Retirement and Financial Planning

What to Expect from Retirement
Sources of Retirement Income
Information on Individual Retirement Accounts (IRAs)
Information on Keogh Plans
Information on Social Security
Retirement Plan Distributions
The Revocable Living Trust
Pacific American Advisors
The Pacific American Retirement and Financial Planning Analyzer

What to Expect from Retirement

Everyone wants to retire with adequate resources. Studies have shown that the five most pressing concerns for the majority of people who are planning to retire within ten years include the following:

Remaining comfortable and financially self-sufficient.
Maintaining a standard of living equal to the current one.
Not outliving all available assets.
Being able to pay all routine and necessary health care costs.
Making provisions for long-term health care, should the need arise.

Fortunately, most people who plan carefully are able to address these concerns and comfortably retire on an annual income that is between 70% and 80% of their current annual income.

To get a better understanding of your own likely financial situation after retirement, you should closely examine and analyze every potential source of income. If you are close to retirement age now, you must do what you can immediately in order to guarantee that you have adequate resources after your retirement and for the rest of your life. And even if retirement is still more than ten years away, the earlier you begin to plan for life after retirement, the more effective that plan will ultimately be. To assist you we have created the interactive Pacific American Retirement and Financial Planning Analyzer.

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Sources of Retirement Income

Social Security

Social Security provides approximately 39% of the average individual's retirement income, and even less for anyone with a higher income. To find out how much you will receive when you are eligible, call 1-800-772-1213 and ask for a Request for Earnings and Benefit Estimate Statement (Form SSA-7004-SM). Once you receive the statement, look it over carefully and make sure the earnings amounts shown are correct; you only have three years to correct any errors.

Employer-Sponsored Retirement Plans

Employer-sponsored pension plans usually account for about 18% of the average individual retirement income. The amount you will receive from any plan depends on your salary, the number of years you were with the sponsoring firm, and the size of the firm's contribution.

Many employers are now offering 401(k) plans that allow employees to save for their retirement by making tax-deductible contributions that grow on a tax-deferred basis until retirement. Some employers make matching contributions to these plans, and if this is true in your case it is important that you maximize these matching contributions. Contact your employer's benefits department to find out what you can expect to receive from any retirement plan.

Keogh Plans

People who are self-employed can make tax-deductible contributions to most Keogh plans totaling 25% of their gross annual income and up to a maximum of $40,000, whichever is less. These investments, like 401(k) plans, also grow on a tax-deferred basis until retirement.

Individual Retirement Accounts (IRAs)

IRAs are not tax-deductible for individuals with higher incomes, but they still offer tax-deferred growth until retirement. For tax years 2002 through 2004, the maximum combined contribution to a traditional IRA and Roth IRA is generally limited to $3,000 (if married, up to $3,000 on behalf of each spouse, even if one spouse has little or no compensation). For 2005 through 2007, it will be $4,000, and in 2008, it will be $5,000.

Catch-up Contributions

For tax years 2002 through 2005, an individual who will be at least 50 years old by the end of the tax year is able to make an additional contribution of $500 to a traditional or Roth IRA. After 2005, the maximum annual amount of the "catch-up" contribution will be $1,000.

In general, younger individuals should invest in more aggressive portfolios that include more risk because these investments have a chance to recover from the occasional drop in value. As you approach retirement, you may wish to reduce the level of risk in your portfolio so that market fluctuations do not endanger your investments when you will most depend on them for income.

Post-Retirement Earnings

Some people plan to continue working when they reach retirement age. While this is a viable option for some individuals, the various health issues related to retirement age can sometime make it impossible for a person to depend on this. Also, any post-retirement income that you earn will reduce the amount of the social security benefit that you are eligible to receive.

Additional Assets

The possibilities are everywhere if you know where to look. You may be able to use an insurance policy that has a cash value or even sell your current home and move into a smaller and more manageable one in order to provide some additional funds for retirement.

The following list identifies some of these 'other' types of potential retirement assets:

Your home, real property and business interests (partnerships and proprietorships)
Stocks, bonds, savings, checking accounts, CDs, cash and loans owed to you
Personal property such as jewelry, antiques, paintings, rare books, stamps, coins and collectibles
Interest in a trust or an insurance policy with a cash value

Information on Individual Retirement Accounts (IRAs)

IRA Definition

An individual retirement account (IRA) is a tax-favored retirement account that you can establish for yourself or for a beneficiary. Usually it is created as a trust or custodial account with an organization acting as the trustee or custodian. Each year you can make contributions that are held and invested for use when you retire.

