Topics Covered:

The Phases of Retirement Planning
The Basics of Saving and Investing
Retirement Programs Where You Work
Retirement Programs for Individuals
Where to Put Your Retirement Money
Case Study: The Consequences of Failing to Plan
Taking Money Out in Retirement


Retirement has changed radically over the last several decades in America. Years ago, when you expected to work most of your life for a single, large employer, you could count on a pension. Retirement planning meant figuring out how to use your free time when you stopped working, not calculating rates of return and deciphering tax rules. You didn’t have to worry — enough money would be there from your pension and Social Security.

All federal employees, 80 percent of state and municipal employees, but just 20 percent of private-sector employees are enrolled in pension plans, and the numbers continue to drop, according to the Congressional Research Service (“401(k) Plans and Retirement Savings: Issues for Congress,” 2009). Even though fewer and fewer Americans enjoy the security of company- or government-sponsored pension plans, retirement still means not working for a wage and having more time for yourself. But, as importantly, it means that in all likelihood you will be living on money you, yourself, saved. In addition to having enough to fund your retirement, you must make sure that, once retired, your investments continue to produce at the same time you are tapping into them to meet expenses.

This change from institution-funded to self-funded retirement constitutes a dramatic shift of responsibility. The magnitude of what is required to go from being cared for financially in retirement by your employer to providing for yourself has not fully hit home for most Americans.

What, then, are the implications? Most importantly, it means retirement planning must span the entirety of your adult life — it is not just something you figure out while cleaning out your desk the day you turn in your keys and say goodbye to co-workers. Additionally, good planning takes time and effort and you bear the responsibility for steering your own course, whether it be done on your own, with help, or by delegating to professionals.

In general, the more you maximize your income and saving and control spending while working, the better off you will be in retirement. Obviously, the fewer resources you have and the more challenges you face (i.e., caring for a disabled child or a frail, elderly parent) the more important it is for you to be fully engaged in understanding your options, get the expertise you need, and make good decisions.

This section provides you with information you can use no matter where you are in the continuum of retirement planning, which begins in early adulthood (when you are getting established and choosing your pattern of saving and spending) and continues on for the remainder of your natural life.

The Phases of Retirement Planning

Without question, the core strategy to succeed in having enough for retirement is living well within your means. Keep in mind, there are significant differences in approach depending on your priorities, age, circumstances, income, and tax bracket. One size does not fit all. But generally speaking, you gain more flexibility and choice the earlier you start putting aside funds for retirement.

Explained below are the five phases of retirement planning and the key aspects of good planning to be carried out during each phase.

PHASE I: Accumulation

This period begins when you enter the workforce and begin setting aside funds for later in your life and ends when you actually retire. A consideration in choosing an employer should be the amount they will contribute to your retirement savings and if they have a pension plan. Sign up for the 401(k), 403(b), or 457(b) plan if offered and contribute the maximum allowed as soon as you start working.

Because you have a number of savings goals (not just retirement) it is tempting to postpone getting started on earmarking savings for retirement. However, it is wisest to acknowledge that the new normal requires retirement savings rates for most Americans to exceed 10 percent, according to the Financial Planning Association. The lower your income, the more of it needs to be saved for retirement because low-income individuals will need to live on 90 to 100 percent of their current income in retirement as opposed to 70 to 90 percent for higher-income individuals.

PHASE I also represents the time when you earn credits for Social Security and private pension benefits. The amount you receive from Social Security is calculated on the amount you contribute over at least 40 quarters during your working years. When self-employed individuals maximize deductions to avoid taxes, they may not realize they are also cutting back on payroll taxes which, in part, determine how much they will receive from Social Security in retirement. Typically, private pension payouts are determined by years of service and your last several years of wages.

This initial stage of saving for retirement can easily last 30 years or more. Therefore, it is tempting to do nothing for quite awhile. However, because of the power of compound savings (taking the interest earned and reinvesting it along with regular additional contributions) you gain a great deal by getting started as early as possible.

PHASE II: Pre-Retirement

This phase occurs during the final years of the accumulation phase and should begin when you reach 50 years old or are 15 years away from retiring, whichever happens first. Now is the time to get your plan in place, making sure your finances are lined up correctly for retirement day so nothing will be left to chance. If you work for a company with a benefits specialist, arrange an appointment to become informed about the various ways you can convert your employer retirement savings into a stream of income or an IRA. Give yourself time to learn the ropes before you need to make decisions. Also, you may want to research relocating to another part of the country, downsizing, or transitioning to another type of work.

Using a tool known as “scenario planning” can be quite helpful. In this approach, you identify several attractive ways in which you could see your life playing out through retirement. You also list unlikely, but possible, eventualities that would pose serious difficulties. You come up with a plan to handle each scenario. The more “what ifs?” you consider, the better prepared you are for any eventuality.

Start learning about Social Security and your options for beginning to receive retirement benefits. Be sure to factor other income sources into your decision of when to start collecting benefits. Familiarize yourself with the basic forms of Medicare and start getting acquainted with Medicare’s rules and with local insurance providers. Start following the news on changes in the law.

All this takes effort, research and preparation, and all the more so if you are still raising children.

Another important task is to understand how to reduce risks to your retirement savings and at what point to begin shifting to a more conservative mix of investments. Contemplate insurance products, such as long-term care insurance, that can help you in retirement and consider purchasing appropriate ones when you are in your 50s when your health is good and premiums may be less. One of the more difficult aspects of this pre-retirement planning phase is thinking about end-of-life provisions. The more openly the end-of-life issue and your wishes are explored with loved ones, the more prepared everyone will be when the time comes.

It is critical to ensure you have done estate planning by the pre-retirement phase so you have the legal pieces in place that you will later need and also to designate through a power of attorney who will handle your finances should you be unable to do so.

PHASE III: Early-Retirement

This phase lasts from the day you retire until you are 70 years old. For those who do not plan to retire until well into their 70s, the first two tasks of this phase may occur later. A key purpose of this phase is to create a clear communication channel with your family so information can be shared, questions asked and answered, and decisions made in a calm, supportive way. If inter-generational communication around money has not been part of your family culture, it may be useful to enlist the help of a third party to get the process going.

