Jordan Goodman - How To Retire Rich (Part 1)

J ordan E.
Goodmans
HOW TO RETIRE RICH:
Creating Your Own
Personal Fortune Formula
Workbook
Volume One
2003 Jordan E. Goodman
J ordan E. Goodmans HOW TO RETIRE RICHVolume One 2
Table of Contents Volume One
DECISION MAKING BEFORE YOU RETIRE
Session 1: Breaking the Myths of Retirement Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3
Session 2: Are You Ready to Retire? The 10 Key Qualifying Questions . . . . . . . . . . . . . . . . . .4
Session 3: How to Prepare for Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7
IMPLEMENTING YOUR PERSONAL PLAN
Session 4: The Truth About Social Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14
Session 5: Maximizing Your Pension Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19
Session 6: Understanding Defined Contribution Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24
Session 7: Understanding Self-Employed Pension Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . .27
Session 8: Getting the Most from Individual Retirement Accounts . . . . . . . . . . . . . . . . . . . .31
Many of the tables and financial figures listed in this guidebook are based on current government
statistics. Often, they change on an annual basis;, thus, to obtain the most recent information, you
should check them with the appropriate government agency.
DECISION MAKING BEFORE YOU RETIRE
Session 1: Breaking the Myths of Retirement Planning
What have been your lifelong dreams? Do you plan to pursue them once you re t i re? How close do
you think you are from retiring? According to the American Association of Retired Persons
(AARP), over 40% of Americans over 60, re g a rdless of their current economic circumstances, will
experience poverty at some point in their later years. In this session J ordan Goodman intro d u c e s
you to the tools, strategies, and concepts that he provides in this program that will assist in pre-
venting you from becoming one of those sad statistics. To launch you into the program, J ord a n
p rovides you with a Retirement Readiness Checklist that will assist you in establishing just how
ready you are to re t i re.
1. Listed below are 11 myths that are perpetuated today regarding retirement. Go through the
list and mark which myths you currently believe to be true.
Retirement Myths:
When I retire, I wont work. True ____ False ____
Ill need a great deal of money to retire. True ____ False ____
The government will take care of me. True ____ False ____
My company will take care of me. True ____ False ____
Medical insurance will take care of me. True ____ False ____
Social Security payouts will end by my retirement. True ____ False ____
I wont live long. Not much past 75 years old. True ____ False ____
I will have to downsize housing when I retire. True ____ False ____
Education is only for the young. True ____ False ____
When I leave my job, my self-worth will decrease. True ____ False ____
My life will slow down once I retire. True ____ False ____
2. Jordan discusses the significance of setting short-, medium-, and long-term goals for yourself.
In preparation for the long-term goal of retirement, what systems do you currently have in
place to prepare for your retirement?
3. Listed below is your Retirement Readiness Checklist. Take some time to go through this list,
checking the items that apply, to ascertain just how prepared you are for retirement:
Retirement Readiness Checklist:
___ Have you set a desired retirement age for yourself?
___ Do you currently have any savings in place toward your retirement?
___ Do you have an idea of what youd ideally like to do when you retire?
___ Do you plan on continuing with the lifestyle you currently enjoy when you retire?
___ Have you calculated how much money you would need to save for retirement in order
to maintain your desired lifestyle?
___ Do you have solid insurance plans in place for your retirement?
___ Have you calculated how much your desired lifestyle goals will cost?
___ Do you know how much you currently have in your savings?
___ Have you considered what you would like to do with your time during retirement?
___ Do you know what kind of return you expect to get on your investments?
If you checked any of the above readiness questions, you are on your way to some solid retire-
ment planning. If you did not check off any of the above, youve got quite a journey ahead of
you. In either case, this program will assist you in clarifying your desires and needs, along with
creating a solid, comprehensive retirement plan for yourself.
Session 2: Are You Ready to Retire? The 10 Key Qualifying Questions
A re you pre p a red financially, physically, and emotionally to end your career? Without corre c t
p reparation for such an extreme transformation in your life, you could find yourself stru g g l i n g
during a time in which you deserve to experience a great deal of comfort, joy, and ease. In this
session Jordan outlines the 10 questions that you should ask yourself before considering re t i re-
ment.
4. The 10 Key Qualifying Questions:
Can you afford to retire?
What kind of lifestyle do you want when you retire?
Do you plan on supplementing your income when you retire?
Is there a way that you can make residual income throughout your retirement?
How can you fully prepare for retirement?
What lifelong dreams do you want to pursue? Can you aff o rd to pursue them if you re t i re now?
Do you have hobbies and a variety of interests that you wish to pursue to keep you busy
throughout your retirement?
How is your health? Are you adequately insured for any health issues that may arise?
