Retirement Income Visions

Reduce or Eliminate Your Required Minimum Distributions With a Roth IRA Conversion

A lot of people I talk to get upset when they discover that they must begin taking required minimum distributions ("RMD's") from their traditional IRA's beginning at age 70-1/2. They forget about all of the income tax savings that they've realized over the years from either making deductible IRA contributions or from making pre-tax contributions into 401(k) plans that they rolled over into their IRA accounts. This is especially true when they haven't reinvested the tax savings from their deductible contributions which is fairly typical.

Moreover, many people don't realize that IRS has authorized a deduction for their contributions in exchange for the right to tax distributions from their traditional IRA's, whether voluntarily or via RMD's. Whether or not you've taken any distributions from your IRA, beginning at age 70-1/2, you are required to take a minimum distribution each year from your traditional IRA accounts based on their value on December 31^st of the preceding year and an IRS table life expectancy factor. The taxable portion of each distribution includes deductible contributions as well as earnings.

Two Steps to a Nontaxable IRA for High Income Individuals

If your goal is to contribute on a regular basis to a nontaxable investment account without investing in low-yielding tax-free municipal bonds from which you can take nontaxable distributions beginning at age 59-1/2 and assuming you can live with the annual contribution limits, IRS has provided you with this opportunity. Depending on the amount of your income each year, you will be able to achieve your goal in either one or two steps.

In 2010, if your modified adjusted gross income ("MAGI") is less than $105,000 if you're single or $167,000 if you're married filing a joint return, you can contribute up to $5,000, or $6,000 if you're 50 and over, to a Roth IRA assuming that you receive taxable compensation of at least these amounts. Your Roth IRA distributions will be nontaxable provided that you (a) don't take any distributions for at least five years after you make your first Roth IRA contribution and (b) wait until you reach age 59-1/2 to take your distributions.

Two Great Roth IRA Conversion Candidates

In the two previous blog posts, I examined four scenarios where it's possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion, and, as such, qualify as ideal Roth IRA conversion candidates.

This week's blog presents two additional Roth IRA conversion candidates that I would classify as "great," but not "ideal," candidates. Both scenarios have the potential for the IRA owner or beneficiaries to end up with more assets than they would if they don't do a conversion, however, there could be a sizeable amount of income tax liability attributable to the conversion, depending upon the situation. The two scenarios are as follows:

The Ideal Roth IRA Conversion Candidate – Part 2

Last week's blog post, The Ideal Roth IRA Conversion Candidate – Part 1, discussed two situations where it's possible to convert a portion, and possibly all, of a traditional IRA to a Roth IRA while incurring minimal or no income tax liability attributable to the conversion. This week's post presents two additional Roth IRA conversion "ideal candidates." 

As mentioned in last week's post, all four situations, in addition to assuming availability of a traditional IRA, require preparation of an income tax projection, including calculation of potential exposure to alternative minimum tax, or "AMT," to determine the amount of the traditional IRA that should be converted to a Roth IRA to achieve this result. The two situations that are the subject of this week's post are as follows:

The Ideal Roth IRA Conversion Candidate - Part 1

The last two blog posts, Three Roth IRA Conversion "Show Stoppers" and Clearing the Roth IRA Conversion Hurdles presented three scenarios in each post where the answer to the question, "Should you convert your traditional IRA's to Roth IRA's?" was a definitive "no" and "probably not a good idea," respectively. Assuming that you weren't eliminated from the Roth IRA conversion game by any of the three "show stoppers" and you cleared all three "high hurdles," are you a candidate for a Roth IRA conversion?

Whenever you are evaluating candidates, whether it be for political office, employment, or some other situation, you always want to compare the individual against an established ideal candidate profile. In the case of a Roth IRA conversion, the ideal candidate is someone who will incur minimal or no income tax liability as a result of the conversion.

Clearing the Roth IRA Conversion Hurdles

Should you convert your traditional IRA's to Roth IRA's? This question is a hot topic this year with the repeal of the $100,000 modified adjusted gross income barrier for converting traditional IRA's to Roth IRA's. Last week's blog post, Three Roth IRA Conversion "Show Stoppers" discussed three scenarios where the answer is a definitive "no."

