Wednesday, December 28, 2011

Tax-sensitive and age-related rules of retirement. What you need to know.

The process of retiring in our 60s is an age-related continuum with many options along the way. Do you start taking Social Security at 62 or do you wait till full retirement age or later? How long do you keep working? And how do you make that change, "cold turkey" or by moving to part-time?
What do you do with your 401(k) nest egg if you leave the big job? When should you start withdrawing from that account? What does your financial picture look like when mandatory withdrawals kick in during your 70th year.  Below are a few answers:
For me it's been a continuous learning experience as I decided to start taking Social Security in January 2011 at age 64 and moved over to Medicare and Medicare-advantage coverage when I turned 65 in October.
The age-related changes continue. However two key pieces of my planning are turning out to be different than I first assumed.
Assumption No. 1: I could pay back Social Security for the benefits received by using inheritance when my mother died. Mom hasn't died and Social Security has changed the rules, eliminating the pay-back option.
So now I'm stuck with a lower-payout rate than I would have received if I'd waited until my full retirement age of 66. I'm at peace with this decision since I really had no choice because of my "early" retirement from my full-time job nearly two years ago. The combination of part-time work and Social Security has given me flexibility to travel, do pretty much everything I want and not have to tap into my real nest egg. Meanwhile this year, I refinanced my mortgage, reorganized my insurance coverage, went on Medicare and have applied for a reduced property taxes through a forest preservation program in my county. All that has reduced my everyday household living costs.
The good news: This year I couldn't make more than $14,640 in earned income without facing reductions in 2012 Social Security benefits. Now going into 2012 -- because I'll be 66 in October -- that threshold increases to $38,880. In 2013, there will be no limit on my earnings while also collecting Social Security benefits. However, up to 85 percent of my benefits in 2011 could be subject to federal income tax depending on how much I earn from other sources. I'll keep you posted on that when I get into my 2011 tax return reporting process.
Assumption No. 2. When I planned out my next 30 years, I expected to continue to accumulate wealth through my tax-deferred 401(k), now Rollover IRA account. I should have read the rules more carefully. Yes, I understood that I would have to start making withdrawals from my Rollover IRA at age 70 and one-half. What I didn't realize is that the government dictates how much those taxable income withdrawals must be. The mandatory amounts are much greater than I planned.
In fact, if I live as long as my mother who is going on 96, the federal mandatory withdrawals will mean I'm out of savings before I die. At least that's what I think could happen. I'm going to have to adjust my part of what I have to withdraw from my nest egg, pay taxes on it and reinvest it. It turns out that there are BIG penalties for not making the withdrawals at 70 and one-half.
For all of you with Roth IRAs, good news: You are not required to take any withdrawals from any Roth IRAs set up in your name. That's because the taxes have already been paid.
Changes in Social Security at 70
At 70, the rules also require that you start taking Social Security benefits, even if you don't want to do that. Since I am already tapping my benefits, that's not a worry for me. If you wait until 70, your deferred benefits will be higher than if you start earlier. That's a good option if you don't need those benefits and can wait, and are in good health. As will all my reporting information, check this out for yourself, make sure you understand your options and don't take anyone's word for this. I have received information from friends who think they know what they're talking about and from brokers, who should know better.
In the coming year, I will:
1. Reexamine my long-term retirement and investment strategy in light of the mandatory Rollover IRA withdrawals.
2. Continue to adjust my household expenses.. that means.cutting, leaving more money for travel.
3. Ramp up my part-time income to the maximum allowed in 2012....$38,880. It's a matter of trade-offs in time, energy and effort. Working at home has its challenges and rewards.
4. Upgrade my Web site to make it revenue positive. Another exciting year in retirement. Yahoo!!!
For more on age-related milestones, click here.

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