Creating a Solid Retirement Strategy

Creating a Solid Retirement Strategy

How to Create a Solid Retirement Plan

These days, preparing for retirement can feel like you’re in some sort of matrix. Not only are there more retirement investing options than ever, but the future looks very unsettled. How can you create a solid retirement plan in this environment?

Start with retirement asset location

How's Your Plan Working?This is simply about deciding where your retirement assets will be located. This is a critical decision because there are so many options.

Some people are content to accumulate all of their retirement assets in a single retirement investment vehicle. While that may be convenient, it’s not the best type of retirement planning from a strategic standpoint. Just as you would diversify your investment portfolio, you should also diversify your retirement plans. As the saying goes, don’t put all your eggs in one basket.

When it comes to retirement planning, there are a few basic options, and you’ll want to take advantage of them, especially from a tax standpoint.

Here are the primary options:

Taxable accounts. These are traditional investment brokerage accounts, or even mutual funds, that are held outside of tax-sheltered retirement plans. You should have a significant portion of your money in these accounts because they will enable you to withdrawal funds once you reach retirement age without incurring any tax consequences. They can also represent primary emergency funds after you retire, that way you can preserve your tax-sheltered accounts for income generation.

Tax deferred plans. These include employer-sponsored retirement plans, such as 401(k) plans, as well as traditional IRAs. These should represent the largest share of your retirement assets, since they are tax-deferred, and some have very generous contribution limits. They are however taxable upon withdrawal, which is why you need to diversify your money into taxable accounts and tax-free plans.

Tax-Free plans. This relates primarily to Roth IRAs. Though you get no tax deduction when you contribute to these plans, the investment earnings on the plan are tax-deferred. But more important, there’ll be no tax on withdrawals as long as you are at least 59 ½ and have been in the plan for at least five years when you begin taking them. This will mean that at least some of your income in retirement will be tax-free, and that will be extremely important if you have multiple income sources. You can contribute to $5,500 to a Roth IRA for 2015, or $6,500 if you are 50 or older.

How do you chose among these retirement plans?

Obviously, retirement investing in tax-deferred plans will be your first choice, since these will likely represent your most important income when you retire. If you have an employer-sponsored plan, such as a 401(k) plan, you should certainly enroll in the plan, particularly if the employer matches contributions. Failing that, you should set up your own IRA and fund it each and every year with the highest amount you’re able.

If you do have employer-sponsored plan, you should supplement it by contributing to a Roth IRA. There are income limits for Roth IRAs for those who are covered by an employer-sponsored retirement plan. But you can still make what is known as a “backdoor Roth IRA contribution”, by making a nondeductible traditional IRA contributions (there are no income limits for this), then doing a Roth IRA conversion (see below).

You should also fund taxable investment accounts, since you never want to have all of your money in tax sheltered plans. If you do, and you need something more than your emergency fund has, you’ll have to pay taxes and early withdrawal penalties to pull money out of your tax sheltered accounts.

It should go without saying that you should invest all you can in taxable accounts in the event that you are not covered by employer-sponsored retirement plan.

Basics on Social Security – But will it be there when your turn comes?

Social Security has become the giant X factor in retirement planning. As it is currently constructed the plan is fiscally unsound. That means at a minimum, we should expect less from it than current retirees are receiving.

There are at least three possible outcomes to the Social Security crisis – short of the plan blowing up and disappearing forever:

  1. Benefits will be reduced
  2. The retirement age will be increased, perhaps substantially
  3. We’ll be paid in inflated dollars that will have far less purchasing power than they do nowThis is why it is so important to make sure that you have retirement savings. They’re probably the best insurance we have against a partial or full default by Social Security.It’s also possible to manage how much benefit you receive from Social Security. For example, the later that you retire, the higher your monthly benefit will be.

    You can get an estimate of your future Social Security benefits, by going to the Social Security Administration’s Retirement Estimator page. On that page you’ll be given instructions on how to use the estimator, and what the qualifications are. You can use the estimator to run various scenarios as to what your benefit will be.

    How to rollover an IRA

    If you have IRAs, you’ll most likely be faced with the task of rolling one or more over at some point in the future.

    Any IRA account can be rolled over into another IRA without incurring a tax liability or penalties, as long as it‘s done in a timely manner (within 60 days of distribution). Employer-sponsored retirement plans can also be rolled over into an IRA upon terminating your employment.

    The rollover methods into an IRA are similar to what they are for a Roth IRA conversion (see below), except that the funds are being rolled over into a traditional IRA, not a Roth.

    How to convert a Traditional IRA to a Roth IRA

    You can also roll a traditional IRA over into a Roth IRA, but it‘s more complicated.

    Roth IRA contributions are limited to $5,500 a year ($6,500 if you’re 50 or older), however there are no dollar limits for IRA conversions to a Roth IRA. Also, the income limits that apply to Roth IRA contributions do not apply to Roth IRA conversions.

    Unless you are rolling one Roth IRA over to another, the rollover of funds from a traditional IRA will create a tax liability. The amount of the rollover will be subject to ordinary tax rates, but there will be no 10 percent early withdrawal penalty tax on the transfer.

    The tax bite can be substantial, as you will be exchanging a tax-deferred retirement asset for one that will be completely tax-free in retirement. For many people, that will be an exchange well worth making.

    The transfer must be done properly or the penalties will be severe. It is best to handle the Roth conversion with strong input from a competent tax expert, fully coordinated with the brokerage firms or trustees that are involved. Translation: Roth IRA conversions are not the time for the DIY thing.

    Here are the IRS rules on traditional IRA to Roth IRA conversions:

    • Rollover – You receive a distribution from a traditional IRA and contribute it to a Roth IRA within 60 days after the distribution (the distribution check is payable to you);
    • Trustee-to-trustee transfer – You tell the financial institution holding your traditional IRA assets to transfer an amount directly to the trustee of your Roth IRA at a different financial institution (the distributing trustee may achieve this by issuing you a check payable to the new trustee);
    • Same trustee transfer – If your traditional and Roth IRAs are maintained at the same financial institution, you can tell the trustee to transfer an amount from your traditional IRA to your Roth IRA.

    The conversion is reported on your tax return with the IRS Form 8606, Nondeductible IRAs. More information is available through IRS Publication 590, Individual Retirement Arrangements (IRAs).

    There’s a lot involved in retirement planning, and you’ll have to have a solid strategy as to how to approach it.