Assuming that none of the three "show stoppers" are applicable to your situation, you're ready to lace up your running shoes and step onto the track. I liken the Roth IRA conversion decision-making process to the 100 meter (women) and 110 meter (men) high hurdles events in track and field.

Three Roth IRA Conversion "Show Stoppers"

Effective January 1^st this year, the $100,000 modified adjusted gross income barrier for converting traditional IRA accounts to Roth IRA accounts was eliminated. Now that the floodgates are open and everyone can convert their traditional IRA's to Roth IRA's, if you haven't done so already, should you jump on the bandwagon? While the potential benefits of tax-free withdrawals and not being subject to required minimum distributions ("RMD's") (See Year of the Conversion) are extremely attractive, there are several obstacles one must overcome before switching horses.

Before discussing these obstacles, which will be continued in next week's blog post, it's important to keep in mind that when contemplating a Roth IRA conversion, it doesn't have to be an all-or-nothing event. You can, and it's often preferable, to do partial conversions of traditional to Roth IRA's over one or more years.

Roth IRA – Retirement Plan Holey Grail?

With all of the buzz in the investment/retirement planning community about Roth IRA's as a result of the January 1^st elimination of the $100,000 modified adjusted gross income threshold for converting a traditional IRA to a Roth IRA, you would think that they're the only game in town. Although the two main attractions of a Roth IRA that were introduced in last week's blog post, Year of the Conversion, i.e., nontaxable distributions and no required minimum distributions ("RMD's"), are two desirable benefits of any retirement plan, there is a price you must pay to obtain them.

The Ideal Retirement Plan

In order to understand the Roth IRA club entry fee, let's take a step back and examine the eight features of an ideal retirement plan to see which ones are present or lacking in a Roth IRA:

1. Contribution ability not subject to income test
2. Fully deductible contributions
3. Unlimited contribution amounts
4. Nontaxable income
5. Nontaxable distributions
6. Distributions at any age without penalties
7. No required minimum distributions
8. No income tax liability upon conversion to the plan

Year of the Conversion

 If you grew up in my generation, you probably remember Al Stewart's 1976 hit, "Year of the Cat" from his platinum album with the same name. Well, 34 years later (boy, am I getting old!), 2010 is being dubbed by the financial community as the "Year of the Conversion" in reference to the removal of the income threshold in connection with Roth IRA conversions.  

Although the Roth IRA and the Roth IRA conversion technique were both established by the Taxpayer Relief Act of 1997 for taxable years beginning in 1998, like a lot of tax legislation that provides for potentially favorable benefits, the ability to  take advantage of the latter until now has been dependent on one's income level. From 1998 through 2009, only taxpayers with modified adjusted gross income of less than $100,000 were eligible to convert a traditional IRA to a Roth IRA.

What Tools Does Your Financial Advisor Have In His or Her Toolbox?

I want to wish all of my readers a very Happy New Year! The theme of the last eight blogs, beginning with the November 9^th post, Using Fixed Income Annuities to Build Your Income Portfolio Ladder, through last week's post, The Thrive® Income Distribution System – A Revolutionary Retirement Income Planning System, was creating and optimizing retirement income with fixed income annuities. To summarize, the strategic implementation of single premium immediate ("SPIA's") and deferred income ("DIA's") annuities by trained and experienced professionals as part of a comprehensive retirement income plan can be a powerful solution for generating guaranteed (subject to individual insurers' claims-paying ability), inflation-protected, and tax-efficient income that, when combined with other sources of income, e.g., Social Security, is designed to match a client's projected retirement income needs.

If you're within ten years of retiring or if you retired within the last ten years, you may be wondering why your financial advisor hasn't talked to you about any of the strategies discussed in the last eight blogs. Rest assured, you're not alone. A 2009 Fidelity study found that 83% of investors between the ages of 55 and 70 who are working with a fee-based adviser believe it's more important for them to generate guaranteed (subject to individual insurers' claims paying ability) income for retirement than to deliver above-average returns.

The Thrive® Income Distribution System – A Revolutionary Retirement Income Planning System

Talk about innovative strategies for creating and optimizing retirement income! Today, I have the distinct pleasure and good fortune to be interviewing Curtis Cloke, the inventor of the Thrive® Income Distribution System ("Thrive®"), one of the leading retirement income planning solutions available to financial advisors. I personally use the Thrive® system with my clients who have been receptive and enthusiastic. The following are eight questions I asked Curtis about the system together with Curtis' answers.