There are three primary tasks during this phase. One is to assess how well your finances are working now that you are using your retirement savings. Do you need to modify your investment strategy? Make changes in your living circumstances? Have unexpected events occurred that require re-evaluating your approach?

The second task is to fine-tune your income and expense projections. Although the life expectancy of someone who is 60 years old is estimated by the Congressional Research Service to be 83 years old, many financial planners suggest projecting cash-flow out to age 100, just to be safe. This projection, which includes assumptions about growth of savings, inflation, taxes and living expenses, is an important tool in managing your finances and in making decisions.

The third task involves taking into consideration how you will meet minimum distribution requirements from your tax-deferred accounts — IRAs, 401(k)s, etc. — when these required withdrawals kick in at age 70. Even if you have not retired by this point, minimum distributions must begin. (For details, see section below.)

PHASE IV: Mid-Retirement

This phase begins at age 70 and lasts as long as you are able-bodied and high-functioning. Despite your good health, it is helpful to begin looking at what steps you would like your family to take should your condition decline significantly. In most cases your ability to make all your own decisions, care for yourself, engage with the world on your terms, and manage your affairs does not vanish in a split second. The loss of abilities is the natural consequence of the aging process and often happens gradually. At the same time, it is our nature as human beings to resist letting go of our autonomy. Even talking about the possibility is avoided. It takes courage to dive into a conversation about giving up and transferring control.

During this phase, it is common that one member of a couple will be the primary caretaker for the other whose health has already declined.  Communicate with family members and build a team of professionals around you to advise and help as needed.

PHASE V: Late-Retirement

This phase begins when your health has taken a turn for the worse and there is little likelihood of it being fully restored. You require significant help to function day to day. The hope is that by this point all the planning done in prior years makes this transition as manageable and life-affirming as possible. No one knows ahead of time how his or her life will come to an end. It is that uncertainty that contributes to not taking any action. However, if you have done some scenario planning earlier on — a technique where you lay out and consider a range of possibilities from worst-case to best-case — then you may have anticipated the course your life is taking. At this point much of the decision-making over your life is either shared or entirely in someone else’s hands.

The Basics of Saving and Investing

Saving is about setting money aside to protect it from loss, and investing is about putting money at risk in hopes of making more. At a minimum, your goal is to preserve your savings and earn enough to make up for losses from inflation and taxes.

The critical first steps are choosing not to spend all of your income and not running up credit card balances. In addition, you are best off ear-marking a certain portion of what you save or invest specifically for retirement.

After years of living close to or beyond their means, Americans are beginning to save once again. According to the U.S. Department of Commerce, Americans saved, on average, almost 6 percent of their disposable income in the fourth quarter of 2010, up from less than 2 percent as recently as 2007. [US Dept of Commerce, Bureau of Economic Analysis, News Release: Personal Income Outlays, November 2010]

As mentioned above, you should strive to set aside a minimum of 10 percent of your gross wages for retirement no matter what the economy is doing. If your income is low or you are older and have little saved, this retirement savings rate should ideally be higher, if at all possible. Set aside the maximum allowed by law into retirement accounts like Individual Retirement Accounts (IRAs) or plans at work. You can always cut back in later years if your account balances prove to be more than adequate to fund your retirement. It is the nature of compounding that gives an advantage to those who begin saving at an early age. If you reinvest interest and dividends or capital gains earned when investments are sold at a profit, you maximize your possible return.

There are two main ways to invest: (1) With a lump sum acquired through a gift, inheritance or sale of a home or other large asset, or (2) a little bit at a time. When you save the same amount regularly over time (such as $500 every month) you are doing something called dollar-cost-averaging, buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high. This is what most Americans do when they have a fixed amount taken out of their paycheck and invested for retirement.

How Much Will You Need?

The main goal before you retire is to make sure that you have enough money when you do retire so you can maintain your standard of living. How much is enough depends on when you wish to retire, what your anticipated living expenses will be, what rate of return you can expect on your savings, and whether you will continue to work at all after retirement.

The anticipated date of your retirement affects two important factors: how much time you will have to save up for retirement and the number of years you can expect to live after you retire. A qualified financial adviser can help you sketch out your retirement plans in terms of timing and lifestyle. Once you put these down on paper, she can help you calculate how much money you need to have set aside to meet your goals and how it should be invested. Unfortunately, one likely answer will be that “You’ll probably need more money than you think.” Americans are living longer than ever before and inflation inevitably eats away at the value of dollars saved.

Many Web sites now offer free tools and information to assist with retirement planning, including so-called “retirement calculators”. By providing a few details about yourself and your finances, these calculators can predict how much you need to save to achieve your retirement objectives.

Once you have an idea of how much you will need, here are other factors involved in determining how well you will manage your retirement savings:

The total amount you contribute over time
How you save (all at once or little by little)
What kind of investment you use (savings accounts, bonds, stocks)
How much your savings or investments grow, less expenses
Whether or not you reinvest that growth
How long you have before you begin spending your retirement savings
How you plan to take money out (again, all at once or little by little)
How and when your money will be taxed and by how much
The inflation rate over the life of your retirement planning.
Ways to Save for Retirement

The government has created and regulates a variety of plans and programs that help you put aside money specifically for use in retirement. The main advantages of using these programs are deferring tax on contribution, the income, or both, and protecting these savings from use for other purposes. Each program targets specific groups: from highly compensated business employees, to business owners, to regular employees, to self-employed individuals, to all workers. Any retirement savings program where there is a tax benefit or deferral is known as a tax-qualified program or, simply, “qualified.” Retirement programs where there are no particular tax advantages are called non-qualified.

Certain individuals with low enough incomes are eligible for a tax credit when they put money into just about any retirement program. Complete IRS Form 8880 to see if you qualify.

Below are thumbnail descriptions of the major retirement savings programs. Because individual circumstances, risk tolerance, and objectives vary greatly, no single path will serve everyone. The main purpose here is to help you match your needs with the most appropriate program. The assistance of a qualified financial adviser may help you determine which of these programs makes the most sense for you.