Is now the right time for you to retire?
Is your social life based on your job environment, or have you developed a fulfilling social
life outside of your work?
J ordan E. Goodmans HOW TO RETIRE RICH Volume One 4
5. Life Goals Inventory List:
In each of the areas of your life listed below, write out any goals that you have desired pur-
suing. If you have accomplished a goal, then make a () beside that goal. Be sure to make
the list as complete as possible. You may wish to revisit this list often, adding items to it,
and checking items off it as you complete them.
Travel
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Education
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Spirituality
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Career
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Friendships
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Relationships
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Home
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Car
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Adventure
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Hobbies
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Health/Fitness
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Recreation
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Other
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Session 3: How to Prepare for Retirement
T h e re are several steps that you can take to make the transition into re t i rement as easy as possi-
ble. In this session J ordan will discuss what pre p a r a t o ry actions you need to take now in order to
e n s u re that you are financially pre p a red to re t i re. You will find several budgeting and fore c a s t i n g
worksheets below. J ordan encourages you to take the necessary time to go through the worksheets
and get a definitive forecast of what you will need for your re t i rement. You can then begin to take
p roactive steps toward funding it.
Listed below are some action steps that J ordan suggests you take in order to pre p a re for your
re t i rement. Make the commitment now to go through the list and begin your re t i rement planning.
Doing so will save you a great deal of stress and anxiety in the future .
6. Keep a diary of your current spending.
7. After several weeks of doing this, you can produce average monthly figures for expenses.
A Monthly Budgeting Wo r k s h e e t is provided on the next page to assist you in your
i n v e s t i g a t i o n .
8. Go through a completed Monthly Budgeting Worksheet and strike out any current expenses
that you will not have once youve retired (perhaps mortgage, commuting costs, financial sup-
port of dependents, etc.).
9. Take some time to add the new expenses and cost estimates for items that you may wish to
purchase during your retirement (education, travel, entertainment, etc.). The Retirement
Expenses Worksheet, page 9, may be helpful
Monthly Budgeting Worksheet
Retirement Expenses Worksheet
10. Now that youve created your new Retirement Expenses Worksheet, take into account the
impact that inflation will have on your retirement plans, and consequently work it into your
the Retirement Expenses Worksheet. This Impact of Inflation chart will assist you in calcu-
lating inflation
into your
preparatory
plans.
11. In order to successfully plan for your retirement,
you need to know where your largest sources of
income will be coming from. Take note of the items
listed in the Largest Sources of Income List.
12. This Capital
Accumulation
Worksheet will
assist you in gaining
a clearer picture of
how your capital
will accumulate
come time for
retirement.
13. The Annual
Savings Worksheet,
on the next page,
will further assist
you in projecting
exactly how much
money you will have
saved for retirement
when the day
arrives.
Capital Accumulation Worksheet
Impact of Inflation
Largest Sources of Income List
, see bottom of page 9.
Annual Savings Worksheet
14. Now that you have completed these worksheets, here are some simple ideas you can imple-
ment in your life that may assist you in saving more toward your retirement.
J Brown bag for lunch
J Energy-proof your home
J Control holiday costs
J Pay off credit cards or get lower-interest cards
J Consolidate all your debt at much lower interest rates; contact the Debt Relief Clearing
House (800-779-4499 or www.debtreliefonline.com)
J Set up a monthly automatic investing program with a mutual fund
15. If you find that you come up short in your financial preparedness, you may wish to practice
dollar cost averaging (putting aside a fixed monthly sum of money for your future). The fol-
lowing tables will give you a clear indication of how practicing this investing technique is a
very effective way to save money toward your retirement.
Investing $10,000 All at the Same Time
Investing $10,000 in a Dollar Cost Averaging Strategy
16. Reverse mortgages and federally insured home equity conversion mortgages are some other
tools that you can utilize to assist you in your retirement savings plan:
Assets: your home, particularly if you paid it off
Reverse Mortgages:
Single-purpose mortgage (usually for one-time necessities, like repair)
Federally insured home equity conversion mortgages (an annuity payment is the best
way as opposed to a lump sum of cash)
You can contact the American Association of Retired Persons (AARP) to get a free
Home Made Money: A Consumers Guide to Reverse Mortgages, published by the AARP,
601 E St. NW, Washington, D.C. 20049; 800-209-8085. www.aarp.org/revmort.
IMPLEMENTING YOUR PERSONAL PLAN
Session 4: The Truth about Social Security
I n this session J ordan discusses in detail the current Social Security system. He dispels common
myths about Social Security, explains how it may be altered in the future, and, finally, how you
can best work with the system to gain the best benefits for your re t i re m e n t .