How to Qualify

If you receive compensation (wages, salary, commissions, tips, fees, bonuses, etc.) or are self-employed, you qualify.

Traditional IRA

In a traditional IRA, your annual contributions may be tax deductible from your gross income, but the amount of the contribution is limited to $3,000 per individual. For contributions to be tax deductible:

You cannot be participating in an employer-sponsored retirement plan, and
your adjusted gross income must fall within IRS guidelines.

Even if your contribution is not tax deductible, once contributed your investments grow without tax liability until they are withdrawn at retirement. If you withdraw funds from a traditional IRA before age 59 and one-half, you are subject to a 10% penalty tax in addition to ordinary income tax.

Additionally, you must accept minimum distributions from a traditional IRA by April 1 of the year following the year that you reach age 70 and one-half. If you fail to take these minimum distributions, you face a 50% excise tax on the amount you should have withdrawn but did not.

Roth IRA

A Roth IRA allows only nondeductible contributions, but withdrawals are tax free if you satisfy the requirement that there can be no distributions within the five-year taxable period beginning with the year of your contribution. High-income individuals are not eligible for Roth IRAs. For those who qualify, funds may be distributed tax free from your Roth IRA under the following circumstances:

On or after you attain the age 59 and one-half
To your beneficiary (or your estate) after your death
If you are disabled or for "qualified first-time home-buying expenses"

Roth IRA contributions are limited to $3,000 per individual. Taxpayers may roll over amounts from existing IRAs into a Roth IRA with certain restrictions. If you withdraw funds from a Roth IRA before age 59 and one-half, you are subject to a 10% penalty tax in addition to ordinary income tax.

Education IRA (Coverdell Education Savings Account)

A Coverdell education savings account is an investment vehicle targeted to education expenses, not to retirement. It is intended to pay for a child's qualified higher education as well as elementary and secondary educations expenses (i.e., kindergarten through grade 12). For tax years beginning after December 31, 2001, the maximum annual non-deductible contribution that can be made to an education savings account is $2,000. The beneficiary of the account must be under 18 at the time of the contribution. Distributions for qualified education expenses of the beneficiary are tax-free.

Information on Keogh Plans

Keogh Plan Definition

A Keogh (pronounced kee-oh) plan is a tax-advantaged retirement plan for self-employed individuals (sole proprietors, partners, or unincorporated professionals). Investors are not eligible for these plans.

Tax Advantages of a Keogh Plan

Your contributions are deducted from your gross income for income-tax purposes. These contributions and subsequent earnings (growth of funds within the plan) are not taxed until withdrawn, usually at retirement.

Employee Coverage

Your seasonal and part-time employees need not be included. Similarly, employees under the age of 21 or who have less than one year of service need not be included. Contributions made for them are also tax deductible.

Contributions

There are two kinds of plans -- a defined contribution plan and a defined-benefit plan.

A defined contribution plan establishes an individual account for each participant and pays benefits based solely on the amount in the account at the time of distribution. For 2002, the annual contribution and other additions to a participant's account may not exceed the lesser of 100% of the compensation actually paid to the participant or $40,000.

A defined-benefit plan is designed to provide a specific benefit amount at retirement. This amount is based on age, anticipated retirement date, and other factors. Tax law restricts the payable benefit to the average of your three highest consecutive years' earnings (or a top figure that changes with each tax year).

You may contribute to either kind of plan until the due date of your tax return (plus extensions), but the Keogh plan must be in existence before the end of the taxable year in order for a contribution to be deducted for that year.

Investment of Funds

You may work with an investment advisor to identify investments that meet your needs. Plans vary, however, in how much discretion you have and certain types of investments are not allowed.

Taxation of Funds at Retirement

You have three choices:

1) You can receive benefits as an annuity or in installments over a period of years. These benefits will be taxed as ordinary income.

2) You can receive a lump-sum distribution that is taxed in the year received (unless nondeductible plan contributions were made). You may qualify for "forward averaging," which allows your lump sum to be taxed as if received over a period of years, resulting in a lower tax bill in most cases.

