Annuities are tax deferred savings contracts that are usually written by insurance companies.  The owner of the contract makes a payment or series of payments to the issuer or insurer and in return the insurance company promises to make a payment or series of payments to the contract owner in the future.  Although they have a reputation for having high fees, they can be advantageous in a variety of situations, including tax deferral as well as insuring against longevity risk of the annuitant and/or owner.  Unlike qualified plans such as 401K and 403B plans and IRAs, there is no annual limit to how much can be contributed to an annuity contract.

Tax deferral

Annuities allow the contract owner to defer taxes on gains inside the contract until their withdrawal.  When withdrawals are made, they are subject to first in first out (“FIFO”) reporting, in that the gains will be deemed to have been withdrawn first, and will thus be subject to taxes.  The contract owner will be subjected to a 10% penalty on withdrawals if the withdrawals are made prior to age 59 1/2.  Taxes on the gains upon withdrawal can be deferred and paid on a prorated basis by taking withdrawals on a periodic basis.

Management of longevity risk

Annuities provide a way to protect the contract owner against longevity risk.  As an example, consider an individual who, at retirement age, has a lump sum which needs to last through retirement.  If the retirement income strategy is to withdraw income only and preserve the principal, then there are no issues and an annuity may not be suitable or necessary.  However, if the retirement income strategy is to withdraw the lump sum gradually over many years, it is difficult to assess how much should be withdrawn as there is no way to know for how many years the withdrawals will be needed.  An annuity can protect against this uncertainty by making payment until the death of the annuitant.

How much should I contribute to my 401K or 403B?

401K plans and their cousins, 403B plans (as well as 457 plans and Federal Thrift Savings Plans – these types of plans are collectively known as “qualified” plans) provide a great way to save for retirement.  Employee contributions are tax deductible, and the earnings are tax deferred until their withdrawal.   There are no earnings restrictions as there are with IRA accounts, and this applies to traditional 401K as well as ROTH 401K contributions.  Making contributions to a 401K or 403B plan is convenient as it is typically withheld from the employee’s paycheck.  Oftentimes, employers will match employee contributions, and sometimes they will make additional profit sharing contributions as well.

The maximum which an individual may contribute to a 401K or 403B plan is $18,000 for the 2017 tax year.  Persons 50 or older may contribute an additional $6,000 per year.  These employee contributions are deferred from the salary of the plan participant, and are not included in the participant’s adjusted gross income.  Employer matching contributions are determined by the employer’s policy and are usually specified in the plan documents and summary plan description.

How much you should contribute to your 401K plan will depend upon your age, income, tax bracket, and investment objectives and retirement goals.  It is recommended, however, that you “max out” the employer match if there is one.  Not doing so will leave money on the table which would have been easy to obtain.

Retirement plans for business owners

As a business owner or self employed individual, there are options available for funding your retirement in addition to those options which are available for anyone with earned income, such as traditional and ROTH IRA accounts.  The most common types of retirement accounts for business owners are SEP-IRAs and 401K plans, which will be reviewed in detail in this article.  For information on additional options available, please see this article on defined benefit pension plans for small business owners.

SEP-IRA retirement plans

A SEP-IRA account is the same as a traditional IRA in most ways.  The only substantial difference is that with a SEP-IRA, the participant can contribute up to 25% of compensation, or $54,000 for 2017 ($60,000 for persons ages 50 or older), whichever is lesser.  This could end up being substantially more than the contribution limit for a traditional IRA account, depending on the compensation of the participant.  In order to be eligible to establish a SEP-IRA, you must own a business (this includes being self employed).  If you have any employees, they are eligible to have a SEP account as well, and must be included if they meet certain criteria (worked for the business for 3 of the previous 5 years, attained age 21, and had at least $600 in compensation.  These requirements can be made less restrictive in the SEP-IRA plan document).  SEP-IRAs have the main advantage of being easy and relatively inexpensive to administer.

401K retirement plans

A business owner, including a self employed person, has the option of establishing a 401K plan for his or her self and employees.  The participant can contribute 100% of compensation, up to the limit ($18,000 for 2017 plus a $6,000 “catch-up” contribution if age 50 or older).  The business owner can also make a non-elective contribution of up to 25% of compensation.  The rules related to the non-elective contribution are a bit more complex for a self employed individual but are in the same general range.  401K plans are in general a bit more time consuming and costly to administer than SEP-IRA plans, however they have the main advantage of having larger contribution limits than SEP-IRAs.  They also allow the participant to take loans against their 401K balance, something which is prohibited by the IRS rules pertaining to IRAs, including SEP-IRAs.


