What You Need to Know About Complicated Retirement Plan Structures
At one point, people retired with Social Security benefits and perhaps a pension, but that’s rarely the case anymore. These days, many people are relying on a number of plans for retirement income, and each contributor to the family retirement plan seems to have a complicated set of rules and structure. For example, separate guidelines and regulations apply to Social Security benefits that are completely different than those for a 401k plan, an IRA and a pension, making overall wealth management a daunting task for many. Contribution requirements, withdrawal rules and tax benefits all vary among these plans.
So, when it comes to retirement plans, a pension and wealth management, here’s a quick overview of some of the most common retirement programs and their structures:
To qualify for Social Security benefits at retirement, you need to have earned a total of 40 Social Security credits. In 2019, you earn one credit for $1,360 in earnings; the earnings figure is adjusted periodically. You can earn up to four of these per year, so most people qualify if they are working consistently and have a minimum of 10 years of work experience.
The amount of benefits you receive depends on your income. You are eligible to receive full Social Security benefits when you’ve reached your full retirement age, as determined by the Social Security Administration. Your full retirement age occurs according to the year of your birth. For people born between 1943 and 1954, for instance, that age is 66. For people born in 1960 and later, the age is 67.
The decision on when to begin receiving Social Security benefits can affect the amount of benefits you’ll receive, so pre-retirees should take into account both the amount and their expected longevity before making a decision.
Folks become eligible to draw early Social Security benefits at the age of 62. However, these benefits are reduced by a certain percentage if you elect to take them early, since that means you will be drawing them for a longer period of time compared to someone who takes them at their full retirement age or later. Someone born in 1960, for example, would have their benefits reduced 30 percent if they retired at 62 rather than 67. The reductions stay in force throughout the time you draw benefits (in other words, for the rest of your life).
On the other hand, if you elect to take Social Security benefits after your full retirement age, the amount increases by roughly 8 percent each year from the time you start until you reach 70, after which there are no further increases. These increases are also in force throughout the time you receive benefits.
Social Security benefits are taxed only if your "provisional income" is higher than $25,000 ($32,000 for married couples filing jointly). Provisional income is your modified adjusted gross income with any tax-exempt interest and 50 percent of your Social Security benefits added back in. If you reach that earnings level, from 50 percent to 85 percent of your Social Security benefits are subject to federal tax.
All of these considerations become doubly complicated for a married couple since both spouses may have a Social Security earnings record and the claiming strategy should be coordinated between the spouses to optimize the family’s retirement income.
Taking Social Security benefits can obviously be very complicated, so it’s recommended that you talk with your financial advisor before making a decision. What worked for a friend, may not work for you.
401(k)s and IRAs
Both 401(k)s and Individual Retirement Accounts (IRAs) are private pension plans. Companies sponsor 401(k)s, and contributions are taken out of a participant’s paychecks pre-tax. Individuals can open IRAs and contribute funds up to a maximum of $6,000 in 2019 ($7,000 for those 50 or older).
To withdraw funds from a 401(k) plan, you must be vested. You should receive a vesting schedule from your plan administrator.
Withdrawals also depend on your age. Participants in 401(k) plans can begin withdrawals without penalty when they retire, if allowed by the Plan, or at age 59-½. These withdrawals are taxed at your ordinary rate. Withdrawals before age 59-½ generally involve a penalty tax of 10 percent in addition to the regular income tax.
You are required to start 401(k) distributions when you reach the age of 70-½. The IRS publishes a table that provides a calculation of the Required Minimum Distribution you must take from your plan in order to comply with this rule. Failure to begin these required distributions can result in hefty tax penalties: Up to 50 percent of the amount you should have withdrawn is assessed. If you are still actively working for the company sponsoring your 401k plan after the age of 70, you may be exempt from the age 70-½ rules.
The rules for withdrawals of traditional IRAs are very similar to those with 401(k)s. You can begin withdrawals from traditional IRA accounts without penalty beginning at the age of 59-½, and are required to begin withdrawals at 70-½ or be hit with the same 50 percent tax penalty.
The required distributions are calculated by using your account balance divided by the Internal Revenue Service’s Uniform Lifetime Table. Withdrawals from traditional IRAs are taxed, because the original contributions conferred a tax advantage in the year of contribution. Withdrawals are taxed at the ordinary rate.
With Roth IRAs, no Required Minimum Distribution (RMD) after age 70-½ is mandated. You can begin withdrawals at 59-½ if your funds have been in a Roth IRA for a minimum of five years. But money in a Roth IRA, unlike that of a traditional IRA, does not ever have to be withdrawn. You can keep a Roth IRA account accumulating as long as you want.
Roth IRA withdrawals are also never subject to tax, because the contributors receive no tax advantage in the year of contribution.
Pensions from a company can give you income in retirement. The eligibility requirements and rules on withdrawal are usually set by the company. As a result, you need to contact them to receive information on the potential amount, what year you can begin receipt of the pension and any rules or regulations that apply.
Pensions are usually taxed at the ordinary income tax rate.
Stocks, Bonds and Savings
If you have stocks, bonds and savings accounts that you plan to use in retirement, there is no specific set of rules about your age and RMDs that apply. Unlike stocks or bonds held in 401(k)s or traditional IRAs, you can hold stocks and bonds in non-retirement accounts as long as you like, subject only to the maturation date of the bonds. The maturation of bonds is not related to your individual age or retirement plan.
Similarly, savings in money market accounts can be held as long as you like. If you’ve purchased Certificates of Deposit (CDs) in non-retirement accounts, it’s important to pay attention to the maturity date, because you may be assessed a penalty if you withdraw before then. But these penalties are related only to the terms of the CD, not to your age or retirement or income tax status.
Interest income is taxed at an ordinary rate. Stock and bond withdrawals made from sales of investments are subject to taxes on capital gains. These tax rates are generally lower.
As you can see, there are a lot of complicated rules to the different retirement plans, so it’s prudent to discuss retirement withdrawals and your tax situation with a financial advisor. Make sure you address any and all retirement plans you have, including IRAs, 401ks, pensions and wealth management as a whole.