17. Listed below are some of the ways that Jordan suggests your Social Security may be altered
in the future:
There may be a means test to allocate a smaller benefit to higher-income people
Minimum age will go up to age 67.
You will be encouraged to retire later (a special credit given to those who delay retire-
ment).
You may pay higher taxes on Social Security benefits.
The percentage of your retirement pay that Social Security is designed to replace may be
reduced from 24% to 20% or less.
Social Security payroll taxes will increase from the current 7.65% for employees to as
much as 15% to 20%.
18. Below you will find two tables to assist you in projecting what your approximate monthly
Social Security benefits might be, based upon your age and annual income.
Approximate Monthly Benefits If You Retire at
Full Retirement Age and Had Steady Lifetime Earning
Age to Receive Full Social Security Benefits
19. You may be able to avoid some unpleasant tax surprises if you follow the advice below:
20. In order to be eligible for Supplemental Security Income (SSI), the government will review
your assets, excluding your home and car (they WILL note bank accounts, investments, and
cash that you have). The benefits that you receive would depend upon how much you earn
and where you live. In order to be eligible you must be:
A U.S. citizen
Living in the United States
At least 65 years of age
Blind or disabled
To see if you qualify, contact your local SSI office at 800-772-1213, www.ssa.gov.
21. In order to gain insight as to whether you are eligible to acquire Disability Benefits, you
must provide the following information to the government:
Whether you are working or not
The severity of your condition (it must be severe)
A list of disabling impairments
Whether your disability interferes with being able to do the work you did previously
Whether you are capable of doing any other type of work
22. If you are eligible, the chart below will assist you in establishing your approximate monthly
benefits:
Approximate Monthly Benefits If You Become Disabled in 2002
and Had Steady Lifetime Earnings
23. If you are eligible for Survivors Benefits, the table below can assist you in calculating your
approximate Monthly Survivors benefits:
Approximate Monthly Survivors Benefits for Your Family
If You Had Steady Lifetime Earnings and Die in 2002
Session 5: Maximizing Your Pension Benefits
Pensions can also be a source of income when you re t i re. There are two types of benefit plans you
could be eligible for. I n this session J ordan discusses pensions and how they can best work to
your benefit when you re t i re .
There are two types of pensions:
Defined benefit pensions: Your employer puts in the money and invests it for you, then
stipulates when you collect it and how much youll get.
Defined contribution pensions: You put money in and decide where you wish to invest it.
You decide when to collect it.
Which plan are you currently enrolled in? If you dont know, then take the time to investi-
gate your plan and learn about which plans are being offered to you.
There are three types of defined benefit pension plans:
Flat benefit formula plan: Pays a flat dollar amount each month after retirement. The
more years you work for a company, the higher the payment.
Career average formula plan: the income you earn over an entire career with a company
determines your monthly payment. It is averaged out and multiplied by the number of
years that you worked for the company.
Final pay formula plan: You get the highest monthly income. Your income is averaged for
the last few years, when you were earning your peak salary. You would then gain a per-
centage based on those earnings and the number of years youve been employed by the
company.
If you have a defined benefit pension plan with your organization, which of the above three
types of plans are you currently enrolled in?
You may also accumulate pay credits if you have a cash balance plan. To give you a greater
understanding of how a cash balance plan works in relation to a traditional pension plan, we
have provided you with two case studies, to show the outcome of each plan.
Often people are not protected when their pension plans terminate. To assist you in avoiding
such mishaps, we have listed below the ten common causes of error.
If your company goes out of business and the pension plan terminates, the federally backed
Pension Benefit Guaranty Corporation (PBGC) will step in as a trustee for the plan. Listed
below are the maximum monthly payout guarantees that it provides:
When the PBGC takes over your plan:
The PBGC reviews your plans record to determine what benefit each person will receive.
If you are already retired and receiving benefits, the PBGC will continue paying you with-
out interruption during its review. These payments will be an estimate of the benefits that
the PBGC can pay under the insurance program, and they may be less than what you were
receiving from your plan.
If you have not yet retired, the PBGC will pay you an estimated benefit when you become
eligible.
Once the PBGC completes its review, it informs you in writing what your pension amount
will be and what rights you have to appeal the decision.
PBGC Maximum Monthly Guarantees
There are a variety of payout options that you have on your defined benefit pension plans.
These are:
A pre-retirement survivors annuity:
Qualified joint and survivor annuity: Pays a fixed amount until you and your dependent
dies. This is the safest because it ensures that you or your spouse will get a monthly
income. Offers lowest payment level, but it covers both you and your spouse for the rest of
your lives.
Life only annuity: It stops when you die, thus your spouse gets none of it at that time.
