Most qualified retirement plans offer significant tax benefits – if you’re willing to follow a few IRS-specified rules, that is. The federal government wants to make plans such as 401(k)s, Keoghs, SEP-IRAs and traditional IRAs available for specific needs, and has enacted laws to help eliminate potential abuses of these tax-advantaged investment alternatives.
Retirement Plans are Intended for Retirement
For one thing, the government wants to make sure that such savings (and income tax benefits) actually go towards providing retirement income. Stiff penalties for early withdrawal help encourage investors to hold off on receiving income from qualified plans until their retirement years.
The government also wants to make sure they can someday tax these accumulated funds. If you have a 401(k), a Keogh, a SEP or a traditional IRA, you must begin taking mandatory minimum distributions from your plan by April 1st of the year following the year in which you turn 70-1/2.
Although the tax code allows you to wait until April 1 of the year following the year you turn 70-1/2, it is generally a good idea to take your first mandatory withdrawal in the same year you reach that age. If you wait, you will have to make two withdrawals in the first year, doubling the amount of taxable income you must declare and potentially increasing your marginal tax bracket.
The amount you are actually required to withdraw each year, and which will be subject to taxation, is based on tables that estimate your remaining lifetime.
Calculating Your Required Withdrawals
It’s vital to maintain a disciplined process of taking minimum withdrawals from your qualified plans. That’s because if you don’t meet the required minimum distribution withdrawals, the IRS will impose a stiff penalty: 50% of the amount not withdrawn, plus the income taxes due. Ouch!
The good news is. the IRS has made calculating your required minimum distributions much easier. Based on your age, you simply divide your qualified plan balance as of the last day of the previous year by the factor from the IRS Pub. 590 table shown below. The resulting quotient is your annual required minimum distribution.
Uniform Lifetime Table
(For use by: unmarried owners, married owners whose spouses are not more than 10 years younger, and married owners whose spouses are not the sole beneficiaries of their IRAs)
|115 and over 1.9||1.9|
How Living Expenses Change During Retirement
There are some upsides to being a retiree – senior discounts, lower taxes, subsidized healthcare, and regular Social Security checks among them. On the other hand, mature Americans must contend with worrisome issues such as rising costs for medical care, long-term care, prescription drugs, and even basic necessities such as food and energy.
To determine your monthly expenses during retirement, you start by dividing costs into two categories: those you believe will change and those you believe will remain largely the same.
Costs You Believe Might Change
- Housing expenses – particularly if you plan to live in your paid-off home or plan to downsize to a smaller dwelling
- Medical insurance – which may shift from a premium for HMO coverage to a Medigap policy
- Costs for dependents – if you have children you believe will be self-sufficient by the time you retire
- Entertainment and travel expenses – for some people, these might decline precipitously; for others, they might be far higher
- Taxes – most retirees find their combined tax burden is less than during their working years
- Automobile-related costs – retirees generally drive less than workers who commute to their jobs every day, thus spending less on maintenance, tolls, gasoline, etc.
- Monthly contributions toward retirement savings accounts – not only can you stop making this contribution, you might even consider spending it!
Costs You Think Will Remain the Same
- Clothing – unless you previously spent large amounts of money on uniforms or other job-specific wardrobe items
- Household expenses – such as telephone, utilities, cable, etc.
Determine Your Individual Needs
Once you analyze all this information, you can determine your estimated monthly income needs as well as how large of an emergency fund to establish. This fund should be held in a liquid form such as a money market account, which provides stability for your funds as well as ready access to them.
Consider reviewing your estimated needs at least annually, because circumstances can and do change in today’s fast-moving world.
Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm. McCartin and Associates and Sound Income Strategies, LLC are not associated entities.