1. What is the Thrive® Income Distribution System?
   
   

   Thrive® is a retirement income solution that helps advisors utilize the least amount of a client's portfolio to provide for their income gap needs with a known and precise amount of their retirement assets. This creates contractually-guaranteed and inflation-adjusted income that allows the client to invest the portion of their portfolio not needed to generate their income needs in traditional accumulation investments providing a significant horizon appropriate for longer-term strategies without being concerned about the sequence of returns. Thrive® is a turnkey web-based platform, including educational tools, marketing materials, client presentations and a calculation system that trains and helps advisors implement the strategy using a compliance-approved action plan and report for the client. The system is designed to help implement the purchase of income products that will create solid and authentic retirement income solutions for which advisors will never have to apologize.

Designing Your Income Annuity Plan

While one of the benefits of income annuities as stated in Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan is reduced dependence on ongoing investment management, anyone considering the purchase of an annuity should first engage the services of a professional retirement income planner.

A professional retirement income planner, after discussing your retirement income needs with you and analyzing your financial situation, will prepare an income annuity plan that includes a comprehensive analysis and recommendations. The analysis should include multi-year cash flow, income tax, and portfolio projections that illustrate the following:

Mirror Your Retirement Income Needs With Period Certain Annuities

One of the most difficult financial planning challenges for any financial planner when planning for any goal, retirement or otherwise, is screening, performing due diligence on, and selecting, financial products that have the greatest potential for helping a client attain his/her goals while being suited to the client's investment temperament. This is especially true when it comes to retirement income planning given the fact that the planner's mission is to (1) find a way to use assets to create predictable, inflation-protected, and whenever possible, tax-efficient, income streams that, (2) when combined with other sources of income (Social Security, pensions, etc.), are designed to match a client's projected and unknown (e.g., potential uninsured long-term care expense) retirement income needs for an unknown period of time (i.e., the remainder of one or more lives), (3) while also retaining a portion of those assets to pay for lump-sum expenses (e.g., car purchases, home improvements, weddings, etc.), and (4) to also accomplish the client's estate planning (e.g., leave money to children and/or to charitable organizations) and other objectives. Suffice it to say, this isn't an easy task, to say the least!

Lifetime Annuity Payout – Watch Out!

Using Fixed Income Annuities to Build Your Income Portfolio Ladder introduced two types of fixed income annuities: single premium immediate annuities, or "SPIAs," and deferred income annuities, or "DIAs." As stated in that blog post, while the use of SPIAs is widespread, DIAs are currently offered by only a handful of life insurance companies.

SPIAs and DIAs come in two flavors insofar as the length of time that life insurance companies are on the hook for making payments to you: life annuities and period certain annuities. While SPIAs have traditionally been favored over DIAs, life annuity payment modes have generally been chosen over period certain annuities. This is understandable since most people don't want to run out of money, with married couples preferring income to last for the remainder of both individuals' lifetimes.

Annuitization Payment Option: The Financial Decision You Will Live With for the Rest of Your Life

Using Fixed Income Annuities to Build Your Portfolio Ladder, in addition to introducing the fixed income annuity strategy, was intended to be a primer on annuities in general. Although, as we learned in Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan, fixed income annuities have a long history, tracing their roots to Roman times with private sector annuities being available in the United States for over two centuries, they are an often misunderstood and misused investment tool.

Unlike CD's to which they're often compared, fixed annuities offer many more potential benefits, including generally higher rates of return over comparable terms, tax-deferral when used in nonretirement settings, potential death benefit, and availability of annuitization with guaranteed (subject to individual insurers' claims-paying ability) and tax-favored (when used in nonretirement accounts) income, often for life. Annuitization, the last potential benefit, is the one that is the most misunderstood and misused, especially when the purpose of the annuity purchase is to produce retirement income.

Deferred Income Annuities: The Sizzle in a Retirement Income Plan

The blog post two weeks ago, Using Fixed Income Annuities to Build Your Income Portfolio Ladder, introduced a powerful income laddering strategy using a customized blend of two types of fixed income annuities to create and optimize retirement income. The purpose of the strategy bears repeating since it is the catalyst for this week's blog. As discussed two weeks ago, this strategy offers retirees the benefit of predictable inflation-adjusted income streams to close projected income gaps as well as generate tax efficiency for the nonretirement portion of one's portfolio while reducing exposure to the gyrations of the stock market.

