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Retirement planning today has taken on many new dimensions that never had to be considered by earlier generations. For one, people are living longer. A person who turns 65 today could be expected to live as many as 20 years in retirement as compared to a retiree in 1950 who lived, on average, an additional 15 years. Longer life spans have created a number of new issues that need to be taken into consideration when planning for retirement.
Lifetime Income Need
Planning for life after retirement and the need to be able to provide a steady stream of income that cannot be outlived is more important than ever. With the prospect of paying for retirement needs for more than twenty years, retirees need to be concerned with maintaining their cost-of-living.
Health Care Needs
Longer life spans can also translate into more health issues that arise as we all age. The federal government provides a safety net in the form of Medicare, however, it may not provide the coverage needed especially in cases of chronic illness. Planning for long-term care in the event of a serious disability or chronic illness is becoming a key element of retirement plans today.
Paying for Retirement
Retirees who have prepared for their retirement usually rely upon three main sources of income: Social Security, individual or employer-sponsored qualified retirement plans, and their own savings or investments. A sound retirement plan will emphasize qualified plans and personal savings as the primary sources with Social Security as a safety net for steady income.
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. As a qualified plan, the contributions are deductible from the employee’s current income. 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 ½ may be subject to a penalty of 10% on top of ordinary taxes that are due.
Traditional and Roth IRAs
Individual Retirement Accounts (IRA) are tax qualified retirement plans that were established as way for individuals to save for retirement with the benefit of tax favored treatment. The traditional IRA allows for contributions to be made on a tax deductible basis if an individual qualifies and to accumulate without current taxation of earnings inside the account. Distributions from a traditional IRA are taxable. A Roth IRA is different in that the contributions are not tax deductible, however, the earnings growth is not 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 taxes.
Distributions from traditional IRAs and employer-sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching 59 ½ , may be subject to an additional 10% federal tax penalty.