Lump sum annuity: You have to know the rate of return that the employer will use in
making the calculations.
Term certain annuities: For 10 or 20 years a higher payment, but after 10-20 years, no
more payment.
Session 6: Understanding Defined Contribution Plans
Defined contribution pension plans are discussed in this session. J ordan outlines the types of
plans and how they work. They are much more widely available than defined benefit pension
plans, and can be very successful investment agents for your re t i rement. He discusses these plans
in detail, including the 401(k) plan, the 457 plan, and the 403(b) plan (off e red by religious, educa-
tional, or charity
g roups).
Jordan suggests
that you partici-
pate in your
employers contri-
bution plan.
Listed here are
two tables to
illustrate the pro-
jected maximum
pretax elective
deferral sums and
the catch-up elec-
tive deferral
sums.
Qualified Employer-Sponsored Retirement Plans:
Maximum Pretax Elective Deferral
Qualified Employer-Sponsored Retirement Plans:
Catch-up Elective Deferral
The rules for taking money out of the 401(k) plan are:
If you take money from your 401(k) you will pay an early withdrawal penalty of 10% and
be taxed during the year of withdrawal, unless yours is a hardship withdrawal (no penal-
ty). To qualify, you cannot have a loan against your 401(k), and you must use the money to
pay for college tuition, room and board, a down payment for a house, or if you face evic-
tion or foreclosure on your primary residence.
New Minimum Withdrawal Rules
Jordan discusses asset allocation options (high-risk, moderate-risk, low-risk funds and self-
directed):
High-Risk funds:
Stocks of aggressive growth
Sector funds
Small company growth funds
Special situation funds
Moderate-Risk funds:
Classic growth funds
Equity income funds that own stocks that pay dividends
Index funds
Low-Risk funds:
Balanced funds (
1
/2 stocks,
1
/2 bonds)
Flexible and asset allocation funds
Utility funds
GICs (guaranteed investment funds) fixed returns like CDs
Below are some guidelines for dividing your investment pie:
Age 20 mid 40s: 50% to 80% in higher risk and moderate, 20% to 30% in low risk
Age 40 50s: 40% in high risk, 40% to 50% in moderate risk, remainder in low risk
Age 60s and beyond: 20% to 30% high risk, 20% to 30% moderate, and rest in low risk
The 403(b) Plans that are offered to people in the not-for-profit sector:
Offer a tax sheltered annuity (TSA) inside this retirement account (church staff, university
professors, etc.)
Money is automatically available to you
Like a 401(k), you put money aside on a pre-tax basis through earnings
They are portable you can roll over your money to new employer plans
Employer contributions are optional; in some cases there is a 25% to 100% match
The 457 plans are more restrictive than 401(k) and 403(b) plans. They:
Are offered by government organizations
Can rollover into an IRA once you leave your job
Will max out in 2006 at $30,000 per year
The three main defined contribution plan mistakes to avoid are:
Failing to rebalance your portfolio once or twice a year
Cashing out when you change jobs (youll take a 10% penalty and pay taxes on it)
Putting all your eggs in one basket
Its important that you take note of what the management fees are when choosing a plan.
The difference with the addition of 1% more fee:
$25,000 with average annual return of 7%, annual expenses 0.5%, accumulates $227,000
$25,000 with average annual return of 7%, annual expenses 1.5%, accumulates $163,000
24. What are your current defined contribution plan investment contributions? Is there a way
that you can contribute to any of these plans so that you can maximize your opportunities?
Session 7: Understanding Self-Employed Pension Plans
I n this session J ordan will break down self-employed pension plans and explain how you can best
plan for your re t i rement if you have such a plan. I f you are self-employed, you actually have more
o p p o rtunities to make the most of re t i rement pension opportunities.
There are several self-employed pension plans that are available:
KEOGH PLAN:
Named after US Representative Eugene Keogh who first introduced the idea in the 1960s.
Defined contribution:
Money Purchase Plan:
Requires that you choose a fixed percentage of your earnings and contribute that per-
centage every year to the plan no matter whether you make a lot of money or lose
money.
The percentage that you contribute every year can be as low as 1% or it can be as high
as 25%, up to a maximum of $40,000 (for 401(k)s and 403(b)s its a lot less than that).
Requires you to contribute this money on an annual basis no matter how profitable
your business is. If you do not contribute, the IRS will penalize you. If you think you
might have trouble making that fixed obligation payment every year, you should prob-
ably do a profit sharing Keogh plan instead of the money purchase Keogh.
Profit Sharing Plan:
Up to 25% of your earnings, up to $40,000 per year.