IRA income limits


ROTH IRA and traditional IRA account contributions are subject to income phaseout limits.  In the case of the ROTH IRA the limits are related to eligibility and in the case of a traditional IRA the limits are related to deducting the contributions.  If you exceed these limits you may want to consider alternatives for deferring taxes on your retirement savings.  There are many options available depending upon your particular situation.  In general, business owners and self employed individuals have more options available to them than do W-2 employees.  The details of the income and phaseout limits are discussed in detail below.

ROTH IRA income limits

You are typically able to make a ROTH IRA contribution if your income falls below certain levels.  If you are married filing jointly, you can make a full ROTH IRA contribution if your adjusted gross income (AGI) is less than $186,000 for the 2017 tax year.  You can make a reduced contribution if your AGI is between $186,000 and $196,000, and contributions are disallowed altogether if your AGI is greater than or equal to $196,000.

If your tax filing status is single or head of household you may make a full ROTH IRA contribution for the 2017 tax year if your AGI is less than $118,000,  a reduced contribution if your AGI is between $118,000 and $133,000, and no contribution at all if your AGI is greater than or equal to $133,000.

If you are not able to make a ROTH IRA contribution due to income restrictions, you may want to investigate whether or not your employer offers a ROTH 401K plan.  If they do not, you should consider making a request to your employer that a ROTH 401K plan be implemented.

ROTH IRA income limits for 2017 tax year
filing status income limit
Married filing jointly full contribution allowed for AGI less than $186,000; phaseout for AGI between $186,000 and $196,000, no contribution allowed for AGI greater than or equal to $196,000
Single full contribution allowed for AGI less than $118,000; phaseout for AGI between $118,000 and $133,000, no contribution for AGI greater than or equal to $133,000
Head of household full contribution allowed for AGI less than $118,000; phaseout for AGI between $118,000 and $133,000, no contribution for AGI greater than or equal to $133,000
Married filing jointly (and lived with spouse at any time during year) phaseout for AGI between $0 and $10,000, no contribution for AGI greater than or equal to $10,000

Traditional IRA income limits

There are no income restrictions related to making a contribution to a traditional IRA, however you may not be able to deduct the contributions if you or your spouse participates in a retirement plan at work.  If you or your spouse participate in a retirement plan at work, the deduction begins to phaseout at $62,000 AGI for single or head of household ($99,000 for married filing jointly) and phases out completely at $72,000 AGI ($119,000 for married filing jointly).  These numbers are for the 2017 tax year.  If you are in this situation, you should consider contributing to your retirement plan at work, such as a 401K plan, as you will be able to deduct these contributions up to their limit.

Traditional IRA income limits for 2017 tax year
filing status no retirement plan at work retirement plan at work spouse has retirement plan at work (and you do not)
Married filing jointly no limits full deduction up to contribution limit if AGI less than $99,000, partial deduction for AGI between $99,000 and $119,000, no deduction if AGI is greater than $119,000 full deduction if AGI less than $186,000, phaseout for AGI between $186,000 and $196,000, no deduction if AGI is greater than $196,000
Single no limits full deduction up to contribution limit if AGI less than $62,000, partial deduction for AGI between $62,000 and $72,000, no deduction if AGI is greater than $72,000 N/A
Head of household no limits full deduction up to contribution limit if AGI less than $62,000, partial deduction for AGI between $62,000 and $72,000, no deduction if AGI is greater than $72,000 N/A
Married filing separately no limits partial deduction for AGI between $0 and $10,000, no deduction if AGI is greater than or equal to $10,000 partial deduction for AGI between $0 and $10,000, no deduction if AGI is greater than or equal to $10,000

ROTH 401K and ROTH IRA income limits

ROTH 401K and ROTH IRA accounts provide retirement savings options which are fully tax free upon withdrawal as long as they comply with certain IRS rules.  A disadvantage of ROTH IRA accounts is that they are restricted to lower income earners.  In order to contribute to a ROTH IRA for the 2017 tax year, your adjusted gross income must be less than $196,000 if you are married filing jointly and less than $133,000 if you are filing as single or head of household, and the amount of the allowable contribution phases out as it approaches these limits.

A ROTH 401K plan, unlike a ROTH IRA, has no income limits for the participant.  Regardless of income, for the 2016 tax year an individual may contribute up $18,000 to a 401K account (ROTH or traditional).  This limit increases to $24,000 for participants age 50 or older.  Unlike a traditional 401K plan, contributions made to a ROTH 401K are made on an after tax basis.  Keep in mind that employer contributions to a 401K plan, unlike ROTH 401K employee contributions, are always taxable to the plan participant upon their withdrawal.

