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Money October 2014

Dollar Sense

Is Your Retirement Plan Doable?

By Teresa Ambord

If you’re now contributing to a 401(k) plan, you are likely getting a healthy tax break for that. But once you stop contributing and start collecting, the tax situation flips. You no longer have a deduction, and the distributions you get will be taxable. Whoops!

If retirement is in your short-term plans, you need to figure out now if that plan is going to work for you or not. The Wall Street Journal (WSJ) recently offered some tips for those hoping to retire in the next five years. While there’s time, think about these things:


Do you have prepaid or discounted legal services through your job?

According to the WSJ, one of the biggest regrets clients have in retirement is that they did not take advantage of this type of plan while they had the chance. If it is available, use it to have will and trust work done while you can.


How much income will you need to retire the way you want to?

Figure out what you spend now. That might mean keeping a record of every dime you spend, for a few months, so you’ll have a baseline. Then make a rough retirement budget, and adjust your current spending to what you expect to have at retirement. Ask yourself what you hope to do in retirement. Do you plan to:

  • Travel and still be able to pay your bills?
  • Relocate?
  • Are you going to work part-time or perhaps pursue a second career?

By making a retirement budget and comparing it to what you spend now, you can know what adjustments you’ll have to make after you stop working full time. What changes in lifestyle will you have to make? While you are working you may eat out a lot. With more time and less expendable income, you might want to become a home cook, or a BBQ chef. Giving thought to such things will help you later.


Where do you want to live in retirement?

Do you plan to stay put, downsize, relocate? Compare the expenses associated with the options:

  • If you plan to move to a condo, what fees should you expect to pay? What are you paying now for upkeep on your home, and possibly for homeowner association dues?
  • If you expect to move to another state, what will the differences be in state personal income tax, property tax, and sales tax? State and local taxes can vary widely. Several states do not charge personal income tax at all, which is a boon, and in other states, property taxes are oppressive. On the other hand, some states have such affordable operty tax that you’ll find you can afford a bigger house than you expected. Find out before you make your decision.
  • What are the costs to move, and the closing costs of buying a new residence?
  • If you do plan to relocate to a new area, spend some time there during each season, before you commit to moving.


Will you have a mortgage in retirement?

WSJ suggests it might be a good idea to refinance your mortgage while you are still working. Interest rates are low now, but may head higher. If you can’t pay off your home before you retire, consider refinancing now to reduce your payments to a level that will be easier to manage on retirement income. Remember, you’ll have your mortgage interest tax deduction to offset your taxable interest income.


What car or cars will you need?

You’ll want your overhead to be as low as possible once you retire, so it’s best to avoid car loans. If you must finance a car, arrange for payments you can handle on your retirement income. If you hope to upgrade your vehicle in retirement, it might be best to do it now while your income is higher. Also consider whether you’ll need two cars or if one will do. If one is enough, you can sell the other, said the WSJ, and tuck away the money or upgrade the vehicle you keep.


What will your taxes be in retirement?

Of course nobody knows what the tax rates will be. But here are some points you can anticipate. If you’re now contributing to a 401(k) plan, you are likely getting a healthy tax break for that. But once you stop contributing and start collecting, the tax situation flips. You no longer have a deduction, and the distributions you get will be taxable. Whoops! Many retirees fail to realize that. You might be able to avoid that harsh reality by moving some funds now into a Roth 401(k) or Roth IRA. You will pay the income due on those funds now, but your future earnings will be tax-free. Plus, if you believe taxes will rise in the future, you can save by getting the tax bite over with now. Conversions can be complex, so don’t attempt them without the help of your tax adviser. (See sidebar.)

Also, if you currently have a mortgage but plan to sell your home or pay off the mortgage before retirement, keep in mind you will lose a significant tax deduction.


What is your health insurance situation?

Will you keep the benefits you now have through your employer? Of course, you won’t be able to qualify for Medicare until you are 65, and even then you will need to cover significant out-of-pocket costs. Sit down with your financial adviser to look at what you have, what employer policies, if any, you can keep, to see what is the best route for you. Be sure to use your current health benefits to the max while you have them, for elective visits like dental and optometry.


How is your money currently invested?

Five years from retirement, says the WSJ, you may want to shift your money away from growth stocks, which carry more risk, and towards a more conservative allocation. That is, put more money in income investments, but not all of it. If the market grows, you’ll want to have some “skin in the game.” According to the WSJ, it’s “often helpful to bucket assets for different time horizons, conservative investments for short-term needs, moderate for mid-term, more aggressive for longer
term.” Even this close to retirement, you still need some diversity in your investment portfolio.


What’s your game plan?

It’s easy to put off thinking about retirement plans till after you retire. How will you actually spend your days? Too many people don’t think it through, and then end up spending their days on the couch, watching “The Price is Right.” Take some time to consider potential hobbies, cultivate new friends, or reconnect with old ones. Lay the foundation for what you’d like to pursue in retirement, so when the time comes, you can step right into Chapter Two. That might mean keeping your eyes open for a good deal on equipment you will need for retirement hobbies or other pursuits.


Sidebar: A Legitimate Way to Sidestep the Roth IRA Rules

Roth IRAs are popular among those who want tax-free distributions once they retire. Since Roth IRAs are funded with non-deductible contributions, the tax bite is over and done. So if you expect tax rates to rise from where they are today, converting to a Roth might be a good idea. Unfortunately Roth IRAs have limitations. If you are married filing jointly, your eligibility to contribute to a Roth IRA is reduced if your modified adjusted gross income is $181,000 and zeroes out at $191,000. For single or head of household filers, the range begins at $114,000 and zeroes out at $129,000.

People with high incomes may be ineligible to make Roth IRA contributions… but there is a legitimate way around that. Anyone can contribute up to $5,500 per year to a traditional IRA. If you are at least 50, you may contribute up to $6,500. People who are eligible to participate in an employer’s qualified retirement plan, or people who earn too much can only make IRA contributions which are non-deductible. That means the tax bite has been paid, the same as if you had a Roth IRA. Before any interest is earned on the account, it might be a good idea to ask your IRA custodian to convert your traditional IRA to a Roth IRA. There will be no taxable income and no taxes on the conversion.


Teresa Ambord is a former accountant and Enrolled Agent with the IRS. Now she writes full time from her home, mostly for business, and about family when the inspiration strikes.

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