Those who individually earn more than $200,000 annually or as a couple, $300,000, or who have a net worth in excess of $1,000,000 are classified as Accredited Investors by the Securities and Exchange Commission and thereby gain access to very sophisticated investments that may be perfect for retirement planning.

Retirement Programs Where You Work

A number of retirement programs are available through employers. Try to become informed about all the programs offered by your employer so you can select what is best for you. The US Department of Labors Employee Benefits Security Administration Web site provides helpful information:

The bulk of programs fall under one of two headings: Defined Benefit (DB) plans or Defined Contribution (DC) plans.

Defined Benefit plans are commonly known as pensions. That means the amount that the participant receives is determined by a formula unrelated to the amount of money contributed and the subsequent investment return. The pension plan sponsor, whether it is a company or government, shoulders the responsibility to come up with payments when a participant retires. Typically, that payment amount is determined by years of service and salary level. Receiving the benefit as a stream of periodic payments (usually monthly, like Social Security retirement benefits) is called annuitization. Most pensions allow beneficiaries to select the length of payout and whether or not to name his or her spouse to continue receiving benefits upon the death of the primary beneficiary. Most plans offer participants beginning retirement the choice of receiving a lump sum payout instead. Your decision on taking a lump sum is very important and should be made with full understanding of the consequences. While you can use the proceeds to buy an immediate annuity, which might provide a larger monthly payout than what the pension plan offers, others choose to invest the money and rely on those returns to provide income.

Another form of pension program, where only the employer contributes, is known as a Cash Balance plan. Because it has some features of a 401(k) plan, it is also known as a hybrid pension plan. The formula for determining benefits favors younger employees and employees unlikely to spend their entire work life with this one employer. The value of an individual employees pension account can be determined at any time as either a lump sum or as a lifetime monthly retirement payment.

Finally, an employer may simply purchase an annuity contract for the employee. (See below for a discussion of annuities available to individuals.)

Many people eligible for pension benefits don’t know it. If you believe you might be entitled to a pension from a previous employer (even if they have gone out of business or have been acquired), check with a pension counseling project near you or visit to see if you might be eligible.

Some government programs have both Defined Benefit are Defined Contribution components — for example the Civil Service Retirement System (CSRS) and the Federal Employees Retirement System (FERS).

Today, more and more attention is being focused on pension programs that have insufficient funds to meet their oblications and are attempting to renegotiate benefits with participants. The Pension Benefit Guranty Corporation (PBGC), a government safety net funded by premiums assessed on private pension funds, will step in if a pension fund becomes insolvent. However, the maximum monthly benefit permitted when the PBGC takes over is $4,500 regardless of what an employee had been entitled to under the original pension rules. PBGC currently protects the pensions of more than 44 million American workers and retirees in more than 27,500 private single-employer and multi-employer defined benefit pension plans.

Unlike Defined Benefit plans, Defined Contribution plans do not guarantee a specified benefit. What you receive is determined by the combined market value of contributions and accrued growth (or loss) at the time you want to begin withdrawals. Depending on program specifics, contributions can be made by your employer, the employee (you), or both. You, as the beneficiary of the Defined Contribution plan, take on all the risks associated with investing and the performance of the underlying securities.

The primary Defined Contribution plans authorized by the IRS include profit-sharing, stock bonuses, money purchase plans, 401(k), 403(b), 457(b), Thrift Savings Plan (TSP), SIMPLE 401(k), SIMPLE IRA plans, and SEP IRAs. A separate account is provided for each employee covered by the plan. The retirees benefit is based solely on the contributions to the account and any investment gains and earnings. There are no guarantees.

Because of the wide variation among plans, we will focus our discussion on Defined Contribution plans where you make important decisions in the accumulation phase as well as beginning and during retirement.

Defined Contribution Plans

The government has created a broad array of savings vehicles with assorted tax incentives if you promise to keep your money untouched until you reach 59 1/2 years of age (but no later than age 70 1/2 ). The trade-off is control. You lose the right to access these assets for other purposes without incurring a penalty.

Keep in mind that Defined Contribution plans always take place through your workplace. Accordingly, a key question is how much, if any, your employer contributes on your behalf. Although employers do not have to contribute anything, the more additional funding that comes from the employer the better. If your employer does contribute, you should at least put in what you have to in order to receive the maximum match. A common arrangement is for the employer to contribute half of what you put in. For example, the employer may add up to a maximum of 3 percent of your compensation if you save 6 percent from your wages. In this case, you would want to contribute at least 6 percent to take advantage of the full match.

Even if you receive no match from your employer, it is still advantageous to participate in your employer-sponsored retirement plan. You decide whether or not you participate, how much you have taken out of your paycheck, and how you want the funds invested. You enjoy the benefits of dollar-cost-averaging (explained above) and you have a wide selection of investments to pick from.

When stock from the company itself is offered as a choice be cautious because your risk is great — your paycheck already depends on the viability of your employer. If your employer runs into hard times, you may lose your job, take a pay cut, or be asked to work less. If the stock price plummets as well, you risk losing retirement savings.

401(k), 403(b), 457(b), Thrift Savings Plan (TSP)

All these employer-sponsored retirement plans are similar in design, but there are subtle, but meaningful, differences and it is important to know them. Check with your Human Resources department at work to get complete information, and consult your financial advisor. Common to all is the opportunity to avoid paying income taxes now on the wages you have earned but are putting into your retirement account through work. Taxes will be due when you take the money out in retirement on both what was contributed and the growth. Some 401(k) and 403(b) plans also permit after-tax contributions to be made. These plans are known as a Roth 401(k) or Roth 403(b).

The most you can contribute in 2010 and 2011 is $16,500. If the plan allows for catch-up contributions when you are 50 or older, this permits you to contribute an additional $5,500. 403(b) and 457(b) plans have different formulas for catch-up contributions. It is always wise to check with your plan administrator on the specifics that apply at your company and for you individually. If you are eligible for multiple plans and programs, keep in mind the total contributed by you and your employer(s) cannot exceed 100 percent of your compensation or $49,000, whichever is less.

401(k) plans are available to for-profit and non-profit organizations.