You can contribute the full amount one year and nothing the next, depending on how
your business performs. This flexibility often makes people much more interested in
doing a profit sharing than a money purchase Keogh.
The Combination Option:
You can do a Keogh that combines both money purchase and profit sharing plans that
offers you the option of contributing the maximum of $40,000 but does not lock you
in to a maximum contribution.
You can start with a profit sharing plan and then add a money purchase plan with a
set annual contribution limit such as 8% or 10%.
In good years you can add money to the profit sharing plan up to the maximum of
$40,000; in lean years you pay only the minimum.
Keogh plans are available:
If youre the sole employee of your business but also if you have others working for you in
a small business.
Rules for other employees regarding contribution limits, how much of their salary you can
contribute, and other matters differ slightly from those for the single workers. But in gen-
eral you must contribute at least the same percentage of income for your employees as for
yourself.
Defined benefit Keogh:
Allows you to contribute much more than the $40,000 per year of a defined contribution
Keogh.
Each year the amount of money you add can be significantly greater or less than the
amount you invested in the previous years.
You would have to get an actuary who can project your defined benefit amount in retire-
ment to help you figure this out. But if you do that, you can potentially put away a lot
more money into a defined benefit Keogh than you can with the $40,000 limit of a defined
contribution Keogh.
Are usually established by high-income people in their 50s with very successful businesses
who have so far neglected to set up any kind of a pension plan. These plans allow them to
catch up by investing a greater amount of capital all at once to create a large pension ben-
efit in retirement.
Other rules about Keoghs:
Unlike an IRA, you cannot open a Keogh account right up to the April 15th tax-filing
deadline. You must establish a Keogh by December 31st of the year in which you file for
the deduction. This is a key point to remember because one of the biggest advantages of a
Keogh is that all your contributions are tax deductible. Although you must open the
account by the end of the year, you can make a contribution or add to an existing Keogh
up to April 15th and claim the deduction in the previous year. Just make sure you open
that account by December 31st.
In general its difficult to withdraw cash from a Keogh before you reach age 59
1
/2 if you are
the employer. Employees and owners enrolled in the Keogh plan can borrow up to half
their vested balance up to $50,000, but it must be repaid through payroll deductions over
the next five years.
There is definitely a certain amount of paperwork that goes along with establishing and
maintaining a Keogh account. If you deal with a reputable mutual fund company, broker-
age firm, insurance company or bank, the people there should be able to help you com-
plete most these necessary forms, although they may charge you a little bit for the service.
Accountants and financial planners will prepare Keogh documents.
The main form you have to prepare is called the IRS Form 5500, which is the annual
report required if your Keogh plans assets exceed $100,000. If theyre under $100,000, you
do not have to file the Form 5500.
SIMPLIFIED EMPLOYEE PENSION (SEP) PLAN:
This plan combines some of the best features of both the IRA and Keogh and its much
easier to establish than a Keogh because it involves a lot less paperwork.
Like an IRA, a SEP establishes an account for each participant, both you and all the
employees in your company. As in a profit sharing Keogh, you can contribute to a SEP one
y e a r, but not the next if you desire. If you have a bad year, you dont have to contribute to
the SEP.
As with other pension plans, you must pay a 10% penalty plus income tax if you withdraw
money from a SEP before age 59
1
/2.
In the same way that you cannot borrow against an IRA, you cannot borrow against a
SEP asset. However, the government does not require annual filings of set plan assets as it
does for Keoghs.
You can invest the money in a SEP just as you can with any IRA, in a mutual fund, bank,
credit union, brokerage firm, insurance company, or many other financial instutions.
Eligibility for a SEP is attained if an employee is at least 21 years old, has worked for the
firm at least 3 of the past 5 years, and has earned a certain minimum, currently $450,
though that number goes up each year with inflation a little bit.
Half of your firms employees must agree to participate before the plan can become effec-
tive. You just cant offer a SEP for you only and not have any of the employees in it.
However, if you are the sole employee of the firm, you can set up a SEP just for yourself.
Like a Keogh, a SEP allows a self-employed person to contribute up to $40,000 of his or
her annual income.
Other rules for SEPs are very similar to IRAs. You can set one up until the April 15th tax
deadline; therefore, if you miss the December 31st deadline for opening a Keogh, you
could open a SEP instead.
SIMPLE IRA:
Simple stands for Savings Incentive Match for Employees.
Typically set up for firms with 100 or fewer employees.
Employees can put $8,000 into an account. This amount will be going up to $10,000 in the
year 2005.
If youre over age 50, you can put in an additional $1,000. Thats going to go up to $2,500
additional contribution by the year 2006. So, in fact, the maximum you can put into these
if youre over age 50 would be $9,000 or $12,500 in 2006 which is similar to what you can
put in a 401(k).