Whether or not a high income earner should contribute to a ROTH 401K plan depends on a variety of factors.  On one side of the argument, a high income earner is in a high tax bracket and may be better off contributing to a traditional 401K as the immediate tax benefit could be significant.  On the other hand, ROTH 401K accounts have numerous advantages related to tax free withdrawals as well as limited rules related to required minimum distributions.  A careful analysis should be done of your financial situation, with particular attention paid to your tax bracket now and your expected tax bracket in retirement.


ROTH IRA or traditional IRA? A comparison


Individual retirement accounts (“IRAs”)  provide an excellent option for funding your retirement due to their numerous tax advantages.  They are typically administered by a financial institution such as a bank, broker/dealer, trust company or insurance company, which acts as the trustee for the account.  There are many types of IRAs, including SEP IRAs, SIMPLE IRAs, rollover IRAs, traditional IRAs, and ROTH IRAs.  The two most common types of IRAs are ROTH IRAs and traditional IRAs, which I will review in detail here.  Each of these retirement savings vehicles has its advantages and disadvantages from a tax perspective.  Which one is more advantageous for your particular situation will depend on a variety of factors, including your age, time horizon, income (and tax bracket), investment objectives, and expected income and tax bracket in retirement.   In most cases I believe that a ROTH IRA provides a greater benefit overall however I will review in detail the advantages and disadvantages of both of these retirement savings vehicles in this article.

ROTH IRA versus traditional IRA
ROTH IRA Traditional IRA
Contributions not deductible deductible*
Withdrawals not taxable taxable
Withdrawal penalty (prior to age 59 1/2) on earnings only on total distribution
Eligibility subject to income limits  no income limits*
2016 contribution limit $5,500 per year ($6,500 if age 50 or over) $5,500 per year ($6,500 if age 50 or over)
Required minimum distribution no yes

*deduction subject to phaseout limits if you have a retirement plan at work

IRA Contributions

For both the traditional IRA and ROTH IRA an individual may contribute up to $5,500 if under the age of 50, and up to $6,500 if age 50 or over per tax year, for 2016 and 2017.  However, an individual may not contribute more than their employment income.  ROTH IRA contributions are also subject to income limits.  While traditional IRAs do not have income limits, you may not be able to deduct contributions if you or your spouse have a retirement plan, such as a 401K or 403B plan, at work.


Traditional IRA – take a tax deduction now, pay taxes later

As long as you are not subjected to certain income phaseout limits, IRA contributions are tax deductible in the year in which they are made.  You will, however, have to pay ordinary income taxes on the withdrawals.  You will also be subjected to a penalty tax if you make withdrawals prior to age 59 1/2 (unless you qualify for certain exceptions).  Money invested in a traditional IRA grows tax deferred, so you will not have to pay taxes related to the growth or income in the account until you start taking withdrawals from the IRA.  You can make contributions to a traditional IRA up until age 70 1/2, after which point you will need to take a required minimum distribution each year (this is true for SEP and SIMPLE IRAs as well).  The amount of the required minimum distribution which you must take increases each year based upon your age according to mortality tables which are part of the IRS code.  The required minimum distribution rule makes it difficult for the account holder to continue to grow the account after age 70 1/2 as funds must be withdrawn from the account every year, thus subjecting these funds to income taxes.

Even if you do not qualify to take a deduction for your traditional IRA contribution, you can still benefit from its tax deferral feature.  However, you may be better off making a contribution to a 401K plan instead, as you will be able to deduct your contributions there up to the limit.

ROTH IRA – no tax deduction now, withdraw tax free later

ROTH IRA contributions are not deductible in the year in which they are made.  However, ROTH IRA withdrawals are not taxed as long as the ROTH IRA has been in existence for at least five years and are taken after age 59 1/2 (if either of these criteria are not met, the earnings on the ROTH IRA are subject to a 10% penalty tax).  ROTH IRA contributions can be made at any age, and there are no required minimum distributions as there are with a traditional IRA.  These features make the ROTH IRA a very attractive choice for retirement because the account holder is able to keep the funds in the account for extended period of time, where they can continue to grow and compound tax free.  The account holder has the option to withdraw portions of the ROTH IRA assets to fund retirement, and is able to do so tax free, but is not required to.

Certified financial planner

The Certified Financial Planner™ (CFP®) designation is a professional designation which is frequently held by financial planners, investment advisers and other financial advisers.  It is conferred by the Certified Financial Planner Board of Standards, Inc.  Candidates must have a bachelor’s degree (or higher) from an accredited college or university, three years of full-time personal financial planning experience and complete a course of study in financial planning topics.  These subject areas include investments, taxes, estate planning, insurance planning, employee benefits, and asset protection.

A candidate may be exempt from the course of study requirement if he or she holds a CPA, ChFC, CLU, CFA, Ph.D in business or economics, a Doctor of Business Administration, or an attorney’s license.

