What’s in it for me? A step-by-step guide to saving for retirement.
There’s nothing more satisfying than a hard day’s work.
But after spending a couple of decades earning a paycheck, a little rest and recuperation would be nice, too.
So, are you on track to meet your retirement goals?
For an increasing number of workers, that's a tough question to answer.
In today’s world of volatile markets and ever-changing tax laws, designing an effective retirement savings plan is more difficult than ever.
Luckily, these blinks are here to help.
Drawing on Ed Slott’s decades of experience as a financial expert, this practical guide lays out the common problems plaguing savings schemes, then walks you through a five-step program to get your retirement plan on track.
With the detailed advice provided here, your financial future will be more than secure.
In these blinks, you’ll learn how one fumble can end a legendary savings career; why 2010 was a great year to die; and what makes math useful in the real world.
Small changes in tax law can greatly impact your retirement plan.
Crack open a history book and you’ll find that the American story is packed with exciting events and monumental moments.
From the Revolutionary War to the moon landing, the United States has had plenty of highlights.
But alongside these hits, there’s a less-celebrated but equally important story – the history of US tax law.
In the beginning, America had no income tax.
Then, in 1913, the Sixteenth Amendment introduced a modest 7 percent tax.
Since then, the rate has gone up and down.
It reached a peak of 90 percent throughout the 60s, and today it hovers around 37 percent.
You see, US tax law is always changing.
Understanding the nuances of this system is crucial for preparing for retirement.
The key message here is: Small changes in tax law can greatly impact your retirement plan.
So why is understanding tax law so important for planning your retirement?
Well, for one, changes in the tax code can greatly affect how much of your money you get to keep and how much ends up in the US Treasury.
Most people don’t pay careful attention to how changing tax laws impact their savings, and as a result, may end up paying more to Uncle Sam than they really have to.
Consider this: In past generations, people didn’t rely on personal retirement accounts.
Most people funded their retirement through a mix of Social Security payments and company pensions.
Then, in 1974, the government introduced Individual Retirement Accounts, or IRAs.
This legislation let people save for retirement by placing money in special tax-deferring accounts.
The money you saved in an IRA wasn’t taxed, at least not right away.
Of course, tax law is always changing.
And while people carefully scrimped and saved to fund their IRAs, the government didn’t keep up its side of the bargain.
On December 20, 2019, Congress passed the SECURE Act.
Among other things, this law changed how the money in IRAs is taxed.
Suddenly, people who were expecting to pay one tax rate were now expected to pay a completely different one, especially if they were planning on leaving their IRA to their heirs.
That means that while diligently putting savings into an IRA has been a standard retirement practice for decades, the rules have now slightly changed.
While you can continue saving as normal, you may end up paying more in taxes than you realize.
You can avoid this pitfall, though; we’ll delve into how in the next blink.
There are four general strategies for managing retirement savings.
Let’s say you’ve been working at the same company for two decades.
A lumberyard, for example, or a law firm; the actual job doesn’t matter.
What does matter is that you’ve been regularly depositing money into a company retirement plan the whole time.
By now, you’ve got a hefty sum saved up.
When you leave the company, whether you’re retiring, getting fired, or just taking a new job elsewhere, you’ve got to decide how to handle that nest egg you’ve accumulated over the years.
What should you do?
Well, that depends.
There are different ways to manage your retirement savings and each has different tax implications.
The key message here is: There are four general strategies for managing retirement savings.
Managing retirement savings can be very complicated.
But, luckily, in the situation described above, you really only have four options.
You can either, one, leave the money where it is.
Two, move the money into a new IRA account.
Three, withdraw the money as a lump sum.
Or, four, convert the savings into a Roth IRA account.
Let’s take a look at the tax implications of each.
The simplest action is no action at all.
Simply leave your retirement plan alone.
But some companies don’t allow this; you might have to move the money into an IRA instead.
Putting savings in an IRA makes sense because it’s tax-deferred – that is, you don’t pay until you start making regular withdrawals in retirement.
Use a trustee-to-trustee transfer to move the money without being taxed, or perform a rollover.
A rollover lets you withdraw your money.
If you deposit it into another IRA within 60 days, it isn’t taxed.
Now, if you’d rather spend your money than continue saving it, you can always withdraw your savings from your retirement account.
This is called a lump-sum distribution and it frees you to spend your cash as you please.