Employers are required to contribute by either matching 100% of their employees contri-
butions up to 3% of their annual salary.
For employees who put nothing in on their own, employers must chip in 2% of pay on the
employees behalf.
All employees are eligible to participate in a SIMPLE IRA if they earned at least $5,000
during the two preceding years and are expected to earn at least $5,000 in the current
year.
The plan administration costs are usually minimal.
Small-business owners cant often stash away much for themselves; theyre limited to the
same $8,000, plus up to 3% of an employees salary.
SEP IRA (Simplified Employee Pension IRA):
Very similar to a regular IRA, but it has higher contribution limits.
Contributions can vary each year at the employers discretion, but the maximum you can
put in is $40,000.
Is fully funded by the employer, who is required to establish accounts for all employees
who have worked for at least 3 of the last 5 years and earned at least $450 in the last year.
Employees are 100% vested immediately, so all the money that goes into their plans is
immediately available to them if they were to leave the company.
If youre self-employed, you can put away up to $40,000 in a SEP IRA. This can be a very
good option if you have between 1 and 10 employees.
There are no reporting requirements, and you have very limited administrative responsi-
bilities.
The cost of administering the plan is very low and the plan offers tremendous flexibility in
how you contribute and where you invest.
A SEP IRA may be best for you if you have a small company and want to have maximum
flexibility and limited administrative responsibilities.
There are three basic steps that you need to take to set up a Simplified Employee Pension Plan:
1. You must execute a formal written agreement to provide benefits to all eligible employees.
2. You must give each eligible employee certain information about the SEP.
3. A SEP IRA must be set up by or for each eligible employee.
One of the perks for setting up this plan is that you will receive a tax credit for the 50% of
the setup cost for the first three years, with a maximum credit of $500,000 annually.
Session 8: Getting the Most from Individual Retirement Accounts
I ndividual re t i rement accounts, or I RAs, are discussed in detail in this session. J ordan gives you
an overview of I RAs, along with an explanation of when contributions are deductible, rules, re g u-
lations, and how tos of using them to grow your re t i re m e n t .
Listed below are the facts about when your IRA contributions are deductible:
If you earn less than $30,000 in adjustable gross income as a single or $50,000 as a couple
filing jointly, you can deduct your IRA contribution even if you are eligible for a qualified
retirement plan such as a 401(k), 457 plan, Keogh, etc.
There is a tax credit for those who meet a certain age, typically over age 18, and an
income requirement of $25,000 or less for singles, $50,000 or less for joint filers who are
married. This credit is in addition to any deduction or exclusion that may otherwise apply
and varies from 10% to 15% of the first $2,000 of your contribution, depending on your
income and filing status.
If you participate in your employers plan, the portion of your IRA contribution that you
can deduct depends on your adjusted gross income each year. It phases out between dif-
ferent income levels, and over a certain amount you are not able to deduct it at all.
If you have adjusted gross income of your spouse and you filing jointly of below $150,000,
you will be able to take a deduction. That deduction is phased out if your income is
between $150,000 and $160,000 in adjusted gross income. Anything over that level, you
will get no deductions whatsoever.
Because of recent tax laws, the amount that you could put into IRAs has been raised and
will be raised even more in coming years. Right now you can contribute $3,000 per person
to an IRA. Both you and your spouse can both put in $3,000. That is going up to $4,000 by
the year 2007.
In 2008, you and your spouse will be able to put $5,000 in your IRA. In future years, the
limit is indexed for inflation in $500 increments.
There is also a catch-up provision for IRAs. From the years 2003 through 2005 an addi-
tional $500 can be put into an IRA if youre age 50 or older. From the years 2006 to 2010
you can put an additional $1,000 into an IRA. (For example, its the year 2006 and youre
over age 50, youll be able to put a total of $6,000 into your IRA, $5,000 for the regular
amount, plus $1,000 for the catch-up contribution). This is a lot of money that can be
growing either tax-deferred or tax-free.
Nondeductible IRAs:
If you earn more than the maximum level allowed and are eligible for a qualified plan at
work (you have a 401(k) or 43(b) or Keogh plan), you can still make a nondeductible con-
tribution to an IRA.
You and your spouse can each invest $3,000 a year out of your earnings, though this
amount has changed under the recent laws, and is going up over several years. If your
spouse does not work, you can contribute $3,000 for him or her into a spousal IRA.
When you add a nondeductible contribution to your IRA, you must file IRS Form 8606,
because the tax treatment of those funds will be very different from the treatment of
deductible contributions when you withdraw the money at retirement.
When you make an after-tax nondeductible contribution you will not be taxed on any dis-
tribution of your original capital, though you will be taxed on the accumulated earnings.