All candidates must successfully complete the CFP® Certification Examination, which has a reputation for being very challenging, comprehensive and arduous.

CFP® practitioners are subject to the CFP Board’s ethical standards, and must abide by a fiduciary standard.

Certificants must typically complete 30 hours of continuing education every two years, and 2 hours of these 30 hours must be in topics related to ethics.

In many jurisdictions, the CFP® designation will exempt an investment adviser representative from having to pass the Series 65 examination.


Trusts provide a way to preserve and protect assets, as well as pass assets to heirs outside of the probate process.  They are frequently utilized in estate planning to minimize estate taxes.  They can also be used to protect assets by moving assets away from the grantor.  Trusts are typically formed under state law, however unlike corporations and LLC’s they are not usually registered with the state in which they are formed.

Trusts usually have grantors, trustees, and beneficiaries.  The grantor contributes assets to the trust and executes the formation of the trust.  The trustee is designated by the grantor, who manages the trust assets for the benefit of the beneficiaries according to the terms laid out in the trust.

A trust can be revocable or irrevocable.  A revocable trust, frequently referred to as a living trust, allows the grantor to retain control of the assets while at the same time allowing those assets to pass outside of the probate process.  A revocable trust typically does not enable the trust assets to avoid estate taxes.

An irrevocable trust, on the other hand, involves the transfer assets out of the grantor’s name and typically causes the grantor to lose control of those assets.  Because these assets are transferred out of the grantor’s estate, they typically avoid estate taxes in many circumstances.

ROTH IRA conversion and recharacterization

Oftentimes it is advantageous from a tax planning standpoint to change an existing traditional IRA account to a Roth IRA account.  This is known as a Roth IRA conversion. Roth IRA accounts and traditional IRA accounts have different advantages and benefits.  As discussed previously, traditional IRA accounts provide an immediate tax benefit while Roth IRA accounts provide a tax benefit at the time of withdrawal.

A Roth IRA conversion would subject the IRA account owner to income taxes on the withdrawal from the traditional IRA account in the year that the conversion is made.  As Roth IRA withdrawals are tax free, the account owner will not have to pay any additional taxes on Roth IRA withdrawals once the taxes on the Roth IRA conversion have been paid.  A Roth IRA conversion should only be executed after careful analysis and tax planning has been done, with particular attention paid to income tax brackets in the current year as well as projected income tax brackets in future years.

In some other situations it becomes necessary to change IRA contributions which have already been made.  This would occur when the account owner wishes to change  traditional IRA contributions to Roth IRA contributions in order to take advantage of the benefits of the Roth IRA, or vice versa.  A common example of a recharacterization is when an individual subsequently becomes ineligible for a Roth IRA due to exceeding the relevant income limits, after the Roth IRA contributions have been made.  In this case, the account owner can recharacterize those contributions, and typically has until the tax filing deadline, including extensions, to do so.

Medicare advantage and medicare supplement coverage

Certain parts of medicare are administered by private insurance companies.  These include medicare part C (“medicare advantage”), medicare part D (prescription drug plans), and medicare supplement plans.

Medicare part C, frequently referred to as “medicare advantage”, provides a means for medicare eligible individuals to obtain their hospital and outpatient medical coverage through private insurance companies.  This is in contrast with medicare part A and part B, in which such coverage is administered and provided by the federal government.

Medicare advantage plans vary and have different rules,  provider networks and out of pocket costs.  Some medicare advantage plans include prescription drug coverage while others do not, and the premiums for these plans are typically paid for by medicare.  The private insurance companies and the plans which they provide must be approved by and are regulated by the federal government.

Medicare part D includes prescription drug coverage.  As discussed previously, some medicare advantage plans include this coverage while others do not.  Additionally, medicare beneficiaries who are enrolled in part A and part B have the options of purchasing stand alone part D prescription drug coverage.

Medicare supplement plans, frequently referred to as “medigap” plans, are private plans which can be purchased by an individual who is enrolled in medicare part A and part B.  These plans provide a means for medicare participants to obtain coverage for deductibles, co-insurance, and other out of pocket costs associated with medicare part A and part B.  Like medicare advantage plans, medicare supplement plans are regulated by the federal government.

Medicare part A and part B

Medicare coverage is broken down into parts A, B, C and D.  Medicare part A (hospital coverage) and medicare part B (medical coverage) are run by the federal government.  Part C (medicare advantage) and part D (medicare supplement) are administered by private insurance carriers and are approved by the federal government to replace or supplement parts A and B.

How you manage your medicare coverage is an important part of financial planning if you are of the age where you qualify for benefits of any kind.  Here we will provide a very basic overview of medicare parts A and B and how they work.  In subsequent articles we will discuss medicare parts C and D and how you can use these private plans to actively manage your individual situation.

