Category Archives: Retirement Planning

Dealing with topics relevant to retirement needs and approaches to reach long term goals. We aim to help you find ways in which you can reach your goals and make a difference

Early Retirement: Distributions Without Penalty Before Age 59½

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If you are considering retiring early and would like to use your pre-tax retirement accounts before age 59½ then you have significant planning to ensure you make the most of your retirement assets. One possibility is to use a 72(t) exception to avoid the early withdrawal penalty from pre-tax accounts. This 10% penalty is in addition to ordinary income tax.

An exception to the 10% penalty is the 72(t)(2)(A)(iv) OR “a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary”. This exception allows for regular payments from pre-tax accounts but must be tailored to your specific situation.

In general, the 72(t) exception requires that a calculated payment be withdrawn from a pre-tax account annually for the longer of five years or at age 59½. The advantage is that the 10% penalty can be avoided but the disadvantage is that changes to withdrawals or distributions are NOT permitted, or penalties apply. When calculating the annual payment, we consider the age of the pre-tax account owner, the balance in the pre-tax account, and the current interest rate. Higher payments are obtained at later ages, with higher account balances and at higher interest rates.

To help you visualize how the 72(t) amortization works, the table below shows annual payments for a single person at different ages on an account with $100K in pre-tax savings given that the current interest rate is at 6.16%.

Those thinking to retire early should consider using pre-tax assets (with the 72(t) exception) to support their planned cash flow but only if it is the best way to deploy all available assets. When using the 72(t)-exception you need to understand the implications of the rules since large penalties apply for errors or misunderstandings. If you are considering retiring early, we would determine how to best deploy your assets throughout your retirement plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

H.S.A. Contributions – Did You Know?

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Health Savings Accounts (H.S.A.) in retirement can be useful tax-free pools of money that can be used for health care expenses without increasing taxable income and potentially increasing Medicare premiums (through IRMAA). Contributions to H.S.A. accounts are only permitted if you participate in a specific type of health care insurance (High deductible) and only prior to Medicare enrollment.

Since H.S.A. contributions are NOT permitted with Medicare it often leads to misunderstandings on how to contribute maximally to an H.S.A. during the year in which you have both a high deductible H.S.A. insurance plan and eventually change to a Medicare plan. H.S.A. contributions must be pro-rated for the months prior to Medicare engagement (unless you are in an employer funded H.S.A.).

Couples contributing to a family H.S.A. who are over age 55, are entitled to contribute an additional $1K each as part of their catch-up annual contribution. Unfortunately, H.S.A. accounts can only accept one catch-up contribution, so couples are often uncertain how to fund their H.S.A.’s fully. The couple must contribute $1K catch-up each to two different H.S.A. accounts and only contribute the family core amount to one of the two H.S.A. accounts. Let us know if you have questions.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Social Security Benefits Primer

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Social Security benefits were never intended to be the sole financial support during retirement but for 21% of retirees Social Security benefit is the only source of income. For most American workers, Social Security benefits are the only guaranteed retirement income that is also inflation adjusted each year.

All workers in America are entitled to pay into Social Security and based on their pay history, to receive a lifetime income each month starting from ages 62 to 70.

Ideally prior to retirement, you’ll also maximize other income sources that include taxable savings, IRAs, ROTH, Qualified plans (401K, 403b, 457b), annuities, deferred compensation, and employer pension plans.

Since your future Social Security benefit is calculated from your Social Security work history, you must ensure (and correct if necessary) that this history has been recorded correctly at www.socialsecurity.gov/myaccount OR the new www.ssa.gov/myaccount.

Social Security benefit calculation uses your top 35 highest earning years and projects your estimated benefit at your FULL RETIREMENT AGE (FRA).

Your FRA is based on your birth year and, as you can see on this table, it has been increasing. In fact, since 1983 when the FRA was 65, it has been increased gradually so that by 2025 (for those born in 1960 or later) the FRA will be 67. To understand Social Security, you must first determine your FRA.

When can you collect Social Security? At FRA, you can file and receive your full benefit (100%) based on the amount of Social Security tax paid to your Social Security number. The earliest you can collect Social Security benefits on your record is at age 62 (when your FRA amount is reduced ½% for each month or 6% less each year until FRA) and the latest at age 70. If you delay past your FRA, you earn Delayed Retirement Credits (DRC) and for each month it will grow two-third of a percent or 8% per year until age 70.

Example of how benefits are calculated: If you were born in 1960 and your FRA amount is $1K/month then collecting at age 62 will result in a lifetime amount of $700/month but delaying until age 70 would result in $1,240/month (plus annual COLA adjustment).