403(b) plans are available only to non-profit organizations. Originating as Tax Sheltered Annuities, they have evolved over the years to mirror 401(k) plans in most respects. Most differences pertain more to administrative issues.

Employers may offer a Roth 401(k), Roth 403(b), or Roth 457(b) as a benefit to employees in place of or in addition to a traditional 401(k), 403(b), or 457(b). These differ from traditional plans the same way a Roth IRA differs from a traditional IRA. Contributions to a traditional 401(k), 403(b), or 457(b) are made pre-tax, so while it reduces your taxable income in the year you contribute, you have to pay taxes on the money you withdraw during retirement. On the other hand, contributions to the Roth versions are made after taxes. This means you won’t have to pay any taxes when you withdraw the money. The Roth 401(k),Roth 403(b), or Roth 457(b) have the same contribution cap as the traditional versions: a maximum of $16,5000 a year or $22,000 a year if you are over age 50. (These limits will start being indexed for inflation beginning in 2012.) However, there are no income eligibility limits to contribute to the Roth plans (as there are for traditional 401(k), 403(b), and 457(b) plans. You cannot change your mind on a contribution, your choice is irrevocable. Although these Roth accounts are subject to minimum distribution rules, this restriction can be avoided by rolling over your Roth 401(k), Roth 403(b), or Roth 457(b) into a Roth IRA when you retire. (See below for a fuller discussion of Roth IRAs.)

457(b) plans are available to state and local governments and non-profit organizations.

Thrift Savings Plans (TSP) are exclusively for federal employees and have contribution limits comparable to those of 401(k)s. Differences between this plan and those available to non-federal government employees are becoming fewer. Nevertheless, it is prudent to seek advice from someone expert in government employee benefit programs.

Profit-Sharing plans permit a variable contribution year-to-year by the employer. The business or non-profit organization need not be profitable to make contributions.

Money Purchase plans require a fixed contribution by employers regardless of profitability.

Stock Bonus Plans and Employee Stock Ownership Plans (ESOPs) are similar to Profit-Sharing plans except the contribution employers make is in the form of company stock. ESOPS have additional tax advantages over Stock Bonus plans.

For smaller employers and the self-employed, there are less cumbersome workplace plans that still offer many of the benefits of traditional, larger ones. The most common are SIMPLE 401(k)s and SIMPLE IRAs. The most you can contribute to a SIMPLE 401(k) or SIMPLE IRA in 2010 and 2011 is $11,500. If the plan allows for catch-up contributions when you are 50 or older, you may contribute an additional $2,500. The SEP IRA is funded completely by employer contributions. Annually, the employer can contribute as much as 25 percent of employees’ pay into their SEP IRA account on their behalf.

Savings Incentive Match Plan for Employees (SIMPLE) 401(k) and IRA are available to employees with 100 or fewer employees who earned $5,000 or more in one of the previous two years and expect to earn at least $5,000 this year. The employer is required to match employee contributions up to 3 percent.

Simplified Employee Pension (SEP) IRAs permit an employer to contribute up to 25 percent of employees’ wages or, if self-employed, approximately 18.6 percent of net profits. It is similar to, but simpler than, a Profit-Sharing plan.

Payroll Deduction IRAs are relatively new on the scene. The idea is to make it easier for employees to contribute to a traditional or Roth IRA. All the regular IRA rules apply. The only difference is the money is taken out your paycheck and deposited by your employer into a custodian institution instead of you making a deposit yourself. Costs are less than an official retirement plan but you do not have an option to borrow against the account as you would with some of the more formal plans. Smaller employers would be wise to consider this as the easiest, least expensive option if there will be no employer contribution.

Retirement Programs for Individuals

Traditional IRAs (Individual Retirement Accounts) are personal savings plans that allow you to set aside money for retirement, while reaping some tax advantages. You may be able to deduct some or all of your contributions to your IRA from your taxes. You may also be eligible for a tax credit equal to a percentage of your contribution. Amounts in your IRA, including earnings, generally are not taxed until distributed to you. IRAs cannot be owned jointly. However, any amounts remaining in your IRA upon your death can be paid to your beneficiary or beneficiaries.

To contribute to a traditional IRA, you must be under age 70 1/2 at the end of the tax year. You, and/or your spouse if you file a joint return, must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes.

Compensation does not include earnings and profits from property, such as rental income, interest and dividend income or any amount received as pension or annuity income, or as deferred compensation.

Roth IRAs

The Roth IRA was named after former Sen. William V. Roth (R-Del.) and created as part of the Taxpayer Relief Act of 1997. The Roth IRA, in effect, turns a traditional IRA on its head. While traditional IRAs permit the taxpayer to shelter pre-tax earnings but taxes them upon withdrawal, the Roth IRA is for after-tax savings, but both the original deposits and the earnings on them are not taxed on withdrawal. In addition, unlike traditional IRAs, Roth IRAs are available to taxpayers already contributing to a plan at work and to taxpayers who continue to work after age 70. Finally, there is no minimum distribution requirement upon reaching that age. In other words, you don’t have to make any withdrawals at all during your lifetime. And any withdrawals you do make are not taxed and are not counted as part of your gross income, as long as the account has been in existence for at least five years.

Financial experts calculate that for many Americans, a Roth IRA will save them more money than a traditional IRA. This is because the future value of capital gains, dividends, and interest earned, which will never be taxed, often far outweighs the value of deferring taxes on both contributions made and the future growth of the investment itself. This benefit is heightened by the fact withdrawals from tax-deferred accounts in retirement are taxed at earned income rates (not dividend or capital gains rates). Consult with your financial adviser to help decide if a Roth IRA makes sense for you.

A number of guides to Roth IRAs are available on the Web. One of the best is from Fairmark Press, There are also many Web-based calculators to help you decide whether the Roth IRA will offer an advantage over a regular deductible IRA for your situation. Here is one Roth calculator: Moneychimp:


Annuities are useful retirement planning tools for some people, some of the time. They can add to the retirement savings of younger investors who would like to save more than is permitted in traditional tax-deferred retirement plans, such as IRAs and 401(k) plans. For older investors, “immediate annuities” can be more useful, guaranteeing an assured retirement income or, in certain circumstances, protecting the financial well-being of the spouse of a nursing home resident. To determine whether an annuity makes sense in your case, you need to understand what they are and how they work. They are complicated.

