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A Pre-Retirement Primer

Things you may not know about using your benefits nest egg
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by Jean Martin

Illustration by Lisa Adams

You've followed the advice. Over the years, you've kept an eye on your spending and put some of the money you've saved--or the money that you had your employer withhold from your paychecks--into IRAs, Keoghs, 401(k)s or 403(b)s, tax-deferred annuities(TDAs): whatever reasonable opportunities presented themselves for building up a nest egg for retirement. Now you've decided you're ready to start thinking seriously about retirement, and ready to have that nest egg start working for you. If you believe it's simply there for the taking and spending, think again. Even with a nest egg, there's no such thing as a free lunch--as the elementary pointers that follow make clear. It pays to think ahead, so you don't consume all your retirement time in managing your retirement finances.

When you need to start thinking...
Benefits consultants and financial planners recommend a four- to five-year runup to retirement, a period during which you--and your spouse or partner, if you have one--think seriously about your hopes and plans for the future. Presumably you want your nest egg to last your lifetime(s), but do you also want some of it left over for children, friends, or worthy causes? How exuberant a retirement do you anticipate? Will you move south, or travel frequently, or cultivate your garden? What's the state of your health? Working out the answers to such questions will prepare you for certain mandatory decisions you'll need to make in the months before you retire about how the benefits portion of that nest egg you've saved up actually comes to you.

Assuming a reasonable life expectancy, what should you do?
Most Americans who retire in their sixties can expect to live another 10 to 20 years, if not longer. Financial planner Frederick B. Putney, of Croton, New York, executive vice president of Brownson, Rehmus & Foxworth Inc., advises clients to think of their various retirement-income sources as different pots that often have different rules for payouts and for what you are allowed to do with the funds that remain in the pot (shift the investment mix in an IRA, for example). Putney recommends dealing with the most constrained types of income first. (Put another way, if you'd like to leave some kind of estate to your heirs, it's best to spend down your most flexible assets, like stocks, last.)

What's on the table?
Most people will need to deal with Social Security, IRAs, and pension plans.

• You need to decide when, which helps determine how, you want to take your Social Security benefits. For many retirees, that income will be the first "pot" of assets to spend. But do you retire and begin getting your checks at 62, which means settling for a reduced benefit? Do you take your full benefit starting at 65 (or, depending on your birthdate, as late as 67 under new regulations)? Or do you defer benefits until after you turn 70, when you'll receive the maximum benefit and be free of any penalties levied against you for work on the side? (If you work between the ages of 62 and 70 while collecting social security, you may have to give up some or all of your benefits, depending on how much you earn.) Married couples will need to consider both spouses' benefits, if any, and their joint situation in making the decision on when and how to begin receiving benefits. (A general guide to financial planning, like Jane Bryant Quinn's Making the Most of Your Money, can provide a simplified rundown of some of the options you face.)

• If you own IRAs, you will most likely also need to make retirement decisions about how to take payouts. Roth IRAs let you take payouts or not, as you wish, without penalties, but traditional IRAs generally require that you begin making withdrawals by April 1 of the year following the year in which you turn 70Z\x, if you haven't already done so. (You can begin making penalty-free withdrawals once you've turned 59Z\x. In most cases, if you don't make withdrawals after 70Z\x, the IRS will take--in addition to the regular income tax owed on the distribution--50 percent of the difference between what was and what should have been distributed.)
  
  The two payout election decisions you make are irrevocable. First, the MRDs, or minimum required distributions (you can always choose to take more), are calculated on the basis of life expectancy (you choose either single or joint), and the company or institution that manages your IRA will generally do the calculations for you (sometimes charging a small fee). But second, you will also need to decide whether the calculation of life expectancy itself is done on a one-time fixed-term basis or recalculated each year. The recalculation method may provide an income-tax benefit by decreasing the amount of your MRD, and thus the taxes to be paid on it. (Be aware, however, that some IRAs don't permit recalculation of life expectancies.)
  
  Even more important, you also need to name a beneficiary when you determine your payout schedule. Whether you expect to need that income for your own living expenses or hope to share it with others will help determine whether you choose a spouse, another person, a charity, or your estate as beneficiary. Once again, your choices have multiple ramifications, so take advantage of guidance from the IRA manager or another reputable source. If you anticipate leaving money behind, for example, experts generally advise picking a younger person, rather than your estate, as beneficiary in order to maximize the potential for tax-deferred inheritance income for the heir.