Distributions are taxed, though.
The exact amount varies depending on your unique circumstance, but in general, you’ll be taxed about 20 percent.
This could be higher if you’re well below retirement age.
Finally, you can convert your savings into a Roth IRA.
This is a special fund that isn’t taxed when you start making regular withdrawals in retirement.
To get this benefit, you must pay taxes on your Roth deposits up front.
It’s a tough deal at first, but you’ll probably save more money in the end.
And that is the goal of retirement, isn’t it?
Meet Robert.
Your retirement income depends on your age and savings level.
Robert just ended a long career as a high school math teacher.
Now, at the ripe old age of 72, he’s going to retire.
Congratulations, Robert, you’ll never have to work your way through a knotty set of complex equations ever again.
If only that were true!
Now that Robert is retired, he won’t be receiving a salary.
Instead, he’s going to pay his living expenses by making regular withdrawals from his IRA savings account.
And, unfortunately, the laws passed by congress make this process a bit confusing.
If Robert wants to stay on the right side of the law, and get the most out of his savings, he’ll need to keep those math skills fresh.
The key message here is: Your retirement income depends on your age and savings level.
The money you save in an IRA is meant to replace your salary in retirement.
So, after you retire, you’ll begin drawing funds from your IRA.
These withdrawals are sometimes called distributions and are taxed as income.
The size of your annual distribution and how much it’s taxed depends on several factors including your age, how much savings you have, and a whole array of complicated addendums and loopholes.
You can make distributions at any time.
But if you do so before the age of 59 and a half, you’ll have to pay an additional 10 percent early-distribution penalty on top of the normal income tax rate.
So if you withdraw $5,000 at age 40, you’ll pay a $500 penalty.
However, this extra levy won’t apply if you’re using the money for disability or medical expenses, higher education fees, or to buy your first home.
Now, you don’t have to start making withdrawals until you reach your required beginning date, or RBD.
For most people, the RBD is April 1 after they turn 72.
After this date, you’re required to make a required minimum distribution, or RMD.
Your RMD is calculated by dividing your total IRA savings by your life expectancy as estimated by the IRS Uniform Lifetime Table.
Let’s return to Robert.
At 72, the Uniform Lifetime Table gives him a life expectancy of 27.
4 more years.
So, if Robert has $500,000 in his IRA, his RMD is $18,248.
17.
This is how much Robert should distribute this year, but he needs to recalculate that number each year from now on.
If he follows this requirement, he’ll always have some funds to rely on through his well-earned golden years.
Help out your heirs with a stretch IRA.
There’s one unpleasant fact that everyone has to face: Sooner or later, we’re all going to shuffle off this mortal coil.
When your time inevitably comes, you won’t be able to bring anything with you, so it’s important to decide what happens to your estate when you're gone.
With physical objects, passing on your inheritance is easy.
Simply state in your will who gets what.
Maybe your house stays with your spouse, your car goes to your daughter, and your priceless antiques go to your art-collecting lifelong friend.
But what about your IRA?
Well, once again, the IRS has made this process into a complicated mess.
So it’s best to know the details.
The key message here is: Help out your heirs with a stretch IRA.
If you were an attentive saver throughout life, chances are your IRA will still contain a hefty sum when you die.
And passing on those savings used to be easy.
You just designated a beneficiary, then that lucky individual could continue receiving a required minimum distribution from your IRA until the money was gone.
This was known as a stretch IRA, as your heir could stretch out the distributions for decades.
The 2019 SECURE Act changed how this process works, though.
Now, in order to stretch an IRA, you need to qualify as an Eligible Designated Beneficiary, or EDB.
Only certain people can be designated as your EDB, including your surviving spouse, minor-aged children, and disabled individuals.
To ensure your chosen person gets the perks of a stretch IRA, you must designate them as a beneficiary before you die.
But what about everyone else?
Well, they’re Noneligible Designated Beneficiaries, or NEDBs.
A NEDB can still access your IRA funds but must withdraw them on a tighter schedule.
Specifically, they must completely empty the account within 10 years.
They can do this little by little or all at once, but they must do it.
If your NEDB fails to meet the ten-year deadline, they’ll be subject to a stiff 50 percent tax penalty on the remaining funds.
Ouch!
Importantly, both EDBs and NEDBs must pay taxes on IRA distributions as if they were income.