The two types of fixed income annuities that are used to implement this strategy are immediate and deferred. Immediate income annuities, or "SPIAs" (the acronym for single premium immediate annuities) was the subject of last week's blog. I encourage you to read this post if you haven't done so already. It discussed the unique characteristics and benefits of SPIAs that often position them as the cornerstone of retirement income plans. This week's blog focuses on the second type of fixed income annuity that is used to create and optimize retirement income – deferred income annuities, or "DIAs."

Immediate Income Annuities: The Cornerstone of a Successful Retirement Income Plan

Last week's blog post introduced a powerful income laddering strategy using a customized blend of fixed income annuities to create and optimize retirement income. As discussed, this strategy offers retirees the benefit of predictable inflation-adjusted income streams to close projected income gaps as well as generate tax efficiency for the nonretirement portion of one's portfolio while reducing exposure to the gyrations of the stock market. Two types of fixed income annuities were introduced: immediate and deferred, with the former being the subject of this week's blog.

Annuities have a long history, tracing their roots to Roman times. Contracts during the Emperor's time were known as annua, or "annual stipends" in Latin. Roman citizens made a one-time payment in exchange for a stream of payments for a fixed term or for life.

Using Fixed Income Annuities to Build Your Income Portfolio Ladder

The previous two blog posts introduced the income portfolio plan strategy and the importance of designing laddered income streams to fund a retirement income plan. If you haven't read these two posts yet, I would recommend that you do so before reading this one. This post introduces a powerful income laddering strategy that can be used to create and optimize your retirement income.

As stated in last week's post, due to the fact that our financial situation and needs will change at different stages of our retirement years, a retirement income plan must provide for different and distinct income streams to match our expense needs associated with each stage. One of the most efficient ways to do this is through the use of a customized blend of fixed income annuities. Before discussing this technique, let's first review some basics of annuity investing for those of you who may not be familiar with this often misunderstood type of investment.

Is Your Income Portfolio Plan Laddered?

After ten previous posts, last week's blog introduced the first strategy for creating and optimizing retirement income – an income portfolio plan. It explained that an income portfolio uses streams of income to close the gap between projected income needs and projected income sources while accomplishing the same objective as a traditional investment portfolio, i.e., minimization of investment risk. It also stated that the investments used to generate the income streams include, but are not limited to, CD's, bonds, life insurance, and annuities.

Generally speaking, no single investment can be used to fund a financial plan. The success of any plan is dependent upon a combination of investments, each serving a specific purpose, working together to achieve the goals of the plan. In the case of an income portfolio plan, streams of income from several investments are used to achieve the goal of the plan, i.e., to close the income gap, or difference between projected income needs and projected income sources. While the income streams can occur simultaneously, this post discusses sequential, or laddered, income streams.

Do You Have An Income Portfolio Plan?

We're all familiar with the concept of an investment portfolio. Wikipedia defines it as "an appropriate mix or collection of investments held by institutions or a private individual." It explains that "holding a portfolio is part of an investment and risk-limiting strategy called diversification."

A well-diversified, professionally-managed investment portfolio can enable you to pursue various financial goals, including financial independence, in the accumulation stage of your life. As you approach, and move into, retirement, a customized income portfolio plan is essential for enabling you to close the gap between your projected income needs and your projected income sources without worrying about, and being dependent upon, the gyrations of the stock market.

Retirement Income Planning – The End Game

If you're a subscriber to Retirement Income Visions™, you may have noticed that, although there have been nine posts prior to this one, none of them has stayed true to the theme of this blog, i.e., Innovative strategies for creating and optimizing retirement income. This post will be no exception. As the saying goes, there's a method to my madness. In order to understand and appreciate the strategies and apply them to your situation, it's important to understand the origin of retirement income planning, including the limitations of the retirement asset planning approach.