Annuities are contracts offered through insurance companies. They come in many forms, but, in general, they fall into two categories: deferred annuities and immediate annuities. Deferred annuities provide either a fixed or variable return.

Deferred Annuities

Deferred annuities are similar to IRAs in that they permit you to invest for retirement and delay payment of taxes on your investment earnings until you begin withdrawing funds. These annuities charge penalties for early withdrawal, typically for any withdrawal within seven years of investing funds. Whereas IRAs and 401(k)s require you to have earned income to participate, funds used to purchase annuity contracts can be from any source. With a deferred annuity you can make purchases in the form of a lump sum or regular payments.

Fixed annuities pay a specific interest rate and you cannot lose what you put in. Recently, insurance companies selling fixed annuities with exotic formulas to achieve out-sized, low-risk returns have been criticized for misrepresenting the products and taking unfair advantage of unsophisticated consumers.

Variable annuities offer consumers an array of underlying investments (called subaccounts) that function similarly to mutual funds. These subaccounts capture the potential income and growth of bond and equity markets. However, you also run the risk of your annuity’s losing value if the subaccount investments decline in value. Remember, since variable annuities have features of both an insurance contract and a financial investment fees generally are 1 percent to 2 percent higher than investments alone and there are penalties (surrender charges) for getting out of the contract if you need your money back.

Annuities used to be far more standardized. Not so today. Most come with a large number of features that need to be understood thoroughly before you decide which to include since they affect the cost to you.

The annuity premiums can be invested as the owner (or “annuitant”) directs during the accumulation phase from a variety of options offered by the insurance company. These can include mutual fund-like subaccounts and other investment vehicles.

While deferred annuities share with IRAs and other retirement plans the benefits of compound returns on deferred taxes, they do not enjoy all of the tax benefits of such plans. Only after-tax funds may be invested in annuities and the earnings on such investments are taxed when they are withdrawn. The benefit of deferred annuities comes when they are held for many years.

Due to the early-withdrawal penalties, it is important to invest in deferred annuities only if you have enough outside funds for a “rainy” day–a period of unemployment, a house repair, a disability, or other unexpected occurrence. Otherwise, you may find yourself drawing on the deferred annuity and paying both taxes and penalties at a time when you can least afford to do so.

Financial planners typically recommend deferred annuities for younger clients who have saved as much money as they can in their IRA, 401(k) or other retirement plans and still want to put more aside for retirement. They make less sense for older clients, who are less likely to get much benefit from the deferred taxation and are more likely to face an illness that may require use of the annuity funds at a time when a penalty would have to be paid.

Immediate Annuities

Immediate annuities are, in effect, private pensions. Deferred annuities become immediate annuities when the annuity is annuitized or begins paying a stream of income. Instead of using the annuity as the vehicle in which to save as with deferred annuities, an immediate annuity requires you to buy it with the funds you already have. The annuitant pays money to an insurance company, which agrees to pay a fixed amount back to the annuitant for a period of time beginning immediately. Typically, the insurer agrees to make monthly payments for the duration of the annuitant’s life with a guaranteed number of years of payment, known as a “term certain.” For instance, an annuity for life with a 10-year term certain would pay out every month as long as the annuitant lives. If the annuitant dies within the guarantee period, it would pay out for the duration of the 10 years to whomever the annuitant names as beneficiary.

The amount of each payment is based on the annuitant’s actuarial life expectancy and the length of any term certain. An 80-year-old will receive larger monthly payments than a 60-year-old because the insurance company probably won’t pay out for nearly so long. An annuity for ‘life only’ without a term certain would also pay out more each month, but if the annuitant dies early, it results in a windfall to the insurance company since the insurer would not have to pay anything to the annuitant’s heirs. The annuitant may also purchase an annuity for a ‘term only’ that does not base payments on the annuitant’s life expectancy at all. Again, this arrangement will provide for higher monthly payments, but the payments will end at the end of the specified term.

Immediate annuities (or when you annuitize a deferred annuity) provide a guaranteed stream of income that is not affected by the vagaries of the market. It saves the annuitant from worrying about how to invest his or her savings and whether or not the nest egg will last a lifetime. Annuities of this sort should only be purchased from the most financially sound insurance companies so that there’s as little risk as possible that the payments won’t be made. The biggest problem with relying on immediate annuities as a principal source of retirement income is that they typically are not adjusted for inflation. What may be an adequate monthly income stream today may not be in 10 or 20 years. Inflation adjusted annuities are on the market, but remember you will be charged enough to cover worst-case scenarios.

If you have saved money in stocks, or just sold your house, you can use proceeds from these investments to buy an immediate annuity to provide you with an income stream in retirement so you do not have to worry about managing investments.

Charitable Gift Annuities

A charitable gift annuity (CGA) allows you to make a gift to a charity and receive not only a sizable tax deduction but also fixed annual payments, a portion of which will be tax free as well.

A CGA enables you to transfer cash or marketable securities to a charitable organization or foundation in exchange for an income tax deduction and the organization’s promise to make fixed annual payments to you (and to a second beneficiary, if you choose) for life.

A variety of resources, cash, stocks, or bonds can be used to establish a CGA. The donor of a CGA receives an income tax deduction in the year of the gift equal to the difference between the amount paid to the charity and the value of the annuity reserved to the donor (see link to calculator below). A fixed portion of each annuity payment is tax free, calculated based on the age of the annuitant. When appreciated property is given, the donor pays capital gains tax on only part of the appreciation. If the donor is also the annuitant, the capital gains tax is spread out over many years.

Annuity payments can begin immediately or can be deferred to some future date, allowing donors to enjoy the charitable income deduction immediately and receive a guaranteed income later–for example when they retire and are in a lower tax bracket. By contrast, a child who is providing financial support for a parent may want to establish an immediate CGA for the parent. The child would receive an income-tax deduction and the parent would receive income for life.