Medicare part A – hospital coverage

Medicare part A is hospital coverage, and you do not have to pay premiums for this coverage if you are age 65 and you meet certain requirements.  Medicare part A covers medically necessary services required to treat a disease or condition.  These include hospital care, skilled nursing facility care, nursing home care, hospice, and home health services.

Medicare part B – medical coverage

Medicare part B is outpatient coverage, and you must typically pay premiums for part B.  You must under many circumstances enroll in medicare part B when you are first eligible.  If you do not, you will have to pay a penalty in the form if higher premiums when you finally do enroll, unless you meet certain exceptions.  Medicare part B covers medically necessary supplies and services needed for diagnosis or treatment of your condition.  This includes services received at a doctor’s office, clinic, hospital, or other health facility.




Retirement plan limits and deadlines for the 2016 tax year

Below is a summary of key retirement plan information for the 2016 tax year.


Retirement plan deadlines and limits for the 2016 tax year
plan type  deadlines contribution limit
Traditional and ROTH IRA plan must be established and contribution must be made by the tax filing deadline, no extensions $5,500, $6,500 if age 50 or older
SEP IRA plan must be established and contribution must be made by the tax filing deadline, including extensions 25% of wage or salary compensation or $53,000, whichever is lesser
SIMPLE IRA new plan must be established by October 1 $12,500, $15,500 if age 50 or older
401K plan plan must be established by the end of the calendar year.  contribution must be made by the tax filing deadline, including extensions $18,000, $24,000 if age 50 or older for employee deferrals, $53,000 for total contributions, including employer contributions
Solo 401K plan plan must be established by the end of the calendar year.  contribution must be made by the tax filing deadline, including extensions $18,000, $24,000 if age 50 or older, plus 25% of compensation, or 20% of self employment income, up to a limit of $53,000, or $59,000 for an individual age 50 or older
Defined benefit pension plan contribution must be made by September 15 for plan with fiscal year ending December 31 of prior year benefit amount can not exceed $210,000 or average of highest 3 years of compensation.  Contribution limit is based upon actuarial computations based upon these benefit limits


IRA rollovers and transfers

IRA rollovers and transfers involve the tax deferred movement of funds between different retirement accounts.  Oftentimes there will be a need or desire to move funds from one retirement account to another.  This will occur, for example, after leaving an employer, or when moving your IRA from one financial institution to another.  If these movements of funds are conducted in accordance with IRS rules the account participant can avoid taxable events which normally occur when withdrawing funds from retirement accounts.

IRA rollovers

An IRA rollover is the movement of funds from an employer sponsored retirement plan, such as a 401K or 403B plan, to an individual retirement account (“IRA”).  If done in accordance with IRS rules, the rollover will not result in a taxable event for the account participant.

In rare cases it is possible to perform a direct, trustee to trustee transfer of funds from the 401K plan to the IRA.  Such transfers are typically initiated by the receiving financial institution or trustee.

In the majority of cases, however, rollovers are accomplished by having the 401K plan custodian generate a check payable to either the receiving financial institution which has custody of the receiving IRA account or directly to the 401K participant.  In order to comply with IRS rules and not have the 401K plan withdrawal be treated as a taxable event, funds must be rolled over to the receiving IRA account within 60 days.  This is true even in cases where the 401K plan custodian generates a check payable to the custodian of the receiving IRA account.

IRA transfers

An IRA transfer is a movement of funds from one IRA custodian to another.  These transactions can usually be executed by means of a direct, trustee to trustee transfer, typically initiated by the financial institution on the receiving end of the transfer.

Similar to how IRA rollovers are executed, a transfer can be accomplished by having the financial institution which has custody of the IRA generate a check payable directly to the receiving financial institution.  A transfer executed in this manner must be completed within 60 days in order to avoid having the withdrawal deemed to be a taxable event.

Alternatively, an indirect transfer can be accomplished by having the financial institution which has custody of the IRA generate a check payable to the account holder.  The account holder then has 60 days to roll the funds over to the new IRA account at the receiving financial institution or trustee.  Keep in mind that oftentimes when performing such an indirect transfer, taxes will be withheld by the outgoing custodian.  It is important that the full amount of the withdrawal be rolled over to the new account in order to avoid any taxable event associated with the withdrawal.

Asset location

Where assets are “located” has a significant impact from both a tax perspective and an asset protection perspective.  Assets can be placed/located in retirement accounts, taxable accounts, life insurance policies, annuities, trusts, corporations, and LLC’s.  This can be a complex subject overall.  We will briefly discuss here a comparison between ROTH retirement accounts and traditional retirement accounts, a comparison between retirement accounts and taxable accounts, as well as some discussion of life insurance policies and annuities.