3) You may roll over (transfer) your distribution into an individual retirement account (IRA). This allows your assets to continue to grow on a tax-deferred basis although you must take minimum distributions during the year after the year that you reach age 70 and one-half or face a 50% tax on the amount you should have withdrawn but did not.

Information on Social Security

How Much You Pay

If you are an employee (not self-employed), your employer withholds a 7.65% Social Security tax from your earnings. You also pay a matching amount for a total of 15.3% up to an annual earnings limit. These taxes are used to finance Social Security and Medicare benefits. If your earnings exceed a certain amount, your tax on any income beyond that point is only 2.9%, which includes both your portion and your employer's portion of Medicare tax payments.

Retirement Age

Currently, you become eligible to receive full Social Security benefits at age 65 if you were born before 1938. Beginning in 2003, the age at which full benefits are payable will increase in gradual increments from 65 to 67 (for those born in 1960 or later). No matter what your "full" retirement age is, you may start receiving benefits as early as 62. However, if you start your benefits early, they are reduced five-ninths of one percent for each month before your full retirement age.

Benefit Amount

The amount of your Social Security benefit is based on your date of birth, the type of benefit you apply for, and most importantly, your lifetime earnings. To find out how much you will receive, request a Social Security Statement by visiting their website at www.ssa.gov/mystatement or call 1-800-772-1213. Once you have received your statement, be sure to check your earnings record carefully. You share responsibility with your employer for making sure all of your earnings have been reported and that they are accurate.

How to Apply

If you are approaching retirement age, you must apply for Social Security benefits. Contact your local Social Security office before you retire for details.

Tax on Benefits

Social Security benefits are taxable, based on a "provisional income" formula.

Earning Income During Retirement

There are varying limits on how much you can earn, depending upon your age, without reducing your Social Security benefit payments.

Retirement Plan Distributions

If you leave your present employer before retirement age and if you are vested in your employer's qualified retirement plan, you may be entitled to a withdrawal of your funds, or a "distribution"'. A distribution is typically classified as (1) an eligible rollover distribution or (2) a lump-sum distribution -- or sometimes both. You may want to seek the advice of a professional retirement planner at Pacific American when weighing these various options.

Eligible Rollover Distributions

A rollover distribution is a type of payment that can either be transferred to another account or cashed by you. Distributions cannot qualify as eligible rollover distributions if they are:

Periodic payments made annually (or more frequently) and based on a person's life expectancy, or
made after age 70 and one-half as a minimum-required distribution.

If your distribution qualifies as an eligible rollover distribution, you may do one of three things:

1) You may roll over (transfer) your distribution directly into an individual retirement account (IRA) or into your new employer's retirement plan. This allows your assets to continue to grow on a tax-deferred basis until retirement.

2) You can receive a cash distribution that is fully taxed in the year received, unless you made nondeductible plan contributions, which are not taxable. If you are under the age 59 and one-half, however, you may have to pay a 10% early withdrawal penalty.

3) You can receive a cash distribution and roll it over into an IRA or into a new employer's plan within 60 days of receiving it. This option is complicated, however, by a 20% withholding requirement.

Lump-Sum Distributions

To qualify as a lump-sum distribution, the payment must represent the entire amount and must be made in a single taxable year. A lump-sum distribution is payable under the following circumstances:

If you leave your employer
After you attain the age 59 and one-half
As a result of a disability if you are self-employed
As a result of your death

A lump-sum distribution also qualifies as an eligible rollover distribution, so you are entitled to choose between the same three options offered for an eligible rollover distribution:

1) Roll over your distribution directly into an IRA or into your new employer's retirement plan.

2) Receive a cash distribution that is fully taxed in the year received - with no 10% penalty.

3) Receive a cash distribution, and roll it over into an IRA or into a new employer's plan within 60 days after receiving it (subject to 20% withholding).

If you were born before 1936, and were a qualified plan participant before 1974, you may pay a 20% tax on the portion of your distribution attributable to your pre-1974 contributions. This option is lost when you use an IRA roll over.

The Revocable Living Trust

Many people find it is helpful to establish a revocable living trust to manage their investment program and to simplify their estate planning. Because this type of trust is revocable, you can change the terms of the trust at any time. You can design your trust to operate only if you become disabled or incapacitated, or you can use it to administer your assets when you die so that they are distributed according to your wishes and avoid probate court.