Jane Young, CFP, EA
A variable annuity is an investment contract with an insurance company where you invest money into your choice of a variety of sub-accounts. Sub-accounts are similar to mutual funds, where money from a large number of investors is pooled and invested in accordance with specific investment objectives. Like mutual funds, sub-accounts may invest in different categories of stock or interest earning investments.
One characteristic of a variable annuity is the tax deferral of gains until the funds are withdrawn. However, upon distribution the gains are taxable at regular income tax rates, as opposed to capital gains rates that may be available for mutual funds. Additionally, there is no step-up in basis upon death for assets held in variable annuities.
Variable annuities are generally more appropriate for non-retirement accounts because gains within a retirement account are already tax deferred. Traditional retirement accounts and Roth IRAs meet the tax deferral needs for most investors. However, in some cases a variable annuity may be attractive to a high income investor who has maximized his traditional retirement options and needs additional opportunities for tax deferral. This is especially true for an investor who is currently in a high tax bracket and expects to be in a lower tax bracket in retirement.
When investing in variable annuities, with non-retirement money, there is no requirement to take a Required Minimum Distribution at 70 ½. However, there is generally a 10% penalty on withdrawals made before 59 1/2. Trades can be made within a variable annuity account without immediate tax consequences. The entire gain will be taxable upon withdrawal. There is no annual contribution limit for variable annuities, and you can make non-taxable transfers between annuity companies using a 1035 exchange. However, you may have to pay a surrender charge if you have held the annuity for less than seven to ten years, and you purchased it from a commissioned adviser. Before buying an annuity, read the fine print to fully understand all of the fees and penalties associated with the product. Most variable annuities have early withdrawal penalties and a higher expense structure than mutual funds.
A variable annuity may be an option for someone who wants to purchase an insurance policy to buffer the risk of losing money in the market. For many investors, due to the long term growth in the stock market, this guarantee may be come at too high a price. Some investors are willing to pay additional fees in exchange for the peace of mind that a guaranteed withdrawal benefit can provide. Guaranteed minimum withdrawal benefits (GMWB) can be very complex and have some significant restrictions. Additionally, some products offer a guaranteed death benefit for an extra fee. Read the contract carefully and make sure you understand the product before you buy.
Due to the high costs, lack of flexibility, complexity and unfavorable tax treatment variable annuities are not beneficial for many investors.
Jane Young, CFP, EA
One of the biggest decisions associated with saving for retirement is choosing between a Roth IRA and a Traditional IRA. The primary difference between the two IRAs is when you pay income tax. A traditional IRA is usually funded with pre-tax dollars providing you with a current tax deduction. Your money grows tax deferred, but you have to pay regular income tax upon distribution. A Roth IRA is funded with after tax dollars, and does not provide a current tax deduction. Generally, a Roth IRA grows tax free and you don’t have to pay taxes on distributions. In 2013 you can contribute up to a total of $5,500 per year plus a $1,000 catch-up contribution if you are over 50. You can make a contribution into a combination of a Roth and a Traditional IRA as long as you don’t exceed the limit. You also have until your filing date, usually April 15th, to make a contribution for the previous year. New contributions must come from earned income.
There are some income restrictions on IRA contributions. In 2013, your eligibility to contribute to a Roth IRA begins to phase-out at a modified adjusted gross income of $112,000 if you file single and $178,000 if you file married filing jointly. With a traditional IRA, there are no limits on contributions based on income. However, if you are eligible for a retirement plan through your employer, there are restrictions on the amount you can earn and still be eligible for a tax deductible IRA. In 2013 your eligibility for a deductible IRA begins to phase out at $59,000 if you are single and at $95,000 if you file married filing jointly.
Generally, you cannot take distributions from a traditional IRA before age 59 ½ without a 10% penalty. Contributions to a Roth IRA can be withdrawn anytime, tax free. Earnings may be withdrawn tax free after you reach age 59 ½ and your money has been invested for at least five years. There are some exceptions to the early withdrawal penalties. You must start taking required minimum distributions on Traditional IRAs upon reaching 70 ½. Roth IRAs are not subject to required minimum distributions.