Retirement accounts – ROTH accounts versus traditional accounts

Assets in retirement accounts typically accumulate and grow tax deferred (in the case of traditional 401K, 403B and IRA accounts) and in the case of ROTH 401K and ROTH IRA accounts can be withdrawn tax free.  For this reason, a case can be made for placing assets which have the capacity to generate the largest long term gains (such as small cap stocks) into ROTH accounts, while placing the assets which are lower risk and do not have the capacity to generate large long term gains (such as U.S. treasury bonds) into traditional accounts.  A careful analysis should be done of the tax bracket now and the expected tax bracket during retirement.

Taxable accounts versus retirement accounts

As taxable accounts do not have any tax deferral features, a case can be made for placing growth, non dividend paying assets into these accounts, and placing dividend paying assets into retirement accounts and reinvesting those dividends and interest.  This way, the investor can benefit from the long term capital gains taxes which are typically lower than the income taxes which are levied on dividends and interest.

Annuities versus taxable accounts

Assets in annuities grow tax deferred, with the basis determined by the amount contributed to the annuity.  For this reason, a case can be made that it is advantageous to place dividend-paying assets into annuity contracts while placing non-dividend paying, long term appreciating growth assets outside of annuity contracts.  This way, dividend generating assets can accumulate and grow tax deferred inside the annuity contract, and the investor can benefit from the lower capital gains taxes on growth assets held outside the annuity contract.

Social security retirement benefit

When you decide to take your social security retirement benefit will have a significant impact on the amount of the benefits.  Your “full retirement age”, according to social security rules, will vary depending upon your birth year, between the range of age 65 if you were born in 1937 or earlier, to age 67 if you were born in 1960 or later.  You can take benefits earlier than this, as early as age 62, and receive a reduced benefit amount, or take benefits later than this, up until age 70, and receive an increased benefit amount.  The exact amount of your social security retirement benefit amount can be found on your social security statement, which is sent to you annually by the social security administration.  You can also access your benefit information online at  When you should file will depend on a number of factors including your health and life expectancy and your additional financial resources available to you to fund your retirement.

In many situations a strong case can be made for delaying the taking of social security benefits as long as possible, until age 70, because in many cases this will result in the largest benefit overall.  Of course each individual’s situation is different and a thorough analysis should be done taking into account a number of different factors unique to the individual.  A financial adviser can assist with the process of analyzing your situation in relation to your balance sheet and income statement, to help you determine the option which best suits your needs.

Retirement income planning

Retirement income can be broken down into three general categories: income from investments, income from pension plans, and income from social security.  Of course, many decide to continue working during retirement so employment, self employment or business income may be available as well.

Investment income

Investments can be used to to fund retirement needs by either generating dividend and interest income or by gradually liquidating the assets over the course of retirement.  The main advantage of the first method is preservation of principal, and its disadvantage is that it results in lower income than the second method.  The advantage of the second method is larger income, and the disadvantages include depletion of principal and longevity risk related to the assets lasting throughout retirement.  In certain cases this longevity risk can be managed by means of insurance contracts such as annuities, however such contracts require the policy owner to give up control over the principal.

Income from pension plans

Defined benefit pension plans are another source of retirement income.  Benefits paid are typically a function of age, income received while employed with the company or organization associated with the defined benefit plan, and years of service provided to the employer or organization.  Other factors can also impact the income provided by the plan, including whether or not a spousal survivor benefit is included in the plan.  Pension plan income is advantageous in that there is no longevity risk associated with the benefits, as benefits are in most cases paid throughout the life of the pensioner.  Careful planning should be done with respect to coordinating survivor benefits of the pension plan.  In certain cases, life insurance contracts can be purchased in lieu of activating survivor benefits on pension benefits, however a careful analysis should be done before doing so.

Income from social security

Income from social security is the most common source of income for Americans, providing 40 percent of income for persons 65 years old and older according to the Social Security Administration.  When to file for social security benefits is an important decision and should be coordinated carefully with other retirement income sources in order to maximize retirement income.



Required minimum distribution rules for retirement accounts

Certain retirement accounts are subject to required minimum distribution rules upon reaching a certain age, typically 70 1/2.  At this point, the account participant is required to withdraw a certain amount from the account(s) each year, and these withdrawals are usually subjected to income tax.  The participant may withdrawal more than the required amount and still be in compliance with the rule.  The rules apply to IRA accounts, SEP-IRA accounts, SIMPLE IRA accounts, 401K plans, 403B plans, 457 plans, and other defined contribution plans.  Note that ROTH IRAs are not subject to the rule in most cases.

The amount of the required minimum distribution is based upon age and marital status, and is determined based upon mortality tables.  The details of the calculation will not be covered here, however most account custodians will calculate the required minimum distribution for the account owner.

