age, you must make your first “Required Minimum Distribution” (RMD) withdrawal from your IRA.

27. How do I calculate the amount of the RMD that I must withdraw?

The Internal Revenue Service has issued proposed regulations substantially simplifying the calculation of minimum required distributions from qualified plans, IRA’s and other related retirement savings vehicles.  The calculation is based on the following factors:

1. The value of your IRA account at the end of the previous year.

2.  Your age and a single table based on the concept of a uniform lifetime distribution period.

Consulting with a tax and/or estate planning advisor and financial planner is extremely important for many investors when determining who should be named as your beneficiary and what methods should be elected in calculating the required minimum distribution.

28.  Do the required withdrawals apply to single-premium deferred annuities, too?

Usually not.  Typically, you can leave money in annuity contracts to compound tax deferred until age 85.

29.  What if I forget to withdraw the minimum amount at age 70 ½, or I make a mistake on my minimum distribution and do not withdraw enough?

The penalty is 50% of the “under withdrawal” the difference between what you withdrew and what you should have taken out to meet the Required Minimum Distribution. Your IRA custodian firm should have systems in place to assist you in determining the dates and amounts you should withdraw from your IRA.

30.  I’ve heard that if I take my “rollover” money out of my company plan, my employer will withhold 20%?  Is this true?

It is true.  If your company writes you a check for your pension balance, even if you intend to deposit it to an IRA, they must withhold 20%.  Therefore, if you deposit the check to an IRA, you must use funds from other sources (for instance, other savings or borrowing) to make up the withheld amount.  Otherwise, you must pay income taxes on the 20% that is withheld and not rolled over into the IRA.

31.  Is there a way I can avoid having 20% withheld from my rollover?

Yes.  You can arrange to have the funds transferred directly from the 401k or pension into an IRA.  In that case, your company writes the check to the custodian of your IRA, not to you, and there is no withholding applied to the account balance.

32. I have a $180,000 IRA rollover and I need $1,500 in monthly income from the IRA.  If I make an average return of 6% on my investment portfolio, how long will my money last?  What if I can increase the return to 8% or even 9%?

Earning 6% interest and withdrawing 10% from the account each year would deplete the principal in approximately 15 years.  At 8% interest, the portfolio would run out in 20 years; at 9% return, in 27 years. 

Obviously a portfolio earning more than the rate of withdrawal will never be depleted and can actually be used to provide increasing income in retirement to offset the rising cost of living.

The above figures are for illustrative purposes only and do not represent the performance of any actual investment.  Actual investment results may vary.

33. What are my biggest financial risks in retirement?

For most retired Americans the largest financial risk is the cost of health care, either in hospital, or long-term care provided in a facility or at home.

34. Should I keep my life insurance or cash it in?

The primary use of life insurance is the cash benefit it provides to offset the loss of income that an individual’s family would realize in the event of death of the insured person.  This is the reason many people own life insurance.

But what about in retirement?  Ask yourself this question.  Who loses financially as a result of your death?  One very good reason to keep life insurance after your “non-working” years is to compensate for the loss of pension benefits.  Perhaps you cannot rollover your pension account and must take payments for life.  Many retirees choose to take the higher benefit based only on their life (rather than a reduced payment based on joint life payments) and use the extra income to pay for existing or new insurance to make up the lost payments in the event of their death before their spouse’s death.

35. Isn’t life insurance a bad investment?

Not at all. Although no one likes insurance salesmen, insurance is an integral part of estate planning with the tax advantages often overlooked. For instance, iIt can pay your estate taxes, which can be 55% of your estate, if set up properly. This is obviously a very complicated subject and needs to be addresses in more than just a few words here. 36. What about estate planning?

You should review your wills, trusts, and related documents regularly with your Wealth Management Advisor, Attorney and CPA.  You will need to update your estate plan regularly because of changes in your family and/or changes in laws that affect estate planning.  Titling of your accounts is also a very important consideration.

It is sensible to spend a modest sum on good legal advice for this purpose.  If you do not have an attorney, we can give you a referral. If your attorney does not specialize in estate planning work, he or she may be able to refer you to one who does. 

37.  Are there tax wise ways to transfer wealth to my heirs?

Once again, this is a very complicated subject. Briefly however, there are several provisions in the current estate tax laws and new ones in the Pension Protection act of 2006 that allow individuals to pass wealth to their survivors without estate taxation. (See our recently published Special Report for Advisory Clients: New Rules to Help Your Retirement and Estate Planning)

Each individual can generally leave an unlimited amount of wealth to a surviving spouse without taxation; this is called the “marital exemption.”  To a non-spouse heir each individual may leave an amount that is not subject to estate taxation that currently is $1,000,000.  In other words a married couple may then be able to leave $2,000,000 of wealth to children or other heirs untaxed.

Additionally, the Roth IRA is an excellent vehicle for this purpose. Also, a gift up to $11,000 in 2007 to any individual is not subject to gift taxation and would normally not be considered in the taxable estate of that individual at their death. The laws are confusing so stay informed. Be aware of how to use the “Stretch IRA” for spouse and non-spouse beneficiaries.

