Wealth Management Services



Wealth Management Services


Retirement Accounts:

Remember you're facing a retirement that's probably going to be longer than your parents' and will involve more uncertainties. This new kind of retirement probably means there are many American workers worrying about, instead of planning for, the future.

You can choose to stop worrying and start figuring. Not only will you come up with facts to work with, the chances are good you might change the way you save. The 2006 EBRI survey also found that 51 percent of people who tried to figure out their financial futures ended up changing their retirement savings plans.

If you are a married woman: In preparing for retirement, women face the very real possibility of spending part of their retirement years without the support of a husband - most likely through widowhood. The loss of a spouse can sometimes mean the loss or reduction of benefits that can place women in financial jeopardy. For that reason, women will need to focus on their financial resources as a single person as well as half of a couple.

Consider what happens to your Social Security and to retirement benefits if your spouse dies or you divorce. Know what assets you can count on. Check Social Security benefit documents, retirement plan documents, and wills. Remember that wills are important, but they may not provide the protection desired. Depending on the way assets are titled or the terms of a will, the money women believe they can count on may not be passed to the surviving spouse.

Next, we can estimate how much that money could be worth because it will probably grow - in the 10 to 15 years between now and retirement.

In addition, we let you see how much your money can grow by investing it in different ways. In fact, you will be able to assign different rates of return to different types of savings and to see how your decisions can impact the growth of your money over the next 10 to 15 years. Rates of return are simply the amount your money earns over a certain period.

How your money increases over time will depend on the nature of your investments, the rates of return, and other factors, such as the economy. One kind of investment, for instance, is a bond, which is often referred to as a "fixed income" investment because the interest rate is fixed. As an example, if you owned a bond with an original value of $10,000 and you got a 5 percent return (or yield) on your investment, your original investment would increase to $16,289 in 10 years.

403(b) plans are going to look a lot like 401(k) plans starting January 1, 2009 when the new final regulations become effective. Non-profits can generally also sponsor a 401(k) plan, and some are considering making a switch. But while the plan document requirement is now common to both, there are some important differences that non-profits should consider about making a change. Here are just a few:

  • Discrimination Testing. 401(k) plans are subject to testing. 403(b) plans are not, but must make deferrals "universally available".
  • Investment Options. 401(k) plans have a wide-range of investment options. 403(b) plans are restricted to custodial accounts invested in mutual funds or annuity contracts issued by insurance companies.
  • Catch-up Contributions. Qualifying 403(b) plans can permit up to an additional $3,000 in catch-up contributions by eligible employees in addition to the $15,500 and $5,000 catch-up limits applicable to both types of plans.

For those of us who work with business owners, we buckle up our seat belts during the last quarter of the year. Buckle them up a little tighter in December, and tighter still at actual year end.

We call it the “retirement plan season”, the time when many business owners decide to set up a retirement plan before the year end deadline. We’ve “celebrated” New Year’s Eve on more than one occasion by waiting for a signed plan document to be faxed or emailed to us.

It’s not that business owners aren't usually aware of what a qualified plan retirement plan can accomplish, but procrastination is part of human nature - and sometimes a business owner's nature. He or she may say, “I’m going to wait until year end to put a retirement plan in place since I can still get the tax benefits for the whole year.” The owner (and maybe even the accountant) believes that setting up a retirement plan today, next month, or at year end are all the same thing.

That ain’t necessary so. There can be a real cost of waiting until the year end deadline. Here are some reasons why sooner rather the later is the time to set up a retirement plan.

1. Not enough compensation for a shareholder-employee of an S corporation.
Many owners will minimize W-2 compensation for payroll tax reasons. The balance of their income goes on their K-1s. (Not always looked on kindly by the IRS who may say that isn't "reasonable compensation"). However, only W-2 compensation can count for retirement plan purposes. Minimizing W-2 income can also minimize retirement benefits.

2. Not enough time to maximize 401(k) contributions.
Adopting a 401(k) in the latter part of the year may not give an employee enough time to maximize his or her own contributions. Remember 401(k) contributions must be elected in advance and withheld by the employer. A December plan adoption only provides December payroll as a basis for employee deferral.

3. Timely notice not given to employees.
Tax planning is a time-sensitive activity, and sometimes notices to employees must be made in order to achieve desired results. For example, an employer sponsoring a SIMPLE must give its employees notice of the plan provisions and employer contribution levels, including any plan changes, at least 60 days prior to the start of the next calendar year. An employer who does not give the requisite termination notice by November 1, 2008 means no profit sharing/401(k) plan for 2009. An employer with a SIMPLE should keep November 1, 2008 in mind if a different plan type is intended in 2009.

Timing can be everything.

The right IRA for you

A Roth seems like the obvious choice over a traditional IRA since it has tax-free withdrawals. Not always.

Question: If you contribute to a traditional IRA, after many years most of your account value will be in the form of investment earnings, which are taxable when you withdraw them. With a Roth, on the other hand, your balance will be tax-free. So it seems to me that the advantage of tax-free withdrawals from the Roth in the future greatly outweighs any tax-deduction benefit you get from a traditional IRA. Doesn't that make the Roth a better deal?

Answer: A lot of people aren't quite sure how to assess the value of contributing to a traditional IRA vs. doing a Roth. That's not surprising, given the number of factors that can affect which is the  better choice for a given person in a given circumstance.

Generally, I think having at least some money in a Roth IRA (or Roth 401(k), if that option is available to you) is good idea for several reasons. But before I get to them, I'd like to step back and explain how both traditional and Roth IRAs work in a way that, I hope, will give you and others a better understanding of them and help you decide which type to fund.