The older the annuitants are at the time of the gift, the greater the fixed income the charitable organization will pay. The Committee on Charitable Gift Annuities sets annuity rates for all charities to follow. Although it is not mandatory that the rates be used, most charities that offer gift annuities voluntarily adhere to the rates.

Example: Mrs. Generous, age 82, gives $10,000 to Favorite Charity in return for a single life annuity. She will receive an annual annuity payment of $940 (figured at 9.4 percent per year). Her charitable income tax deduction will be $4,692.29 the year the gift is given, or spread over five years following. Of the $940 received each year, Mrs. Donor can exclude $639.48 as tax- exempt income for 10 years. The gift is excludable from estate taxes. (Calculation is for illustration purposes only; for your actual benefits, consult your attorney or financial adviser.)
While the regulation of charitable gift annuities varies from state to state, almost all states that regulate charitable gift annuities require the maintenance of financial reserves, annual filings with the attorney general of the state, and compliance with other regulatory requirements.

If you want to know what your tax deduction and annual income from a CGA might be, a company called PhilanthroTec offers a free Web-based gift calculator that runs the numbers. Go to: Bear in mind that calculations vary depending on the assumptions used, the timing of the gift, and the donor’s unique financial situation. For your actual benefits, consult your attorney or financial advisor.

Be sure to seek the advice of an elder law attorney or financial advisor before purchasing annuity products.

Where to Put Your Retirement Money

There are as many opportunities to grow money as there are people with great ideas. Some people choose to save for retirement outside of the conventional vehicles like 401(k)s and IRAs.

When systemic market failures surfaced around the globe in 2008 and caused massive market turmoil, seasoned investors as well as novices were caught off guard. What was supposed to be safe turned out not to be. Many Americans who were counting on the appreciated value of their homes to convert to a stream of income for retirement were left vulnerable, finding themselves with far less to work with than they expected.

Another example of misreading risk has to do with asset allocation, which is a risk reduction strategy where you divide your money among a variety of investment types that do not go up or down in value at the same time. Diversification reduces risk. However, when markets recently stopped functioning and there were few if any buyers of anything, pretty much everything dropped in value. In a severe down market asset allocation does not necessarily protect you very well from loss the same way it does in an up market. For many people, all their assets declined in value.

Without succumbing to fear, it is generally prudent to assume you are facing greater risks than meet the eye. This means staying alert, vigilant and knowledgeable and, most importantly, being open to changing direction if need be.

Following is a survey of types of investment what you might consider before making choices on saving for retirement. It is important to know your criteria. What is important to you? What is going to allow you to sleep comfortably at night?

Financial Institutions

If you are looking for tax benefits as you save for retirement, invariably you will need to work with one or more financial institutions, such as banks or brokerages. The IRS requires you to put tax-qualified retirement savings in the hands of an approved custodian — usually a financial institution. Whatever funds you have placed in their hands are known as custodial holdings. In this day and age of mergers and acquisitions and rapid invention of new investment products, there are increased unknowns around institutional reliability. Fortunately, unless the investment itself goes sour, there is a fairly robust firewall between the fortunes of the custodial institution and the safety of your investment. However, when the public perceives institutional weakness they may want to pull assets out and, if they do, this could drag down investments you have with the custodian in question for no good reason.

It is more difficult to identify good companies given the continuing trend for large financial institutions becoming one-stop shops with a huge variety of types of products and services. For example, insurance companies buy and sell lines of products from one another, meaning that your insurance policy or contract may not stay with the company from which you purchased it. Servicing companies are often hired to handle customer relations.

The primary institutions that handle retirement investments are insurance companies, banks, investment and asset management companies, and governments — local, state and federal.

Insurance Companies offer products protecting against loss. For retirement purposes, annuities, along with long-term care insurance, are the main insurance company products of interest. For the most part, annuities do not benefit from sitting inside retirement plans since they already enjoy certain tax advantages. Capital gains, interest and dividends occurring within any annuity go untaxed until funds are paid out of the contract; there is no “double” tax-deferral benefit from having an annuity within an IRA or 401(k).

Insurance products can be purchased from the companies directly but more commonly are available through brokers — some who sell products from different carriers and some who sell only for one company. You should either visit different companies for quotes or use an independent broker.

Investment and asset management companies comprise the institutional backbone of retirement saving. These companies are regulated by the federal Securities & Exchange Commission (SEC) and by state securities divisions. Investment and asset management companies serve three functions: custodians of your accounts, providers of services and investments, and “making a market” (where a sufficient number of buyers and sellers trade goods, services and securities). You may have a custodian who has no direct involvement with your actual investment. For example if you own 10 shares of stock XYZ and it is held in an IRA brokerage account at ABC Investments, ABC has nothing to do with XYZ directly but must keep tabs on your account and find a buyer for your stock should you elect to sell it and execute the transaction.

Part of making a wise selection around who you want to be the custodian and manager of your money is knowing how much help and guidance you want and need. You may find yourself with multiple custodians and investments if you have had several employers with different 401(k) plans or have inherited portfolios. It may take some doing to organize your holdings so they are manageable.

Banks (including commercial banks, cooperative banks, and credit unions) offer savings products that can be appropriate for retirement planning. Many of the largest ones now provide investment and insurance products and services as well.

The U.S. Government provides retirement savings products directly to the public in the form of bonds. A relatively new Web site, allows you to find the products available to the public that you can purchase directly through the Web site. U.S. Government savings products can also be purchased through banks and investment management companies.

Types of Investments

Just because there are tax-qualified retirement programs does not mean you must use them to fund your retirement. Remember, the objective is always to create a stream of income to handle your expenses from the day you retire until the day you die. If you have a different way of creating sufficient passive income to take care of you in retirement, then do it!

Cash and Cash Equivalents are the starting point for investing. This category includes cash in your pocket, checking and savings accounts, money market accounts and, when you own mutual funds, the cash portion of the fund that is usually invested in short-term debt. Typically, these investments pay low interest rates. They make sense when safety and liquidity are the prime objectives, giving you instant access to your money, However, even money markets can be vulnerable if demand dries up for whatever investments it holds during skittish markets.