See your wealth management advisor for more detailed information on estate planning. 

38. Is there a way to gift more than $11,000 per year to my children?

One method of leveraging gifts is often used by individuals that are concerned about the amount of estate tax their heirs may have to pay. By gifting cash each year to an irrevocable trust (or directly to heirs) that purchases life insurance on the life of the donor, gifts can be multiplied.  While life insurance owned by an individual is considered part of that individual’s estate, life insurance that is owned by an irrevocable trust is (subject to meeting certain requirements) not included in the deceased’s estate.  Therefore at the death of the donor the beneficiary/heirs receive the proceeds income tax free and estate tax free, effectively increasing the value of the annual gifts.

39. I already own life insurance; can I gift this insurance to my children or a life insurance trust?

An insurance policy can be gifted to a trust or heirs, but the donor must survive that transfer by three years or it will be included in the value of the donor’s estate.  New purchases of life insurance by a trust or children on the life of a parent or donor may not be subject to this three year rule.

40. I’m concerned about the change that retirement will bring to my daily routine.  What can I do
to prepare myself for this change?

Carefully consider what you will do with your time, who you will see, and what is important to you.  Make a weekly schedule of activities and events that you intend to pursue in retirement.  Talk things over with your spouse and family and get involved in retirement activities prior to actually retiring. Consider a “dress rehearsal” by taking a two-week vacation at home and pretending you have retired.  Many pre-retirees have found this to be a practical way to find out if they are ready (or not) to retire.

41.    The idea of not working makes me uncertain about my (our) financial future.  How can I know that the resources I have accumulated will help me meet my needs for the rest of my life?

This is the purpose of financial planning for retirement.  Remarkably, many individuals work for up to forty years accumulating wealth, and then spend only a minimal amount of time analyzing and projecting their income at retirement. (See our recently published article: Flipping the Switch to Retirement)

42. I hear and read about people that do their own investing at lower cost than those that use Financial Consultants.  Why should I pay more to invest?

Some individuals take the “do it yourself” approach.  Others should not.

Ask yourself these questions:

1. Am I knowledgeable about the investment markets?

2. Can I do my own financial planning?

3. Do I have the extra time that I want to commit to these tasks?

4. Will I enjoy handling my own investments and planning?

5. Is the potential savings worth the potential risks of making a mistake?

If you are answering “yes” to these questions, you might want to take your retirement planning into your own hands. Interestingly, most high net worth individuals do not do it themselves. 

43. Assuming I decide to work with a Financial Consultant, how can I get started?  How can I find someone to help me with my retirement and investment planning?

Go with an experienced independent wealth management advisor (not a stock broker or financial planner) that you like and trust, preferably one who specializes in retirement planning so they understand your goals and needs as well as the tangled web of tax laws.

44. What does it cost to work with a Financial Consultant?

Much less than what you might think. At major firms financial consultants or stock-brokers, are compensated by commissions and in some cases, on an annual percentage of the amount invested in other “fee-based” investment accounts.

Your total charges will vary based on your needs and the services required to meeting your objectives.  Be wary of advisors who avoid answering questions on this subject.  Also, be sure to ask for a description of what services will be provided for the fees and charges you expect to pay.

45. Is there a way that I can simplify my investing during retirement?

Many investors, over the course of their working years develop numerous investment accounts at banks, brokerages, mutual fund companies, etc.  If you can select one investment firm or advisor that meets your needs and you are comfortable working with, it is possible and actually quite easy to consolidate your investment holdings.

Many investment firms can transfer your existing investments into your account(s) at that firm, greatly simplifying your situation, your tax preparation, your future estate distribution, not to mention making things much easier for your wealth management advisor to properly advise you.

46. What are the biggest mistakes retirees make?

Unfortunately, some retirees just don’t have a financial plan, which can lead to over-spending or under-spending as a result. Ironically, many newly retired workers are too conservative.  Our experience has been that some retirees should spend more money in the first few years of retirement and enjoy their health and high energy.  They also have a backlog of “to-dos” that they have been wanting to experience like travel, cruise, etc.  Often we find that, unless prompted to start enjoying life, some retirees settle into an attitude of “we have to save the money for later.”

Be the expert…or hire one! Personal finance and making a retirement plan is serious business. You need to get the fundamentals down pat, spend a lifetime updating yourself on the subject, and learn the ins and outs of calculations for retirement in particular. For some reason people always think they can take short cuts with their retirement planning. The majority of people actually spend more time researching to buy a refrigerator than they do planning for their retirement! The biggest mistake one can make is to fail to educate themselves or hire a finance specialist to take care of them. Men and women, but especially men, hate to ask for directions. This is a cliché about driving, and I don't know if it's true or not, but it most assuredly is in personal finance.

Keith W. Springer is a Registered Investment Advisor and President of Capital Financial Advisory Services, providing Wealth Management and Mortgage Consulting Services.  For more information, please call Keith Springer at 916-925-8900 or keith@capfas.com

Will You Run Out of Money
Before You Run Out of Time?

In the chart below, the figures show how many years it will take for your principal and earnings to become fully depleted if you spend more money than your portfolio is actually earning.

Years until All Capital Is Depleted