I'll start by stating a premise that many people overlook or simply don't understand about traditional and Roth IRAs - namely, that theoretically at least, they're equal in terms of the tax advantages they offer. This isn't immediately apparent. And I've talked to many people, including advisers, who don't seem to get this. But I think a little example will show you what I mean.

Shopping Retirement Plans
Let's say you've got $4,000 that you can put into either a traditional or Roth IRA. (The maximum IRA contribution for this year is $4,000, plus $1,000 if you're 50 or older; next year, the max goes to $5,000, plus $1,000). And let's assume that you'll earn 8 percent a year on your contribution for 20 years.

If you invest your four grand in the Roth, you'll have $18,644 in your account after 20 years. And, assuming you meet the withdrawal criteria money will be tax-free. If you put the $4,000 in a traditional IRA, you'll also have $18,644 after 20 years. But you'll owe tax on withdrawals. So if you're in the 25 percent tax bracket, your balance is worth only $13,983 after taxes, much less than the Roth.

But hold on. You also get a tax deduction with the traditional IRA. So to make the comparison even, you've got to factor in the value of that deduction. If you're in the 25 percent tax bracket, a $4,000 deduction saves you $1,000. If you invest that $1,000 and earn 8 percent for 20 years, you end up with $4,661. Add that to the traditional IRA's after-tax balance of $13,983, and you end up with $18,644 - exactly what you've got in the Roth.

Remember, though, I said the traditional IRA and Roth IRA are theoretically equal. In the real world, even if you were disciplined enough to invest your $1,000 savings from the traditional IRA's tax deduction, you would have to invest that money in a taxable account since you had already reached the annual IRA contribution limit.
So you won't get an 8 percent return a year after taxes. You'll get something less than that. Which means your $1,000 will grow into something less than $4,661. Which means that even after factoring in the value of your traditional IRA's deduction, the Roth IRA still comes out ahead.

So all things being equal, the Roth has an advantage. It effectively allows you to shelter more money from taxes. Congress could have adjusted for this by setting a lower contribution ceiling for Roths, essentially lowering the Roth limit as you move into higher tax brackets. But it didn't.

An IRA for you and your spouse
Ah, but let's not be so quick to assume that just because the Roth has this advantage that it's automatically the better deal. In fact, reality can intrude again in a way that can whittle down or even eliminate the Roth's advantage. How? Well, it comes down to tax rates.

When I compared a Roth to a traditional IRA in the example above, I assumed that you were in the same tax bracket, 25 percent, when you withdrew your money as you were when you contributed to it. But what if everything in the scenarios I described above remained the same, except that you dropped to, say, the 15 percent bracket in retirement when you were ready to dip into your IRA accounts?

Well, in that case, you would have $15,847 ($18,644 minus 15 percent, or $2,797 for taxes) after-tax in your traditional IRA, which is more than the $13,983 you had with a 25 percent tax rate. That would leave you just $2,797 short of the Roth.

That means as long you earned roughly 5.3 percent or more annually after-tax on your $1,000 tax-deduction savings - or, in other words, as long as you gave up less than a third of your annual return to taxes, which I think is doable if you invest in something reasonably tax-efficient like an index fund or tax-managed mutual fund could come out ahead in the traditional IRA rather than the Roth.

In short, the tax rates you face prior to and at the time you withdraw your money can also determine whether a traditional IRA or Roth is a better deal.

Generally, if you expect to be in a lower tax bracket at retirement than you were when you made the contribution, then the traditional IRA is the better deal since you're effectively avoiding tax on your contribution and earnings when the tax rate is higher and paying it later when the rate is lower.

If you expect to be in a higher bracket when you withdraw the money, then Roth is the better choice because you're paying tax at a lower rate and avoiding tax when the rate would be higher.

Retirement savings doomed by fees
And if you expect to stay in the same bracket, the Roth is the better choice because of its inherent advantage of effectively sheltering more money. As a practical matter, however, we can't always know whether we'll be in a higher, lower or the same tax bracket in the future.

Most people probably expect that their taxable income will fall in retirement, dropping them to a lower tax rate. But if you save like a demon and have tons of money in tax-deferred accounts like a 401(k), the withdrawals could push you into a higher bracket, at least in some years. And, of course, there's always the possibility that Congress could raise rates in the years ahead.

Which brings me back to my position that I think it's a good idea for most people to have at least some money in a Roth. Most people are likely to have the bulk of their retirement savings in a regular 401(k), which means withdrawals will be taxable (except, of course, any nondeductible contributions, if you made them). So a Roth provides a way of diversifying your tax exposure and gives you more flexibility for managing withdrawals (and your tax bill) in retirement.

If it appears you're about to move into a higher bracket in a given year in retirement, for example, you can pull tax-free money from your Roth. But there are also other reasons to do a Roth. Whether you want to or not, you've got to begin making required minimum draws from traditional IRAs after reaching age 70 1/2.

When to cash in your IRA
With a Roth, however, you can leave your money in there to compound tax free as long as you want - and even give the gift of tax-free returns to your heirs. And unlike withdrawals from IRAs and 401(k)s, the money you pull from a Roth isn't counted in determining whether any of your Social Security payments are taxed. So having access to a Roth could help keep the IRS's mitts off your Social Security benefits. To sum up, it's tough to say whether a traditional IRA or Roth is always a better deal for a given person. But for the reasons I've laid out in this column, I believe it's a good idea for everyone to consider putting at least some money in a Roth, whether you do so through regular annual contribution, converting a regular IRA to Roth IRA or, if those routes are out, doing a nondeductible IRA that you latter convert.

Even if it turns out in retrospect that the Roth wasn't the best deal, having access to a pot of tax-free cash can still give you peace of mind and a bit of maneuvering room in retirement



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