Be sure to keep these accounts separate, a nondeductible IRA and a deductible IRA,
because the tax treatment is so different when you take the money out.
Although a nondeductible IRA is not as financially rewarding up front as a deductible IRA,
it can still be a very potent long-term tax shelter in which to accumulate a retirement nest
egg. Because all dividends and capital gains are tax-deferred until at least age 59
1
/2 and
possibly until 70
1
/2, you gain the advantage of tax-sheltered compounding. In the long run,
that shelter is worth far more to you than the one-time tax reduction resulting from a
deductible IRA contribution.
You have until the April 15th tax deadline to open your IRA account (if youre eligible, you
can deduct your contribution on the previous years tax return).
Its far better to make your IRA deposit soon after January 1st of the year in which you
claim the deduction so you have the full year of tax shelter growing with your money.
You can continue to contribute to your IRA until you reach age 70
1
/2, at which point you
must start withdrawing capital according to the IRS schedule. The sooner you open an
IRA the better because the values of compounding really add up over time (if you put
$3,000 a year into an IRA and your money earned 7% annually, in five years the money
would grow to a little over $18,000. In 15 years it would be over $80,000, in 25 years over
$203,000, and after 35 years at earning 7% a year, you would have over $443,000).
So remember:
- $3,000 per year each for you and for your unemployed spouse
- IRS Form 8606
- Have until April 15 deadline
- Contribute until you reach age 70
1
/2 at which point you have to start withdrawing
- Put $3,000/yr at 7% annually:
At 5 years you would have: $18,459
At 15 years $80,664
At 25 years: $203,029
At 35 years: $443,740
Roth IRAs:
Named after Delaware Senator William Roth, who came up with the idea of the expanded
IRA, it was put into action in the 1997 tax law.
You and your spouse can each put in up to $3,000 a year, even after youve reached the age
of 70
1
/2.
You can withdraw all principal and earnings totally tax-free after age 59
1
/2 as long as the
assets have remained in the IRA for at least five years after the first contribution.
The assets can also be withdrawn tax free if you suffer a major disability.
If you died before starting withdrawals from a Roth, the proceeds go to your beneficiaries
tax-free. This is very different from a regular IRA, because if you die with money still in
the IRA growing tax-deferred, theres a big tax on that money as it goes to your beneficiar-
ies.
Unlike regular IRAs, you dont have to take distributions from Roth IRAs starting at age
70
1
/2. In fact, you dont have to take distributions at all in your lifetime if you prefer.
Therefore, you can pass on money to your relatives free of taxes as long as you keep the
money in the Roth IRA.
You do not receive a deduction for contributing to a Roth IRA. But the value of having
that money growing tax-free and having completely tax-free withdrawals far exceeds the
tax break you get from an up-front deduction.
You are permitted to withdraw assets without the usual 10% early withdrawal penalty
under certain circumstances. If you use the money for the purchase of a first home up to
$10,000, if you use the money for college expenses, or if you become disabled, you can
take out money from the Roth IRA without having that 10% early withdrawal penalty.
You can contribute the full $3,000 if you are a married couple with adjusted gross income
of $150,000 or less, or if you are single with adjusted gross income of $95,000 or less.
If you earn between $150,000 and $160,000 for a married couple filing jointly, the ability
to open a Roth IRA becomes phased out. And the same is true for singles with income
between $95,000 and $110,000. If your income is over those limits in a particular tax year,
$160,000 for couples, $110,000 for singles, unfortunately you are not allowed to make a
Roth contribution.
You can also roll over assets from a traditional IRA into a Roth IRA if you follow cert a i n
rules. Your adjusted gross income must be $100,000 or less in a particular year. That
allows you to roll over money from existing nondeductible and deductible IRA balances
into your Roth without owing the 10% prepayment penalty. However, when you under-
take such a rollover you must pay income tax on all previously untaxed contributions and
e a rn i n g s .
When transferring IRA funds:
Be extremely careful when transferring these rollovers. The money should be transferred
directly between the two investment companies or you will be hit with a large tax penalty.
The rollover rules:
Company plans including 401(k)s, 43(b)s and government 457 plans can be rolled over
into IRAs or into other 401(k), 403(b) or 457 plans.
After-tax funds, thats the nontaxable amount inside your IRA, still cannot be rolled over
into a 403(b) plan as they could under prior law.
457 plans do not accept after-tax contributions, so you cannot roll after tax money into
one of these.