As explained in The Retirement Planning Paradigm Shift – Part 2, retirement planning is undergoing a paradigm shift. Instead of relying on retirement asset planning as a solution for both the accumulation and withdrawal phases of retirement, people are beginning to recognize, understand, and appreciate the need for, and value of, employing retirement income planning strategies during the withdrawal phase. No doubt about it, per Retirement Asset Planning – The Foundation, retirement asset planning is the way to go in the accumulation stage to build a solid foundation for a successful retirement plan. However, as discussed in The Retirement Planning Shift – Part 2, as a result of the uncertainty of traditional retirement asset planning as a solution for providing a predictable income stream to match one's financial needs in retirement, retirement income planning was born.

Safe Withdrawal Rate – A Nice Rule of Thumb

Last week's post, The Sequence of Returns – The Roulette Wheel of Retirement, showed how "luck of the rate-of-return draw" can have a dramatic affect on a retirement asset plan in determining whether you will outlive your investment portfolio. In two scenarios where the retirement age (65), portfolio beginning value ($500,000), average rate of return (7%), withdrawal rate (5%), and inflation factor applied to the withdrawal rate (3%) were identical, and the only variable was good vs. bad early years, there were quite different results. With the "Good Early Years" scenario, after 25 years, at age 90, distributions totaled $964,000, the portfolio earned $1.385 million, and the portfolio value was $921,000. Under the "Bad Early Years" scenario, the portfolio was depleted after 16 years at age 81 after taking distributions totaling $541,000 and the portfolio earning $41,000.

Many people would argue that 5% seems like a reasonable withdrawal rate, however, as we saw, under the "Bad Early Years" scenario, this proved to be too aggressive. The financial planning industry, after many years of debate, has settled on a rule of thumb of 4% as a "safe withdrawal rate." That is to say, you can withdraw 4% of the value of your portfolio in your first year of retirement and then increase your withdrawal amount by an inflation factor in subsequent years without depleting your portfolio during your lifetime. As an example, assuming a portfolio value of $500,000 at retirement and a 3% inflation factor, you could withdraw $20,000 ($500,000 x 4%) in Year 1, $20,600 ($20,000 x 1.03) in Year 2, $21,218 ($20,600 x 1.03) in Year 3, etc.

The Sequence of Returns – The Roulette Wheel of Retirement

So here you are, crossing the threshold from earning a living to going into retirement. You worked hard for many years. You built a sizeable, diversified investment portfolio. You hedged your bet by purchasing life insurance and long-term care insurance. Your will and other estate planning documents have been updated to reflect your current goals and financial situation. Everything's in place, or so you think.

Welcome to the roulette wheel of retirement, otherwise known as the "sequence of returns." If you haven't planned for this financial phenomenon, your retirement could be quite different than you envisioned. To illustrate this important concept, let's take a look at three hypothetical scenarios. In each one we'll use the following five assumptions:

Withdrawal Drag – The Silent Killer

As you approach retirement, are you aware of the silent killer lurking on the horizon? Let's call our silent killer "W.D." When you enter the retirement zone, W.D. will be right behind you, looking over your shoulder, waiting to spring into action. When you dare to take your first withdrawal from your portfolio, W.D. will pounce – only you won't know it. You will continue on, as if nothing happened, innocently taking your withdrawals each month. As each deposit hits your checking account, W.D. will extract a toll on your portfolio, one that will increase in size with each transaction. And guess what? You will never know what hit you. You see, W.D., or "Withdrawal Drag," is the ultimate portfolio silent killer.

Before we expose the secrets of "withdrawal drag," first some background. When you're saving for retirement, or you're in the "accumulation stage," as we retirement income planners like to refer to it, assuming that you take no withdrawals from your portfolio, you realize the beauty and grace of compounding rates of return. To appreciate compounding, let's start with simple interest.

Retirement Asset Planning – The Foundation

Last week, in Retirement Planning Risks, I discussed six risks associated with retirement planning in general. In order to understand and appreciate the value and importance of retirement income planning and its associated strategies, let's take a closer look at retirement asset planning.

As was presented in The Retirement Planning Paradigm Shift – Part 2, the focus of retirement asset planning is on the accumulation and "spending down" of one's assets. The accumulation phase is common to various financial planning areas, not just retirement, including house purchase planning and education planning, to name a couple. With most types of planning, you're typically designing a plan for the purpose of accumulating funds for either (1) a single expenditure at some specified, or target, date, in the future, e.g., a down payment on a house, or (2) a series of expenditures for a limited and specified series of target dates, e.g., a four-year college education.