Fixed Income investments are debt instruments, meaning they are asking to borrow money from you and in return they will pay you interest plus return the principal at a specific date in the future. The simplest form this takes is Certificates of Deposit (CDs) which have maturity dates ranging from three months to five years. All government offerings are fixed income investments. The U.S. Treasury sells Treasury Bills, Treasury Notes, Treasury Bonds, Treasury Inflation-Protected Securities (TIPS), Savings Bonds, and EE/E Bonds. Municipalities, states, various special purpose authorities, and quasi-governmental authorities all sell debt. In addition, corporations raise money selling bonds in the open market. The riskier the venture issuing the bonds, the higher the interest rate you should expect to be paid.

Equities or Stocks come to mind whenever you think of long-term investing. They are securities which, when owned, give you actual ownership of the company. Today, institutions (like other businesses, pension funds, mutual funds, investment houses, etc.) own most of the shares of the largest, most prominent publicly-traded companies. Equities are considered a good place to invest in a rising economy. Some pay dividends, providing income even if the value of the stock has dropped.

There are also groupings of stocks, called indexes, based on some classification characteristic. These are helpful to get a quick indicator of how well a grouping is doing as a proxy for that segment of the overall economy, Size is used as one classification characteristic. Another is industry sector.

Mutual Funds were invented to tap into that large pool of capital sitting in the hands of the less well-to-do. In the United States, mutual funds were created in Boston in the 1920s. The new industry did not recover from the Depression until the mid-1950s. Since then it has continued to expand, with trillions of dollars invested today and more than 10,000 mutual funds available to consumers.

The mutual fund concept pools dollars from many investors into one investment vehicle comprised of a grocery basket of individual securities, including stocks or bonds or other investments, all depending on the objective of the fund. Investors enjoy the benefits of diversification and can put together a portfolio to match their risk tolerance, goals, and financial situation. 401(k) and similar programs offer enormous choice in funds for participants.

Exchange Traded Funds (ETFs) trade like individual stocks but are a collections of many stocks or other securities. ETFs experience price changes throughout the day as they are bought and sold, whereas the price of a mutual fund changes only once, at the close of business each day. Rather than redeeming shares from the mutual fund company, owners of ETFs who sell receive their money from ETF buyers on a stock exchange. Like mutual funds, ETFs offer diversification and are typically structured to represent an index of underlying stocks, bonds, or commodities. You get the benefit of 20, 30 or more individual holdings you might not be able to afford to buy individually. A disadvantage of ETFs is that trading volume can be erratic, which can result in large spreads between what a seller wants and what a buyer is willing to pay. An advantage is no minimum purchase is required, although you do have to pay a commission to buy or sell.

Separate Accounts are mutual fund-like accounts managed by a brokerage company or financial advisor. They differ from mutual funds in that the individual actually owns the individual securities, which are pooled with those of other investors. (Separate accounts are not to be confused with subaccounts or separate accounts in insurance products.)

Precious Metals are an investment often held by true believers. People who trust the physicality of a metal are attracted to it as a reliable, dependable investment that has a tangible, measurable, marketable value no matter what is going in world economies or in high finance. Precious metals are perceived as a hedge against inflation or trouble in the financial markets.

Precious metals can qualify for inclusion in a retirement account like an IRA, but under the IRS rules you must invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the U.S. Treasury. You can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion. And you can avoid the rigmarole of direct ownership by purchasing precious metal mutual funds.

Collectibles are essentially prohibited as investments in tax-qualified retirement accounts. This would include such items as artwork, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages, and other collectibles. However, that is not to say you cannot earmark them for your retirement and sell them on the open market when the time is right. Be aware that highly appreciated items may incur a significant capital gains tax, especially if the items were acquired for next to nothing and have now become extremely valuable.

Real Estate is one of the overlooked allowable investments for tax-qualified retirement purposes. Real estate can be purchased directly using money already within an IRA, although you cannot live on the property or incur any direct benefit. These are somewhat complex transactions and you give up tax benefits typically associated with real estate ownership; however, in the right circumstances with the right guidance a real estate IRA could be appropriate.

Aside from a tax-qualified real estate venture, the most common retirement savings strategy is to invest in one’s own home, eventually paying off the mortgage and then coming up with an exit strategy since the IRS permits a tax-free gain of $250,000 on the sale of one’s residence for an individual or $500,000 for a couple as long as certain requirements have been met. But with housing markets barely recovering from the slide in values, it may mean rethinking one’s dependence on equity in a primary residence as the cornerstone of funding retirement.

Businesses have long been used a ticket to retirement. There are many ways to use a business to fund retirement. These include crafting company retirement plans that permit the owner to direct sizeable assets to fund his or her retirement to growing a business with an eye to either selling or stepping back from day-to-day operating responsibilities and taking some form of distribution or compensation. Consider buying a business to run in retirement. Obviously, operating a business is not for the faint of heart, but if your skills and comfort match up well with a business opportunity, it may be right for you. Related to ownership of a business is ownership of rental property where you can generate enough cash flow to cover property expenses with enough left over to supplement retirement income. Another way to generate income is to receive royalties or licensing fees for intellectual property you created and protected.

Taking Money Out in Retirement

Many people are not prepared for the shift from employee to retiree. From a financial point of view, if you do not have a private pension and have to rely on your savings, then how you invest most of your financial assets while drawing down on some of them requires a good deal of attention. You could call this task devising a retirement income strategy.

Keep in mind that whatever you saved in tax-deferred accounts will be taxed when you take it out. If you were married and took out $69,000 in 2011 from a qualified retirement account, that income alone would put you in the 25 percent tax bracket. This is why Roth IRAs can be helpful. You pay no tax on whatever you withdraw whenever you want after age 59 1/2.

Remember, even though you are allowed to spend retirement funds at 59 1/2 it doesn’t mean you have to. One of the best strategies is to postpone retirement for as long as you can manage to avoid tapping into your nest egg. Get yourself a spreadsheet and project out your expenses, taxes, inflation, income, Social Security, growth of investment assets, and your drawdown on retirement savings, and run the numbers to age 100. One of the least recognized but more potent strategies is to be flexible on your spending needs. The wider the range of acceptable spending level, the more power you have to adjust outflow to support your investment strategy. Work with a competent advisor to help you think through different scenarios and how they would affect your projections.

