2021 is almost here, and for many of you, it’s the year you finally get to retire. Some of you are approaching the big day with excited anticipation, while others have questions and concerns.
If you are going to retire in 2021, you’ll want to take some actions now and make sure you understand how things change once you retire.
To that end, we will review information about your retirement accounts, Social Security, and your post-retirement spending.
Retirement Accounts
If you will stop receiving a paycheck in 2021, this could be your last chance to make contributions to your retirement accounts.
Those contributions are limited by your earned income, so now’s the time to make the biggest contribution possible.
Contributions to IRAs
For 2021, the maximum IRA contribution is $7,000 (including the $1,000 catch-up contribution). These limits apply to both traditional and Roth IRAs. If you are married, your spouse and you can contribute up to $7,000 each.
You can deduct contributions to traditional IRAs, but you’ll have to pay ordinary taxes on withdrawals.
Roth IRA contributions are not deductible, but withdrawals are tax-free if you follow the rules.
Contributions to 401ks
You can elect to defer up to $26,000 (including $6,000 in catch-up contributions) of earnings into your 401k retirement account.
Your employer can also contribute to your 401k. The maximum employer contribution must ensure that the total paid in for the year is the lesser of:
- 100% of the employee’s compensation, or
- $58,000
Your contributions to a traditional 401k are excluded from your taxable income. If you have a Roth 401k, you do not exclude your contributions from taxable income, and withdrawals are tax-free.
Early Withdrawal Penalties
The rules for withdrawals from your IRA or 401k before age 59 1/2 mandate a 10% penalty, subject to limited exemptions. The exemptions differ for IRA and 401ks.
Withdrawals of contributions from Roth IRAs are never taxed or penalized. Withdrawals of earnings are taxed and penalized if they occur within five years of opening the account.
The same fate applies to withdrawals before age 59 ½, subject to certain exemptions.
Required Minimum Distributions
Traditional IRAs have required minimum distributions (RMDs) that kick in when you reach age 70 ½. The annual amount subject to RMD rules depends on your life expectancy as tabulated by the Internal Revenue Service.
The first RMD is due by April 1 of the year after you reach age 70 ½. Subsequent RMDs are due by December 31 of each year. Once you reach age 70 ½, you cannot make any more contributions to your IRA.
The same rules apply to RMDs for traditional and Roth 401ks. The only difference is that the start date for RMDs (and end date for contributions) can be delayed as long as you continue your employment. Self-employment doesn’t count in this regard.
Roth IRAs do not have RMDs but do observe the age 70 ½ cut off of contributions.
Rollover Considerations
You can roll over traditional accounts to other traditional accounts tax-free. You can roll over traditional accounts to Roth accounts, but you’ll have to include the rollover amount in your taxable income.
You can roll over a Roth 401k to a Roth IRA. You cannot roll over your Roth IRA.
If you are retiring in 2021, you may want to roll your 401k to your IRA once you retire. This will make it easier to manage your money and could reduce your fees.
However, in some cases, you might be able to continue receiving health benefits after retirement if you keep your 401k. If so, you might want to postpone the rollover.
If you are retiring in the year you reach age 70 ½, you’ll want to ensure you complete your contributions before reaching that age.
Beneficiary Considerations
Your 401k beneficiary is your spouse unless you do not have one or your spouse agrees to give up the right to be your beneficiary.
You can name anyone to be your IRA beneficiary, except a trust account.
When a beneficiary inherits a retirement account, the beneficiary has at least five years to withdraw the balances. Surviving spouses can stretch out withdrawals over their expected lifetimes.
If you inherit a Roth account, you will not owe taxes on distributions, except for earnings distributions within the account’s initial five-year period.
Tax-Efficient Distribution Strategy
A haphazard approach to withdrawals and distributions can cost you. Mark Kuhne, Investment Consultant-Advisor from Croix River Wealth Management, calls this the “ticking tax time bomb” – saying you need a strategy to avoid depleting your retirement nest egg.
“A customized tax-efficient distribution strategy could save you much more money and help your retirement assets last longer,” Kuhne points out. “Your strategy must include 1) which accounts to take funds from, 2) in what order, and 3) will conversion opportunities work for you? Strategic planning must acknowledge volatility, uncertainty, complexity, and ambiguity. Protect tomorrow…today!”
Social Security Benefits
Social Security can be a significant part, but only a part, of your retirement plans.
Most folks are familiar with Social Security retirement benefits that are accessible starting at age 62. You can wait until age 70 to receive the maximum payout of your retirement benefits.
Social Security also offers benefits for the disabled, dependents and survivors.
You earn retirement benefits through covered employment. Generally, this means you’ll get monthly checks if you worked at least 10 years at a nongovernmental job that collected Social Security taxes.
Full retirement age is 66, but the eventual payout continues to increase if you postpone benefits up to age 70. Your circumstances, such as your financial needs and your health, will determine whether it’s better to wait until 70 or take the money sooner.