This is where EDBs have an advantage.
They can draw down the account more slowly, meaning they’ll probably pay lower taxes on each distribution and the account will have more time to grow tax-free.
Pay now to save later by investing in a Roth IRA.
Imagine you’ve retired.
Finally free from the drudgery of work, you spend each day doing exactly as you please.
You sleep in each morning, go golfing in the afternoon, and have drinks with your pals in the evening.
Your leisurely life is funded by your IRA distributions, and overall, it’s pretty great.
Still, it could be even better.
Imagine you’re receiving your regular IRA distributions but with fewer strings attached.
Imagine having no required minimum distributions, and more importantly, imagine paying no income tax on your withdrawals.
Sound too good to be true?
It’s not.
This scenario is completely possible thanks to a special saving scheme called a Roth IRA.
The key message here is: Pay now to save later by investing in a Roth IRA.
The IRAs we’ve discussed so far have been traditional ones.
The money deposited in these funds is tax-exempt when you save it, but you pay income tax later on, when you distribute it.
Roth IRAs, which were first introduced in 1998, work the exact opposite way.
With a Roth IRA, you still pay income tax on the money you deposit, but from that point on, these funds are never taxed.
At first, this may seem like a strange arrangement.
After all, why pay now when you don’t have to?
Couldn’t you invest the difference and end up with more money down the line?
In some cases, maybe.
But, for most people, Roth IRAs are a better deal.
Due to Social Security, investment income, and other factors, most people retire into a higher tax bracket, so taking distributions from a tax-free Roth IRA saves a lot of money.
There are two ways to begin saving with a Roth IRA.
The first is by making annual contributions.
As of 2021, if you make less than $125,000 a year, you can contribute up to $6,000 to your Roth IRA each year.
Or you could perform an IRA conversion.
This process lets you roll any amount of money from your traditional IRA into a Roth IRA – all you have to do is pay the appropriate income taxes on the amount of money you convert.
Once your money is socked away in a Roth IRA, you can’t convert it back to a traditional IRA.
You also can’t withdraw any distributions until five years after your first contribution.
However, once you’re over the age of 59 and a half, you’re free to withdraw those funds as fast or as slow as you’d like.
Avoid costly estate taxes by shifting your money into life insurance.
Bill Buckner was one of the best baseball players of all time.
He competed in an astounding 22 major league seasons, more than nearly any other player.
That’s not all.
Over his illustrious career, he had more hits than champs like Mickey Mantle, Reggie Jackson, and Joe DiMaggio.
But in 1986, he made a blunder.
In game six of the World Series, he fumbled an easy catch, letting the ball roll between his legs.
The error cost his team the game and eventually the title.
Just like that, his illustrious career was forgotten.
Most people only remember him for this one mistake.
Retirement savings work the same way.
Even if you carefully cultivate your nest egg over decades, a small error at the end could cost you your legacy.
The key message here is: Avoid costly estate taxes by shifting your money into life insurance.
Let’s say you’ve carefully saved for decades and your retirement accounts have grown into an impressive stockpile for you and your heirs.
The last thing you want is for all that work to get wiped away by taxes after you die.
Yet this is exactly what happens for many people.
Luckily, this blunder can be avoided using an unlikely tool – life insurance.
Remember, the IRAs you leave to your beneficiaries are subject to income taxes.
And if you’ve accumulated more than $10 million in assets, those same IRAs could also qualify for hefty estate taxes after your death.
In contrast, life insurance policies aren’t always taxed, either as income or as part of your estate.
So, in some cases, it makes more financial sense to invest in life insurance than in traditional IRAs.
It works like this.
Let’s say you want to leave money to your children.
Well, instead of putting that money in an IRA, place it in an irrevocable life insurance trust, or ILIT.
Then use that ILIT fund to pay the premiums on a robust life insurance policy for yourself, with your child designated as both the owner of the policy and the beneficiary.
This way, when you eventually pass on, the insurance policy won’t count as part of your estate.
Your child will receive the insurance payouts free of income and estate taxes.
Obviously, this process is a bit complicated and delivers the most benefits to those with very high levels of savings.
Still, it’s worth looking into if you want to keep most of your hard-earned cash for your loved ones.
Be careful not to lose your savings to high estate taxes.
Dan Duncan chose a good year to die, or at least, his ultimate end came at an opportune time for his heirs.
