Maximizing Your Retirement Savings

You have contributed to Social Security your entire life, and now you wonder if it will be there for you when you are ready to retire. None of us have that answer, but there are ways to help ensure you maximize your opportunities to save for retirement.

First of all, if you are employed and have access to a qualified plan, you should contribute the maximum amount possible. If you are not able to contribute the maximum amount allowed, you should at least contribute the percentage matched by your employer. For example in 2009, you are allowed to contribute up to $16,500 to a 401(k) or 403(b) (if you are age 50 or older that amount increases to $22,000). If you cannot financially afford to contribute the $16,500, but your employer matches the first 5% of your contributions, then you should make every effort to contribute the full 5%. Otherwise, you are “leaving money on the table” that could be invested for your retirement.

Secondly, if you have contributed the maximum amount you can to your qualified plan or if you do not have access to a qualified plan, you can open or add to your traditional IRA. Your contributions to a traditional IRA may be tax deductible depending on your modified adjusted gross income and whether or not you and/or your spouse has access to a qualified plan at work.

Now is an excellent time to invest tax-deferred, whether it be in a qualified plan at work or an IRA because the market is currently down and we know we should try to “buy low and sell high.” It’s often difficult to continue investing when you see your account decrease in value, but remember if you continue your contributions while the market is down, you increase your chance of having more dollars in retirement.

Avoiding Penalties for Early Retirement

Distributions from an IRA prior to age 59 ½ may be subject to a 10% IRS penalty in addition to ordinary income taxes. Under Internal Revenue Code 72(t), there are certain exceptions that will allow the 10% penalty to be waived by the IRS, such as death, disability, medical expenses greater than 7.5% AGI, Substantially Equal Periodic Payments, etc.

The Substantially Equal Periodic Payments portion of the IRS Code 72(t) is of particular importance to early retirees, because it allows a person to access their IRA funds prior to reaching age 59 ½ without paying an additional 10% penalty. There are certain conditions that must be met, however, to take advantage of this exception. The conditions include:

• Payments have to be based on the IRA owner’s life expectancy or joint life expectancy of the IRA owner and his/her beneficiary
  
• Payments must be substantially equal periodic payments
  
• Payments must be calculated using an interest rate no more than 120% of the applicable federal mid-term rate for either of the two months immediately preceding the month the distribution begins


• The IRA owner must continue the payments for the later of five years or until age 59 ½, whichever is longer

The three methods of calculating the 72(t) SEPP payments are:

Amortization method – think of this method the way you would your mortgage. The account balance is “amortized” over the IRA owner’s life expectancy or the IRA owner and designated beneficiary’s joint life expectancy. The interest rate used cannot exceed 120% of the applicable federal mid-term rate.

Annuity factor method – The account balance is divided by an “annuity” factor. The annuity factor can be derived by using up to 120% of the applicable federal mid-term rate, the attained age of the IRA owner and the
annuity table in Revenue Ruling 2002-62.

Required Minimum Distribution
method – The account balance is divided by the IRA owner’s life expectancy (use the IRS life expectancy table, either the single or uniform table). Just remember whichever table used must continue to be used for all subsequent years.

The annuity factor method often results in the highest income payment and the RMD method usually results in the lowest income payment.

Traditional vs a Roth IRA

There are two different types of IRAs available today, the traditional IRA (deductible and non-deductible) and a Roth IRA. Traditional IRAs are usually funded with pre-tax dollars, which means you will have to pay taxes on the entire amount when you withdraw your funds. Roth IRAs are funded with after-tax dollars, and can be taken tax-free when certain conditions are met. You may be hearing a lot lately about converting your traditional IRA to a Roth IRA in order to take advantage of tax-free withdrawals in retirement. In 2010, more people will become eligible for Roth Conversions because of the Tax Increase Prevention and Reconciliation Act of 2006. Currently, an individual with modified adjusted gross income of more than $100,000 (either married filing jointly or single) cannot qualify for a conversion. Beginning in January, 2010, however, anyone regardless of their income will be able to convert. In addition, the income taxes due for the conversion can be paid over two years (remember the amount converted will be added to your income for the year) rather than having to pay all the taxes in one year. With this new legislation you will be able to include half the amount converted when you file your 2011 taxes and the other half when you file your 2012 taxes.

There are many reasons you may want to consider converting your traditional IRA to a Roth, such as being able to take tax-free distributions of earnings after 5 years and age 59 ½ and the ability to pay taxes at possibly a lower tax bracket now than you would in the future. Whether or not to convert your traditional IRA to a Roth IRA will depend on many factors including your ability to pay the income taxes due from a non-IRA account, your time horizon before taking distributions (the longer you can wait to take distributions the better), and the difference between your current and future income tax bracket. As with any important financial decision, you should always talk with your personal financial advisor about your specific situation to determine whether it is the right choice for you.