• One big question many people face is whether to take the money they've accumulated in a pension or tax-deferred account as a lump sum when they retire. Opting for one big check means taking on responsibility for managing what may well be the largest single component of your nest egg, so consider carefully how much you already know about the financial possibilities and tax implications--and how much time you are willing to invest to do the job right.

An option for those who don't want the burden of hands-on control is to roll the money over into an annuity. According to Paul Zizzo, a senior benefits consultant at Harvard, if you're retiring at 65 or 70, and think you're likely to exceed the projected life expectancy for your age group (which generally means 12 to 15 years down the road), an annuity may make sense because it guarantees income for the rest of your life. (As a fringe benefit, IRA payouts rolled over into annuities are no longer subject to MRD requirements.) Be aware, Zizzo notes, that the annuity options offered by your employer may be more favorable than those that turn up as you shop around. And also keep in mind, says financial planner Frederick Putney, that an annuity is a rigid contract that means you've given up all rights of ownership in the assets you've signed over--so think carefully about the likely long-term stability of the institution to which you're entrusting your funds.

If an annuity's lifelong payout sounds appealing, and you're also interested in making a gift of some size to a favorite charity, inquire whether the charity itself offers annuities. You may learn about opportunities over and above the traditional version. Anne McClintock, director of Harvard's planned giving office, describes deferred charitable gift annuities as potentially a source of "great supplemental retirement income on a tax-advantaged basis." The option allows individuals who have income to save beyond the maximum allowed in a 401(k) or 403(b) plan, for instance, to set aside that additional money for retirement while saving on taxes in a different way--by making a charitable gift. If you set up a $10,000 annuity (the minimum amount at Harvard) at 60, for example, but defer payouts until you retire at 70, you will increase the regular tax write-offs for a charitable contribution and benefit the designated charity on the side.

All this assumes, of course, that you live to enjoy your retirement. But what becomes of your spouse or dependents, or other intended beneficiaries of your savings, if you die sooner than expected? Obviously, estate taxes come into play--not to mention the termination of payments under annuities keyed only to your life. As quickly becomes clear--recall the simple example above of choosing between a younger person or your estate as your IRA beneficiary--you need expert advice from tax planners, attorneys, and other advisers to sort out the interrelated operation and effects of inheritance taxes and income taxes on what you leave your heirs. (And if you are among the many individuals whose retirement assets include shares of stock, the effect of likely capital-gains taxes must be factored into the mix as well.) Frederick Putney adds a professional's wry twist to the old adage about death and taxes: Remember that tax rules and estate-tax rules are always subject to change, so give yourself the ability to make rational decisions and revised choices when that happens.

The most important thing is not to let yourself be overwhelmed and immobilized by all the rules and regulations. Retirement isn't a one-size-fits-all arrangement and you will only help yourself, and those you care about, by figuring out what works best for you. Read books and articles, look over the literature provided by banks, mutual funds, consumer groups, and professional organizations. As employers have begun to shift part of the responsibility for individual pension management to their employees, benefits departments have begun to offer more in the way of educational materials and workshops as part of their overall benefits package. Companies may hire outside consultants like the Personal Financial Education Company, in Framingham, for example, which offers a full-day program on "The Art of Retiring." Aimed at those 60 and older, the workshop discusses the best way to take one's TDA distributions, tax implications of the various options, and retirement investment strategies, as well as retiree medical options and estate-planning. To underline the importance of making such decisions in a family context, spouses are encouraged to attend.

Employers may also try a more individual educational approach. At Harvard, the staff benefits office has devised four different versions of the annual retirement statement, geared to the age and savings patterns of the recipients (as demonstrated by the presence or not of a TDA). The statements for "mature" employees (those 50 and older) provide projections of annual retirement income (adjusted for inflation) from the staff retirement plan, from your tax-deferred annuity (if you have one), and from social security at the ages of 55, 62, and 65. The aim, says Merry Touborg, director of communications for Harvard's office of Human Resources, "is to prompt more action and thinking" on staff members' parts.

Such information can help you figure out many of the questions you need to ask to plan for your own future. If you need more help with the answers, you may want to consider consulting a qualified financial planner. The Institute of Certified Financial Planners, headquartered in Denver, is one source for more information and referrals; the national organization offers a consumer-assistance line (800-282-plan) and a website "Planner Search," at www.icfp.org/plannersearch. Considering what's at stake, paying an expert for some individually tailored advice may prove one of the best investments you can make.

But remember, as with your savings, time works to your advantage: starting your retirement planning early gives you more options, to let you do the things you really want to do.

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