Funding your retirement “buckets”
Posted on September 1, 2016 by bob in MoneyWise
Since a synonym for “retirement” is “unemployment,” pre-retirees of every age should have a goal of accumulating resources for that day when they will cease working for a paycheck. By my count there are nine different “buckets” which can be funded during one’s working years for use during retirement. Not every option is available to each person, and most folks must decide how to deploy limited discretionary funds among the ones they can access. While a typical retiree may rely on one to four of these, using more can create flexibility. Here is a list of the nine buckets with some basic information about each.
1. Social Security — To qualify for retirement benefits, you or your spouse must pay in a specified quarterly over a minimum of 10 working years (40 quarters). The benefit amount depends on a variety of factors. From 0% to 85% of the benefit will be subject to federal income tax. Alabama income taxes do not apply.
2. Traditional pension — Fewer companies offer these, but governmental entities often do. Covered persons have to pick an annuity benefit structure at retirement—life only, joint and survivor, etc. Some provide cost of living adjustments. Benefits are subject to federal income tax; most if not all are Alabama income tax free.
3. Traditional IRA, 401(k), profit sharing plan, etc. — Contributions are usually deductible from taxes and distributions are subject to federal and Alabama income tax except for the withdrawal of any non-deductible contributions. Distributions are restricted before age 59.5 and specified distributions are required after age 70.5.
4. Roth IRA — Contributions are not tax deductible, but withdrawals after age 59.5 are income tax free. Contributions are subject to an income limitation and no distributions are mandated.
5. Taxable savings and/or investments — Whether bank accounts, mutual funds, or brokerage accounts, having some funds in this bucket can serve as a liquid reserve against emergencies both while working and during retirement. The tax treatment of interest, dividends, and appreciation depends on the character of the particular assets and how they are managed.
6. Life insurance cash value — If you have individually owned whole life, universal life, or variable life insurance coverage, the cash value may be accessible via policy loan or other means. Policy loan proceeds are not taxable while the policy stays in force. Other withdrawals, including via policy surrender, could trigger taxes, depending on circumstances, and the lapse of a policy with a big loan could be a taxable event. Life insurance cash value can also be converted to an annuity income stream.
7. Non-qualified annuity — Non-qualified means that the annuity is not an IRA or funded with other traditional retirement money. Contributions to non-qualified annuities are not tax deductible, but any growth inside the annuity is tax-sheltered until the time of distribution. Withdrawals can take the form of lump sums or annuity payments. Part of any annuity payment will typically be taxed and part will not, reflecting the fact that both pre-tax and after-tax money is inside the contract.
8. Home equity — As discussed in a three-part series earlier this year, a Home Equity Conversion Mortgage can be an effective means of accessing this asset income tax free.
9. Health Savings Account — Funded with pre-tax dollars during one’s working years, a balance remaining in an HSA at retirement can be used to cover medical expenses later. Among the issues in choosing where to deploy available funds during your working years are:
a. Where can I get the most bang for my buck while working — e.g., taking advantage of employer retirement contributions, such as 401(k) matching, or income tax savings from deductible contributions or sheltering within an account, and
b. Where will I get the most benefit once I retire — e.g., tax-free access to the money, relatively lower risk, cost of living adjustment on a benefit payout, etc.
The best decisions require you, or someone you can rely on for counsel, to understand the options and clearly evaluate the pros and cons based on your situation. The benefits of good choices and the grief associated with poor ones can be significant.
Alan Wallace
Alan Wallace, CFA, ChFC, CLU, is a Senior Private Wealth Advisor for Ronald Blue & Co.’s Montgomery office, www.ronblue.com/location-al. He can be reached at 334-270-5960, or by e-mail at alan.wallace@ronblue.com. | 4489988-04-16