Exceptions to IRA early withdrawal penalty tax

In most cases, you will be subjected to a 10% penalty tax on withdrawals made from an IRA account (for a ROTH IRA, this penalty is levied on the earnings only) if the withdrawals are made prior to age 59 1/2.  Keep in mind that you will always pay regular income taxes on withdrawals from traditional IRA accounts if you were able to deduct all of your contributions and that there are no exceptions to this.  If you did not deduct all of the contributions the situation is a bit more complicated.  There are, however several exceptions which will allow you to avoid paying the 10% penalty tax.  In this article we will cover three of these exceptions:  an exception related to being a first time home buyer, an exception related to qualified higher education expenses, and an exception which relates to taking equal periodic payments from your account.

First time home buyer exception

If you are using the IRA funds for a down payment on your first home, you may withdraw up to $10,000 without paying the 10% penalty tax.  You will, however, still have to pay income taxes.  In order for the home purchase to qualify as a first time home purchase, you must not have owned a home within the previous two years.  If you are married you and your spouse may each withdraw up to $10,000 from your IRA for the purpose of making a first time home purchase.

Higher education expense exception

If you withdraw funds from your IRA to pay for qualified higher education expenses of yourself, your spouse or your child you will not have to pay the 10% early withdrawal penalty tax.  Qualified higher education expenses include tuition, books, supplies and equipment required for enrollment at an eligible higher education institution.

Equal periodic payments exception

There is another exception to the early withdrawal penalty which involves taking equal periodic payments from the retirement account beginning at a time prior to age 59 1/2 and continuing for 5 years or until age 59 1/2, whichever is later.  The rules for using this exception are complex and we emphasize the importance of  consulting with a financial or tax adviser when using this exception.

Social security – retirement, disability, survivors

According to the Social Security Administration, over half of the elderly in the United States receive more than half of their income from social security, and in 2015 social security benefits accounted for almost 40% of the income of the elderly.  Besides providing old age benefits, social security provides protection related to disability as well as benefits for dependents of a decedent.  We will focus primarily on retirement income benefits in this article.

In order to qualify for social security, you must first acquire 40 credits (if you were born before 1929, you may need less).  You can obtain up to four credits per year, and in 2016 you would have earned one credit for each $1,260 of covered earnings.  So if you had earned $5,040 in 2016, you would have earned the maximum four credits for that year.  Once you have earned the required 40 credits, you qualify for retirement benefits, and the amount of your benefits will depend on your earnings throughout your working life.

The retirement benefit amount will depend upon the age at which benefits are filed for, with “full retirement age” being the benchmark .  Benefits will be higher if taken later than full retirement age, and lower if taken earlier than full retirement age.  Full retirement age will vary depending upon your birth year.  Details of your retirement benefits can be found in your social security statement, which is sent to you annually, and can also be accessed online at

Retirement account withdrawals

Retirement account withdrawals

How should withdrawals be taken from retirement accounts?  Factors include investment style and the amount which is withdrawn each year.  The manner in which  withdrawals are taken from retirement savings account has a significant impact on how long these assets will last.  A common practice in the financial services industry is to use Monte Carlo simulations to estimate probabilities of certain outcomes occurring with respect to how withdrawals will affect the retirement assets over time.  In this article we will illustrate how retirement account withdrawals can have different results by using two simple examples.

Can I take a loan against my 401K or IRA?

It is often tempting to take a loan or withdrawal from a retirement account to satisfy a financial need such as making a down payment on a house or paying off another debt.  Taking such loans and withdrawals is highly discouraged as it depletes retirement savings and can have significant impact on these retirement savings in the long run.  It is a serious decision which should not be taken lightly.  In cases where retirement savings must be accessed prior to retirement, a loan has an advantage over a withdrawal in that it will not result in taxable income as long as it is paid back according to its terms. However, certain retirement accounts allow loans while others do not.  This article will discuss the rules applying to different types of retirement accounts.

IRA loans – generally prohibited

Generally a loan can not be taken using an IRA.  Using an IRA as collateral for a loan is prohibited by IRS rules, and can result in the IRA becoming disqualified.  There is an IRS provision which allows 60 days to rollover or transfer an IRA to another custodian if the distribution from the IRA is paid directly to you.  Keep in mind that in this scenario the taxes are withheld from the distribution so you will need to supply additional funds to complete the rollover or transfer.