If after-tax funds are rolled into one 401(k) plan and then into another 401(k) plan, the
transfer must be direct, trustee to trustee, directly from one institution to another. They
cant write you a check. And the receiving plan must agree to keep a separate accounting
of both taxable and after-tax funds and the income earned on those funds. This is why you
want to keep these funds separate, because when the money comes out, there is different
tax treatment depending on how it went in, in the first place.
IRAs can keep a separate accounting of after-tax funds rolled into them as the IRA owner
does that and reported on IRS Form 8606.
Rolling over after-tax money to an IRA represents an opportunity to keep the after-tax plan
money growing tax deferred inside the IRA. But it also poses challenges if you need to tap
this after-tax money in the near future. So you really should plan to keep it until youre
going to take the money in retirement. Know that once you roll over after-tax plan money
into an IRA, you must keep a separate accounting of these funds because it represents the
basis in your IRA. Think of it much the same way you would if you made a nondeductible
contribution to your IRA. You would have to keep track of the nondeductible contribu-
tions so that when you withdraw funds from your IRA you know how much of the with-
drawal will be nontaxable.
You cannot simply withdraw the money tax-free from the IRA. Suppose for example you
rolled $20,000 of after-tax money from your 401(k) into your IRA. You cannot then take
$20,000 tax-free from your IRA. The reason is once the money is in your IRA, it is handled
the same as a nondeductible IRA contribution.
If you do need access to some or all of that after-tax money, then dont roll it over to an
IRA, because youre not going to be able to withdraw it tax-free unless you withdraw the
entire IRA balance. If you have no need for the money and plan to leave it in the IRA
intact for your beneficiaries, then it pays to roll over the after-tax money to your IRA,
which can continue to grow tax-deferred. You must still make the annual required distri-
butions when you turn age 70
1
/2.
To maximize the IRA tax shelter you want to keep the money in there as long as possible. If
you start taking the money out at age 59
1
/2 y o u re going to lose a lot of tax-deferred com-
pounding compared to when you have to start taking it out at age 70
1
/2. If you take the
money out before age 59
1
/2, you owe a 10% early withdrawal penalty and you must pay
state and federal income taxes on your distribution in the year you receive it. However,
t h e re are a few exceptions to this penalty rule. You can make IRA distributions without
penalty if you have these circumstances: if you die the IRA proceeds are distributed to your
b e n e f i c i a ry or estate. If you become permanently disabled, you can get the money out with-
out penalty. Or if the amount distributed is paid out as an annuity over your lifetime or
your life expectancy.
If you have made the maximum use of your IRA tax shelter and have not touched the
money at all until the time youve turned 70
1
/2, you then have to start withdrawing the
money, at least a minimum amount that the IRS has set up. Theyve set up whats called
the minimum distribution allowance rules. You have to receive the first payment by April
1st of the year after youve turned 70
1
/2. Your second distribution must be taken by
December 31st of that same year.
The IRS requires you withdraw a certain amount of your account each year based on a
uniform actuarial table. This has been greatly simplified, and so they can tell you very eas-
ily exactly how much you need to be taking out every year. Its basically based on your life
expectancy. Financial institutions like banks, mutual funds, and brokerages will report to
the IRS each year how much money youre taking out in distributions, so its easy for the
IRS to see that youre taking out enough. If you dont take out enough, the IRS will impose
a penalty of 50% of the difference between what you withdrew and what you should have
withdrawn.
The rules also make it easier for you to select and change the beneficiary of your IRA
account. You can even select a new beneficiary after payouts have begun, and your heirs
can even change the beneficiary after youve died. This is important because the payout
rate is based on the beneficiary s life expectancy. So if the beneficiary is changed to a much
younger person, say your grandchildren instead of your children, the payout can take place
over many more years and there f o re allow the account to grow tax deferred for many more
years than if the beneficiary were middle-aged and had a lower life expectancy.
Another way to draw on your IRA is to take out the entire balance in a lump sum.
However, this subjects you to an enormous tax, which leaves less money for you to invest
to generate income that youll need to live on during retirement.
Another way to get the money out is to buy an annuity with your IRA proceeds. An annu-
ity makes monthly payments to you for the rest of your life, or if you choose, a joint and
survivor option for both the rest of your life and that of your spouse.
As with any other asset, when you open an IRA, you have to designate a beneficiary who
will receive the accounts proceeds if and when you die. If youre married, most likely
youre going to name your spouse as beneficiary. Once you die, your spouse will roll your
IRA assets into his or her IRA. However, if you name someone who is not a spouse to
receive your IRA proceeds, you must spell out in the plan to whom you want the money
distributed.
The IRA withdrawal rules are as follows. You can withdraw before age 59
1
/2 without penalty if
you:
Die
Become disabled
Have a lifetime annuity
Notes:
N i g h t i n g a l e - C o n a n t
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