There are many considerations for your retirement, including tax efficient income strategies, social security and the necessary income to meet your lifetime needs. We want to help you better understand your options for retirement and the potential issues you might face.
Sources of Retirement Income
Retirement preparation usually relies upon three main sources of income: Social Security or public defined benefit plans, individual or employer-sponsored qualified retirement plans, and an individual's own savings or investments. We want to help you develop a sound retirement plan that recognizes Social Security or your defined benefit plan as your foundation of steady income and will utilize qualified retirement plans and personal savings as the primary sources of discretionary income.
Social Security or Defined Benefit Plans
Social Security was established in the 1930’s as a safety net for people who, after paying into the system from their earnings, could rely upon a steady stream of income for the rest of their lives. The age of retirement, when the income benefit starts was, originally, age 65 which was referred to as the “normal retirement age”. Now, for a person born after 1937, the normal retirement age is being increased gradually until it reaches age 67 for all people born in 1960 and beyond. The amount paid in benefits is based upon the earnings of an individual while working. If a person wanted to continue to work and delay receiving benefits, they could do so build up a larger benefit. Conversely, early retirement benefits are available, at a reduced level, as early as age 62.
An example of a public defined benefit plan is the California State Teachers’ Retirement System, or CalSTRS. CalSTRS provides retirement, disability and survivor benefits for full-time and part-time California public school educators through a hybrid retirement system consisting of its Defined Benefit, Defined Benefit Supplement and Cash Balance Benefit programs, and a voluntary defined contribution plan called CalSTRS Pension2.
Employer-Sponsored Qualified Plans
Most employer-sponsored plans today are established as “defined contribution” plans whereby an employee contributes a percentage of his or her earnings into an account that will accumulate until retirement. The amount of income received at retirement is based on the total amount of contributions, the returns earned, and the employee’s retirement time horizon. As in all qualified plans, withdrawals made prior to age 59 1/2 may be subject to a penalty of 10% on top of ordinary taxes that are due.
Examples of employer-sponsored qualified plans are 401(k) Plans, a Simplified Employee Pension Plan or, in the case of a not for profit organization, a 403(b) plan.
Traditional and Roth IRAs
Individual Retirement Accounts (IRA) are tax qualified retirement plans that were established as a way for individuals to save for retirement with the benefit of tax favored treatment. A traditional IRA allows for contributions to potentially be made on a tax deductible basis and to accumulate without current taxation of earnings inside the IRA account. Distributions from a traditional IRA are typically taxable. A Roth IRA is different in that the contributions are not tax deductible. Earnings inside a Roth IRA are not currently taxable. To qualify for tax-free and penalty-free withdrawals of earnings, a Roth IRA must be in place for at least five tax years and the distribution must take place after age 59 ½ or due to death, disability, or a first-time home purchase (up to a $10,000 lifetime maximum). Depending on state law, Roth IRA distributions may be subject to state tax.
Distributions from traditional IRAs and employer-sponsored retirement plans are taxed as ordinary income. Additionally, if these distributions are taken prior to reaching age 59 ½, they might be subject to an additional 10% federal tax penalty.