401K loans – take with caution

In many cases a 401K participant can take a loan against their 401K account balance, if the particular plan allows loans.  You can check the plan document or summary plan description, or check with your company’s HR department to see if a loan is permitted.  Taking such a loan is usually quick and easy and is not subject to any underwriting processes.  The installment payments made on the loans are usually made through payroll deduction from the participant’s paycheck.  401K loans must be paid back according to their terms in order to avoid being deemed to be a distribution and thus subject to taxes.  The loan terms are usually five years or less, unless the loan is used to purchase a primary residence, in which case it can be longer.  Keep in mind that if you are separated from service with your employer while the loan is outstanding, it must be paid back in full according to its terms, usually within 60-90 days of termination, or be deemed to be a distribution and thus be taxable.  “Interest” which is charged on the loan is typically paid back into the participant’s account as payments are made.

Employee pension plan

If you have a defined benefit employee pension plan provided by your employer in the United States, you are one of the lucky ones in that these plans are not offered as often as they used to be.  In recent decades a shift has occurred in the retirement plan landscape away from traditional defined benefit pension plans and toward what are known as defined contribution plans, specifically 401K and 403B plans.  This has resulted in the risk related to funding retirement being shifted from having been borne by the employer to being borne by the employee.  If you are of the relatively few who still has a defined benefit plan, this article will explain some of the basic things you should know related to planning your retirement as relates to your pension plan.

401K hardship withdrawal

A hardship withdrawal can be taken from a 401K plan in certain situations.  Under most circumstances it is not advised to withdraw funds from an IRA or 401K account prior to retirement.  You will be subjected to income tax on the withdrawals at both the federal and likely state and local levels, as well as a 10% penalty tax if the withdrawal is taken prior to age 59 1/2 (unless you meet certain exceptions).  Perhaps more importantly, a withdrawal prior to retirement will have the effect of depleting your retirement savings as well as the future earnings on these savings.

In the case of a hardship withdrawal, you will need to meet certain requirements related to your hardship.  You will be unable to make contributions to the plan for a period of six months subsequent to the hardship withdrawal.  If your employer makes matching contributions to the plan, these will be suspended as well.

Pension plans for small business owners

Defined benefit pension plans provide an excellent option for small business owners looking to save for retirement.  Similar to SEP-IRA’s and 401K plans, business owners can use these plans to save in a tax deferred manner.  The advantage of these plans is that they allow for larger contributions for the business owners, and are therefore ideal for highly compensated owners or partners of small businesses.  The disadvantage is that they are more time consuming and costly to administer than many of their alternatives.  Contributions to defined benefit pension plans are typically tax deductible to the business, and earnings grow tax deferred until they are withdrawn or paid out.  Unlike a SEP IRA or 401K plan, contributions must be made every year.  The contribution amount is based on a number of factors including age, compensation, retirement age, and assumed rate of return on pension assets.  If the business has employees, they must typically be included in the plan.

Choosing your 401K investments

Which investment options you choose in your 401K or 403B plan can have a significant impact on how your account will perform in the long run.  It is recommended that the assets in the 401K plan be allocated according to the time horizon and risk tolerance of the account owner, based upon an asset allocation model.  The asset allocation model has been shown to be one of the most critical determinants of long term investment portfolio performance.  Many 401K plans have limited investment options, although in most cases (but not always) they will have fund options available for each major asset class.  Sometimes there will be an option to invest in a self directed brokerage account, which allows the plan participant to purchase securities on the market, as opposed to choosing the from among the funds which are available in the plan.  We recommend following the steps below when determining the appropriate investment options.  We emphasize the importance of consulting the appropriate advisers in executing this process:

(1) Determine the appropriate asset allocation based upon your risk tolerance, time horizon and investment and financial goals

(2) examine the fund options in your 401K plan, and perform due diligence on the funds as necessary.

(3) allocate assets among funds as appropriate.  Investigate and allocate to self directed brokerage option within 401K if necessary

Investing in real estate through a self directed IRA

A self directed IRA allows an investor to invest in real estate in an IRA account.  The IRS code restricts investments in IRA accounts, and certain investments are prohibited (such as art, antiques, S-corp stock, life insurance, and collectibles).  Investment real estate is allowed, however, as long as the participant is not benefiting from the real estate in any way.  In order to qualify under IRS rules the participant may not use the property in any manner, or receive rental income from the property outside of the IRA.

To invest in real estate, typically the IRA participant must designate a financial institution, in the majority of cases a trust company, as the trustee and custodian of the self directed IRA account.  The IRA participant can then direct the trustee to purchase real estate for the IRA.  All real estate expenses must be paid from the IRA account, and all income from the real estate must be paid directly back into the IRA account.

As long as the self directed IRA is set up correctly and is compliant with IRS rules, the IRA participant is able to enjoy the tax advantages of the IRA.   This includes tax deferral of both the income received from the property as well as capital gains received when the property is sold.  In the case of a ROTH IRA, the participant is also entitles to receive tax free withdrawals, assuming that the normal requirements are met.