You see, Duncan was a very successful Texas oilman.
At the time of his death in 2010, he was worth somewhere close to $10 billion.
Back then, Congress had just eliminated the estate tax, letting Duncan’s lucky children inherit his fortune in full.
Now, however, the estate tax is back.
If Duncan died today, his children would need to fork over about $4 billion to the US government.
Of course, most of us aren’t nearly fortunate enough to worry about paying such a huge fee.
But still, if you want a say in how your savings are spent after you die, it helps to know the basics of estate planning.
The key message here is: Be careful not to lose your savings to high estate taxes.
The estate tax determines how much money your heirs pay to the US Treasury when they inherit your assets.
The exact amount has fluctuated over time.
Currently, the tax is about 40 percent and only kicks in for individual estates valued at more than $10 million.
If you don’t think this will ever affect you, remember that you may end up with more wealth than you think – and congress can always lower the threshold for taxation.
So it pays to know the exemptions.
For instance, the $10 million tax exemption is portable between spouses.
If one spouse dies, they can transfer their exemption to the surviving partner, effectively protecting their wealth up to $20 million.
Or you could lower the value of your estate by gifting it away before death.
The so-called gift exemption lets you transfer up to $10 million completely tax free.
Other strategies to protect your wealth after death include setting up a qualified terminable interest property trust, or QTIP trust.
This trust allows your spouse to access funds after you’re gone, but when they die, the excess money goes to your designated beneficiaries.
This is useful if your spouse wants to remarry, but you want your savings to go to your children and not their new partner.
You can also set up your IRA to distribute to an IRA trust.
This trust distributes money to your beneficiaries, but only in prearranged amounts that you determine.
This is useful if your selected heirs have trouble managing finances – after all, not everyone is as savings savvy as you.
Correct your mistakes before they become bigger problems.
In the previous blinks, we’ve outlined five points essential to securing an ideal retirement and protecting the future of your savings.
You should keep an eye on IRA distribution requirements, designate your heirs, look into Roth IRAs, buy life insurance, and learn the basics of estate planning.
In a perfect world, you’d be able to successfully follow each of these suggestions to a T.
Though in a truly perfect world, you’d also win the lottery and never have to worry about money at all.
Unfortunately, we live in the real world, and here, sometimes things go wrong.
No one’s saving strategy always goes as planned.
But if things go off the rails, there are ways to get back on track.
The key message here is: Correct your mistakes before they become bigger problems.
Saving for retirement is all about planning for the future, but sometimes the future brings situations we couldn't foresee.
Imagine a scenario where you need to access the money in your IRA sooner than expected.
Maybe you made a few bad investments and need to pay off debts, or you’ve decided to retire early.
As you recall, taking distributions before the age of 59 and a half usually incurs a 10 percent penalty.
However, this isn’t always the case.
It’s possible to withdraw from your IRA early without the fees through a process known as annuitizing.
Annuitizing your IRA lets you withdraw a set amount of money annually as long as you commit to doing so for five years without any modifications.
That money is yours to use and will hopefully alleviate any unexpected financial problems.
Another issue that sometimes arises is failing to take your required minimum distribution, or RMD.
This may seem like an innocent mistake, but the penalty for missing an RMD is a whopping 50 percent tax on the RMD’s value.
If you do make this slipup, it’s possible to get the fee waived by detailing the mistake with Form 5329.
Submit this with your next tax return and you may receive a waiver.
Of course, these are just two specific issues you may encounter in your financial life.
The laws governing IRAs are full of complex rules and regulations, covering everything from maximum contributions to which investment categories are permitted.
To avoid future problems, it’s always best to have a seasoned tax expert on retainer to sort out any potential issues.
Final summary
The key message in these blinks: Saving for your retirement requires careful planning, especially when it comes to navigating the rules governing private savings accounts and taxes.
What’s more, recent laws have eliminated so-called stretch IRAs in most circumstances, so passing money to your heirs is trickier than ever.
If you’ve accumulated a large nest egg, look into buying life insurance or taking advantage of the current loopholes in the estate tax law.
Actionable advice.
Look out for state taxes.
Most of the regulations we’ve looked at operate at a federal level.
But don’t neglect to follow state guidelines as well!
States often have specific rules and loopholes which can work to your advantage if you know them well enough.
Consult a tax professional to see which ones may apply to your case.
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