Tag: income tax planning

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Retirement Asset Planning Retirement Income Planning

Do You Want to RAP or Do You Prefer to RIP?

Retirement planning is unquestionably the most difficult type of goal-oriented financial planning. Most goal-based planning is straight-forward, solving for the amount, and frequency, of payments that need to be made to accumulate a sum of money at a future date using two assumptions: rate of return and inflation rate.

College education planning is a good example of the use of this methodology with a twist. Unlike other planning where the future value will be withdrawn in one lump sum, college costs are generally paid for over a series of four or five years. This complicates the planning since it requires the calculation of the present value of the future annual costs of college at the beginning of college, which in turn becomes the future value that must be accumulated.

Retirement Asset vs. Retirement Income Planning

Retirement planning is a whole other world. For starters, there are two stages of retirement planning, i.e., retirement asset planning (RAP) and retirement income planning (RIP). Until recent years, RAP was the only type of retirement planning and, as such, is what’s considered to be traditional retirement planning. RAP’s focus is the accumulation and “spending down” of assets. Although it’s more complicated, much of the methodology used is similar to other types of goal-oriented financial planning.

While RAP works well in the accumulation stage, it isn’t designed for calculating, and planning for, projected retirement income amounts that need to be available to pay for projected retirement expenses during various stages of retirement with unknown durations. As a result of the uncertainty of traditional RAP as a solution for providing a predictable income stream to match one’s financial needs in retirement, RIP was born.

Retirement Income Planning Issues

In addition to possessing the knowledge and experience of financial planners who specialize in RAP (RAPers?), retirement income planners (RIPers?) require an expanded skill set and associated knowledge to assist their clients with issues that are unique to RIP before and throughout a client’s retirement years. Planning issues extend well beyond asset accumulation and include, but aren’t limited to, the following:

  • Medicare
  • Long-term care
  • Social Security claiming strategies
  • Conversion of assets into sustainable income
  • Income tax minimization
  • Choosing strategies to address gaps in income
  • Retirement plan distribution options
  • Retirement housing decisions
  • Philanthropic
  • Estate transfer

Recommended Timeframe

Retirement planning is a time-sensitive and arduous task that requires a high level of discipline and commitment over the duration of one’s adult years, not to mention specialized expertise. Given the relatively short accumulation period compared to the potential duration of retirement complicated by an unknown escalating cost of living, the RAP phase should begin as soon as possible.

There are always competing goals, including saving for one’s first house and education planning, to mention a couple. All financial goals must be balanced against one another, keeping in mind that the ability to provide for your support – before and throughout retirement – supersedes all other goals.

RIP works best when it’s initiated long before you plan to retire. In addition to the nature and complexity of the various planning issues, this is very important given the fact that historically approximately 50% of all retirees retire before they plan on doing so. Given this reality, a 20-year pre-retirement RIP timeframe is recommended.

Finally, it’s important to keep in mind that RIP doesn’t end the day you retire. The success of your retirement years is dependent upon your ability to employ and adjust RIP strategies for the duration of your, and your spouse’s, if applicable, retirement years.

Do you want to RAP or do you prefer to RIP? As I hope you can appreciate, you need to do both at the appropriate time in your life in order to enjoy your retirement years on your terms.

See Planning to retire? Start with the right question

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Roth IRA

Roth IRA Conversion Insights – Part 1 of 2

Retirement Income Center

Last week’s post completed a six-part series discussing the three primary benefits to be derived from a Roth IRA conversion: (1) elimination of taxation on 100% of the growth of Roth IRA conversion assets, (2) elimination of exposure to required minimum distributions on traditional IRA funds converted to a Roth IRA, and (3) potential reduction in taxation of Social Security benefits.

Part 6, the finale of the series worked through two comprehensive scenarios – one with no Roth IRA conversion and a second with a Roth IRA conversion – to determine which one was projected to result in more total investment assets throughout the life of the scenario. As emphasized in the post, the results of the two scenarios cannot be generalized and used as the basis for determining whether a Roth IRA conversion is appropriate in a particular situation. Furthermore, a detailed analysis needs to be prepared by a retirement income planner for every potential Roth IRA conversion situation.

Having said this, there are several insights to be gained from analyzing the two scenarios that can be applied to any potential Roth IRA conversion analysis. This post will discuss the first three with next week’s post addressing three others.

Actual Results are Likely to be Different Than Projected Results

By far, the most important insight to keep in mind going into any Roth IRA conversion analysis is that actual results are likely to be different than projected results. Without listing them individually, the multitude of assumptions that must be considered and the interaction between them is the reason for this. Contributing to the complexity and uncertainty is the lengthy timeframe that needs to be considered in most situations with the associated potential for multiple changes in the realization of each assumption. In addition, the timeframe needs to include spouses’ and other potential beneficiaries’ lifetimes when applicable.