Investing correctly is one thing; executing your plan of taking money out in retirement is another. A comprehensive approach to sorting out your options is best and should include consideration of worst-case scenarios.

When You Reach 70 1/2 Years of Age

One of the most critical and frequently overlooked issues in retirement planning comes after most people have retired. Beginning on April 1 the year after you reach age 70, you must begin taking minimum distributions from your retirement plan. How you structure these distributions can have a profound effect on your own retirement and even more on what you leave your heirs.

There are some basic steps you can take to get the most out of your retirement plan. Failing to follow these basic strategies could wind up costing you and your heirs many thousands of dollars in unnecessary taxes. A case study of how poor retirement planning can cost one’s heirs appears at the end of this section.

Calculating Your Minimum Distribution

Congress created the rules governing the minimum distribution of retirement plan funds to encourage saving for retirement and to allow retirement assets to build up tax-free during the plan owner’s working years. You do not pay tax on income you put into a tax-deferred retirement plan when earned or on investment income or gains on the account itself. However, the funds you withdraw upon retirement are treated as taxable income in the year you take the distribution. And if your children withdraw the funds from a tax-deferred account that they inherit from you, they will be taxed on such distributions at their income tax rates.

Since the idea of retirement plans is to encourage taxpayers to save for retirement, lawmakers imposed a penalty for early withdrawal before age 59 1/2 — and a penalty for failure to withdraw once the owner reaches retirement age — after age 70. Until recently, there was also a penalty for excess withdrawals — in other words, for those who saved more than they need for retirement — but that penalty has been repealed. These penalties apply to all tax-advantaged retirement plans, including Individual Retirement Accounts (IRAs), both Roth and regular 401(k), 403(b), and 457(b) plans; Thrift Savings Plans, SIMPLE 401(k), SIMPLE IRA, SEP IRA plans, and pensions.

The withdrawal penalties are in the form of excise taxes. Early withdrawals, those taking place before you reach age 59 1/2, are subject to a 10 percent excise tax (with limited exceptions). In other words, you pay the government 10 percent of the amount withdrawn in addition to the taxes that would normally be due upon withdrawal. As for late withdrawals, you must begin taking distributions by April 1 in the year after you reach age 70 (known as the required beginning date), or pay a whopping 50 percent excise tax on the amount that should have been distributed but was not.


The rules regarding distributions were simplified in 2001. To determine your required distributions, you can consult a simple chart. Unless you name a spouse as beneficiary who is more than 10 years younger than you, the beneficiary of your account has no impact on your minimum distributions. This allows you to accumulate more money in your retirement accounts, tax-deferred.

The Designated Beneficiary

It used to be that the first rule of retirement plans was to always designate a beneficiary. While it is still important to designate a person or institution to inherit your retirement accounts, the choice of beneficiary is not nearly as critical a decision as it once was.

First, as explained above, your choice of beneficiary generally won’t have an impact on your required minimum distributions. Second, you can change your beneficiary down the road. In fact, your beneficiary can even be changed after your death by the executor of your estate. The date for determining designated beneficiaries is September 30 of the year following the year of your death.

All this means that your designation of a beneficiary (or failure to name one) will rarely result in the kinds of tax-planning disasters that were common before. In most cases, your heirs will be able to take steps that will ensure deferral of taxes on retirement accounts over their lifetimes. But these changes also mean that it is doubly important that your heirs consult with a qualified elder law or tax attorney to ensure that they are making the best decisions regarding beneficiaries from a tax-planning standpoint.

Designating a Trust As the Plan Beneficiary

For tax planning and other purposes, many couples set up “A and B” trusts (also called credit shelter trusts) to take advantage of the unified credit of the first spouse to pass away. (See the Estate Tax Planning section.) Where a large portion of the estate consists of retirement plans, it often makes sense to have them payable to the trust rather than to the surviving spouse. Unless the trust is properly drafted, however, it won’t be considered a designated beneficiary and the surviving spouse will have to withdraw all the retirement plan monies within five years. Making sure the trust is carefully drafted is complicated and requires the services of an attorney experienced in such matters.

For more information on designating a beneficiary and keeping the beneficiary designation up to date, click here.

Case Study: The Consequences of Failing to Plan

George Parrot (not his real name) died in January 2011 with an estate of $2.4 million, of which $1 million consisted of tax-deferred retirement plans. Although Mr. Parrot’s wife had died three years before him, he had neglected to change the designated beneficiary on his retirement plans to his children. Therefore, the retirement plans are payable to his estate. The children will have to withdraw the funds from the plans within five years of his death. Upon withdrawal, they will have to pay taxes on the income. Assuming a 30 percent average tax rate, this will come to approximately $200,000 in income taxes after taking a deduction for the estate taxes paid.

There are two steps Mr. Parrot could have taken (or his children could now take) to reduce or postpone the taxes due on his retirement plans. First, if his children had been named as the designated beneficiaries, they would not be under the five-year rule. Instead, they could have withdrawn their shares over their own projected life expectancies. For instance, a 30-year-old with a 45-year life expectancy need not withdraw — and pay taxes on — any more than 1/45th of her share this year, 1/44th next year, and so on. She cannot avoid the tax forever, but the longer she can put off withdrawing the funds, the longer the account will grow tax free.

Unless his income was too high to qualify, Mr. Parrot also could have converted some or all of his retirement plans to Roth IRAs. Doing so would have forced him to pay taxes on the converted funds at the time, but they would have continued to grow tax-free indefinitely. And his children would not have to pay taxes on their withdrawal of funds from the Roth IRAs they inherited. This approach has the added advantage of reducing Mr. Parrot’s estate by the amount of the income tax paid, thus reducing the amount subject to state or federal estate taxes.

If, for purposes of example, Mr. Parrot converted $500,000 to a Roth IRA and if he paid taxes at an average rate of 30 percent on this amount (this might be reduced by spreading the conversion out over several years) he would pay $150,000 in income taxes, but any estate taxes due to his state would be reduced.