You might be eligible for disability benefits. If you had to stop working before retirement age due to a disability, you might be able to collect Social Security disability benefits.
You must meet the work requirements and have a disability that will last at least a year (although there is no time requirement if you are blind). You can receive disability benefits until you reach retirement age, at which point you switch over to retirement benefits.
Social Security offers dependent benefits. If you are a retired or disabled worker qualified to receive Social Security benefits, your spouse might qualify for dependent benefits under your earning record.
The same is true for your minor or disabled children. This benefit is available even if your family members don’t actually depend on you for support.
Survivors benefits are available if you pass away. The rules for this benefit mirror those for dependents benefits, except they continue on after you die.
In some cases, parents, grandchildren, or stepchildren might also qualify for this benefit. Surviving spouses can collect from 71.5% to 100% of the deceased’s benefits, depending on the survivor’s age.
Note that, if permitted by your state, same-sex spouses are eligible for Social Security benefits.
Social Security Changes
It’s wise to keep yourself abreast of news that affects your Social Security account. Here are five items to monitor for 2021:
- Depletion: The Social Security Administration faces depletion in 2034, unless Congress acts. Will they? You can contact your representative and urge them to act now.
- Full retirement age: If you were born in 1960 or later, the full retirement age has increased to 67. If you take benefits earlier, your monthly payments will be reduced. You maximize your monthly payment by postponing benefits until age 70.
- Cost of living adjustment (COLA): Social Security benefits should increase by 1.3% in 2021. If you receive $20,000/year in Social Security benefits, your COLA will be $320 in 2021.
- Maximum benefit: The maximum benefit for workers earning at least $132,900 will increase slightly. If you wait until age 70, the maximum monthly benefit will be $3,895.
- Taxable benefits: 85% of your Social Security benefits will be taxable if you are single and earn $34,000 or more in 2021. The threshold for married couples is $44,000/year or more. The tax on Social Security benefits is lower if you earn less than these limits.
Retirement Spending
As you start retirement, you might be concerned that you don’t have enough money. That’s why you need a realistic spending plan to supplement your investment or savings plan.
Retirement often produces a strange conflict: You suddenly have much more free time while simultaneously having significantly less income. Your spending plan should help you navigate your new reality.
How Much Do You Need?
Retirement spending isn’t linear.
A survey from the Bureau of Labor Statistics shows that spending tapers as we age. Household spending for each of the three decades beginning at age 55 was found to be $56,267, $48,885, and $36,673, respectively.
However, the study shows that the percentage of income spent on health care increases toward the end of life as health costs mount.
These facts make budgeting more complex.
A general rule of thumb is that you will need 80% of your pre-retirement income to maintain your lifestyle. So, if you earned $50,000 a year before retirement, you should have at least $40,000 in income after retirement.
Your 70th year is pivotal. Two important events occur during your 70th year. It is in that year that you can no longer postpone taking Social Security benefits or required minimum distributions from your retirement account.
If you are someone who has been able to wait until 70 to receive these cash inflows, your budget will need to reflect this fact. However, many folks start taking these benefits before 70.
Should You Reduce Your “Fixed” Expenses?
Over time, you can reduce non-discretionary spending in several ways, including downsizing, relocating to a less costly area, jettisoning life insurance policies you no longer need, and ending expensive hobbies that have become less important to you.
These steps can reduce your spending and allow you to stretch your money further.
Your retirement budget should reflect clear thinking. Preserving your retirement money over the long run means developing and sticking to a spending budget you can live with.
Figure out how long your savings will last. To get a reasonably accurate figure, you should derive your annual “burn rate.” That’s the amount of savings you’ll need to live on each year. You may have to cut back on your retirement plans.
Alternatives to Make Your Money Last
Your retirement need not stop you from making some extra money. It’s not hard to find one or more easy ways to increase your retirement funds. Here are just a few suggestions.
Create a Bond Ladder
Bonds provide fixed income payments until they mature. You can create a bond ladder consisting of bonds with staggered maturity dates.
For example, you can buy individual bonds that mature in each of the next 10 to 30 years to meet your cash flow requirements.
Buy an Immediate Annuity
Do you have a lot of cash sitting in a low-interest savings account? Consider buying an immediate annuity. You make a lump-sum payment and in return, you will receive monthly income for the rest of your life.
The implied interest rate in the annuity will be substantially higher than the paltry amount savings accounts pay.
Collect Rent
Did you know that you can collect a monthly rent check without lifting a finger? Passive real estate investment funds and real estate investment trusts provide steady income, and you can invest as much or as little as you want.
If you’re under age 70 ½, you can even arrange to make these investments in your IRA and postpone taxes on the income.
The Role of Your Financial Advisor
A financial advisor works with you to help maximize your wealth, develop realistic budgets, and deploy your assets to make them last.
As you enter retirement, a financial advisor should do a complete review of your financial situation and offer you a set of alternatives.
With people living longer than ever and health care costs continuing to rise, a financial advisor is your best bet for taking the actions necessary to increase your enjoyment of your golden years.
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