Multi-Year Income Tax Planning is Critical

When I read, or attend presentations, about Roth IRA conversions, the importance of marginal income tax rates in the year(s) of conversion(s) and the years of distribution from traditional IRA accounts is often emphasized as one of the key factors in a Roth IRA conversion analysis. When I entered the tax profession in 1980 and the top marginal federal income tax rate was 70%, did I know that by 1987, the top rate would be slashed to 38.5% and would stay within three percentage points of this rate for at least the next 25 years with today’s top rate of 35% scheduled to remain in effect through 2012? While a strong argument can be made that a tax increase is inevitable given our huge federal budget deficit, no one knows for certain when this will occur or what future tax rates will be.

It’s not just about tax rates. Comprehensive multi-year income tax planning on both the “front-end” and “back-end” is critical to the success of any Roth IRA conversion analysis. Keeping in mind that a Roth IRA conversion generally shouldn’t be a one-year event, “front-end” planning should include preparation of multi-year income tax projections to determine how much of one’s contributory IRA should be converted and in which years. On the “back-end,” multi-year ongoing projections need to analyze the impact of projected required and discretionary distributions from contributory and Roth IRA accounts as well as nonqualified investment accounts in meeting one’s projected financial needs. Each “back-end” projection should include an analysis of taxable Social Security benefits. Finally, both “front-end” and “back-end” income tax projections need to consider all projected sources of income, losses, and deductions in each year.

Growth of Roth IRA Conversion Assets is Dependent on Roth IRA Conversion Timing

The number one benefit to be derived from a Roth IRA conversion, i.e., elimination of taxation on 100% of the growth of Roth IRA conversion assets, is dependent upon the timing of a Roth IRA conversion relative to stock market valuation assuming that a sizeable portion of one’s Roth IRA conversion portfolio is equity-based. In order to realize this benefit, by definition, there needs to be an increase in the value of one’s Roth IRA from the date(s) of conversion(s) to the future comparison date.

With the Dow Jones Industrial Average increasing by approximately 1,000 points, or 8%, in the past month to finish at 12,811 on Friday combined with a 100% increase, or doubling, from its close of 6,440 on March 9, 1999 a little over two years ago, the determination of the timing of a Roth IRA conversion is more difficult than it was last year at this time. Recharacterization, (see the April 19, 2010 post, Recharacterization – Your Roth IRA Conversion Insurance Policy) is a strategy that’s available for retroactively undoing a Roth IRA conversion that was done prior to a market decline if it’s implemented during a specified limited time period following a conversion.

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Retirement Income Planning

Financial Independence vs. Retirement Income Planning – What’s the Difference?

Retirement Income Center

My clients and those of you who have visited my firm, Financial Design Center’s website are familiar with the firm’s mission statement that is prominently displayed on the bottom of each page of the website: Planning, Managing, and Protecting Your Financial Independence™. In addition to emphasizing our comprehensive approach to the financial planning process, i.e., planning, managing, and protecting, it clearly states the endgame – financial independence. This is our raison d’etre and is the focus of everything that we do for our clients.

You may be wondering, “What’s the difference between financial independence planning and retirement income planning and why are you writing a blog about the latter instead of the former?” For those of you who are actually thinking this, great question!

In order to answer this question, you first need to understand the difference between traditional financial planning and financial independence planning. Traditional financial plans are often designed for achieving one or more financial goals that may include buying a home, paying for college, and accumulating sufficient funds for retirement. Since retirement is the last goal chronologically, it is typically “backed into” using whatever resources haven’t been consumed by other goals. Consequently, traditional comprehensive planning may require you to delay your retirement and/or compromise your retirement lifestyle.

Financial independence planning works from the premise that your ultimate goal is the achievement of financial independence. Your financial resources are directed toward this goal through the development and management of a plan designed to provide an ongoing, inflation-protected, tax-favored distribution of income that will ideally enable you to live in the style to which you’re accustomed, while minimizing the possibility that you will outlive your assets.

You may be thinking, “Well, isn’t this financial independence planning stuff really retirement income planning?” Wow, you guys are good! While they are undoubtedly intertwined, financial independence income planning, or retirement income planning, as it is more commonly known and will be referred to from hereon out, is actually a separate and distinct component of the comprehensive financial independence planning process.

While, as previously stated, the ultimate goal of financial independence planning is the achievement of financial independence, it’s a comprehensive process that also includes planning strategies for achieving traditional financial planning goals, including, but not limited to, education, income tax, risk management (i.e., insurance), investment, and estate planning. Like various financial planning goals, the timing of the commencement of retirement income planning is generally specific to one’s stage in life.

Although I employ the financial independence planning process, which includes retirement asset planning, with all of my pre-retiree clients, in order to maximize its effectiveness, I generally begin to engage my clients in thinking about, and acting upon, retirement income planning strategies when they are 20 years from their projected retirement or financial independence planning dates.