The decision on the type of IRA is based largely on your current tax rate, your anticipated tax rate in retirement, your investment timeframe, and your investment goals. A Roth IRA may be your best choice if you are currently in a low income tax bracket and anticipate being in a higher bracket in retirement. A Roth IRA may also be a good option if you already have a lot of money in a traditional IRA or 401k, and you are looking for some tax diversification. A Roth IRA can be a good option if you are not eligible for a deductible IRA but your income is low enough to qualify for a Roth IRA.
Jane M. Young CFP, EA
You can begin taking Social Security at age 62 but there are some disadvantages to starting before your normal retirement age. The decision on when to start taking Social Security is dependent on your unique set of circumstances. Generally, if you plan to keep working, if you can cover your current expenses and if you are reasonably healthy you will be better off taking Social Security on or after your normal retirement age. Your normal retirement age can be found on your annual statement or by going to www.socialsecurity.gov and searching for normal retirement age.
Taking Social Security early will result in a reduced benefit. Your benefits will be reduced based on the number of months you receive Social Security before your normal retirement age. For example if your normal retirement age is 66, the approximate reduction in benefits at age 62 is 25%, at 63 is 20%, at 64 is 13.3% and at 65 is 6.7%. If you were born after 1960 and you start taking benefits at age 62 your maximum reduction in benefits will be around 30%.
On the other hand, if you decide to take Social Security after your normal retirement age, you may receive a larger benefit. Do not wait to take your Social Security beyond age 70 because there is no additional increase in the benefit after 70. Taking Social Security after your normal retirement age is generally most beneficial for those who expect to live beyond their average life expectancy. If you plan to keep working, taking Social Security early may be especially tricky. If you take benefits before your normal retirement age and earn over a certain level, the Social Security Administration withholds part of your benefit. In 2012 Social Security will withhold $1 in benefits for every $2 of earnings above $14,640 and $1 in benefits for every $3 of earnings above $38,880. However, all is not lost, after you reach full retirement age your benefit is recalculated to give you credit for the benefits that were withheld as a result of earning above the exempt amount.
Another potential downfall to taking Social Security early, especially if you are working or have other forms of income, is paying federal income tax on your benefit. If you wait to take Social Security at your normal retirement age, your income may be lower and a smaller portion of your benefit may be taxable. If you file a joint return and you have combined income (adjusted gross income, plus ½ of Social Security and tax exempt interest) of between $32,000 and $44,000 you may have to pay income tax on up to 50% of your benefit. If your combined income is over $44,000 you may have to pay taxes on up to 85% of your benefit.
The decision on when to take Social Security can be very complicated and these are just a few of the many factors that should be taken into consideration.
Jane M. Young, CFP, EA
Here are a couple issues on Social Security and IRA Rollovers that frequently catch people by surprise.
Think twice about taking your Social Security at 62 or before your regular retirement age, if you plan to work during this timeframe. In 2011, if you earn more than $14,160, Social Security will withhold $1 for every $2 earned above this amount. However, all is not lost, when you reach full retirement age Social Security will increase your benefits to make up for the benefits withheld. Once you reach your full retirement age there is no reduction in benefits for earning more than $14,160. However, the amount of tax you pay on your Social Security benefits will increase as your taxable income increases. This may be a good reason to wait until your full retirement age or until you stop working to begin taking Social Security.
If you are thinking about moving your IRA from one custodian to another I strongly encourage you to do this as a direct transfer and not as a rollover. We frequently use these terms synonymously but I assure you the IRS does not! A transfer is when you move your IRA directly from one IRA trustee/custodian to another – nothing is paid to you. A rollover is when a check is issued to you and you write a second check to the new IRA Trustee/Custodian. This must be done within 60 days or the transaction is treated as a taxable distribution. You can do as many transfers as you desire in a given year. However, you can only do one rollover per year, on a given IRA. This is a very stringent rule and there are very few exceptions even when the error is out of your control. Whenever possible be sure to use a direct transfer not a rollover to move your IRA Account.