When creating your financial plan, we will consider different Social Security timing strategies based on your financial and longevity expectations. When deciding on your best timing we always request that you consider your health, your family’s longevity, and known increases in population longevity.

Compared to what you earned, what can you expect to receive?
As an example, an average earner ($58K) could receive $1,907 or $23K per year in benefits for life, starting at FRA. On the other hand, those who paid Social Security at maximum earnings for 35 years would receive $3,822/month or $45K per year if 2022 was their FRA.

What if you take early benefits while still working? It seldom makes sense to work and take Social Security benefits early because your benefits are reduced by $1 for each $2 earned above an annually set earning level (in 2024 you can only earn up to $22,320 per year ($1,860/month) before your benefits are reduced). Once you reach FRA your Social Security benefits are NOT reduced (regardless of earnings).

We encourage each of you to work with us to review your Social Security history and then use your financial plan to make the best Social Security timing decision for you.

Applying for Social Security should be started three to four months prior to your chosen Social Security benefit start date. You would apply online at www.socialsecurity.gov or call (800-772-1213) or go to the local Social Security office.
One last and very important cyber security reminder: Protect your Social Security log in information (or credentials) – make certain that you are using a secure device when you log into your account.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Guidance on inherited IRA RMD – IRS Notice 2023-54

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The original SECURE Act, signed into law in December 2019, changed many of the long-standing rules governing IRAs and other retirement accounts, and no single measure in the legislation had a more seismic impact on retirement planning. Specifically, the law stipulated that “Non-Eligible Designated Beneficiaries” (i.e., neither surviving spouses or disabled/minor beneficiary) would be required to empty the inherited retirement account by the end of the 10th year after the decedent’s death (and would no longer be able to ‘stretch’ the distributions over their own life expectancy).

While we expected that Non-Eligible Designated Beneficiaries would not be required to take annual distributions in addition to emptying their accounts in the 10-year period, the IRS in February 2022 issued Proposed Regulations that would make a subset of these beneficiaries subject to BOTH the 10-Year Rule and annual Required Minimum Distributions (RMDs). The caveat, however, was that these were merely proposed regulations.

In October 2022 we were informed that there wouldn’t be a penalty if beneficiaries didn’t take a 2022 RMD but by October most had already! Unfortunately, they failed to address the requirements for 2023 and onward.

Finally, this month the IRS released Notice 2023-54, which provides relief once again by eliminating any penalties for failing to take (potential) RMDs for 2023 for these specific beneficiaries. Once again, they punted the RMD decision another year (2024). Keep in mind that these beneficiaries MUST still empty the IRA account by the 10th year.

Although we monitor notices on RMD rules changes and discuss RMD requirements with each of you as needed each year, your engagement in this topic ensures that we understand the relevant regulations for your financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Last Friday’s message from Fed Chairman

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Speaking from Jackson Hole, Fed Chairman Powell said, “Inflation is too high,” adding that they are prepared to raise interest rates further. The inflation rate in June/July has been around 3%.

The Feds effort to dampen inflation is working as the latest data shows a continued shrinkage of money supply.  The conundrum is that nominal GDP is up 6.3% from a year ago so somehow, the broader economy is growing despite less money circulating.

A side effect of all that additional money supply was a rise in stock prices. Excess money tends to end up with consumer spending or investing. However, the money supply is shrinking so this trend may reverse for a time unless we see good financials from companies this fall.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What we heard at the July Fed meeting

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The latest Federal Reserve meeting (July 26th) increased the interest rate another 25 basis points to 5.375%. We have another three upcoming meetings (September 20th, November 1st, and December 13th) left in 2023.

The current focus is now on fall corporate financial reports and the impact of existing debt payments on corporate profits to see if additional interest rate hikes are needed. GDP numbers out by July 27th showed an economy that is growing and consumers who are still spending (particularly in services rather than material goods) indicating that we are not in a recession. The CORE inflation measure (which strips out food and energy) used by the Federal Reserve in their evaluation actually dropped from 4.6 to 4.1% from May to June.

The new increase resulted in mortgage rates that though high (around 7%), compared to recent extremely low mortgage rates, are not historically the highest. It may be surprising to see that in areas with low housing supply (most people don’t want to sell a house with a mortgage below 3%) we are expecting house prices to actually increase 5%-10%. In areas with excess supply the story is different, and prices are dropping in the short-term. Similarly, the increased mortgage rates and abundant supply appear to be negatively impacting the commercial property market.

What does all this mean? Though your home and real estate may be impacted by this rate increase, we are not seeing a similar impact on your portfolio. If you feel strongly that commercial real estate will recover significantly this would be a time to invest in commercial REITs. Though we see promise in undervalued commercial real estate, we have more confidence that residential (not commercial) will outperform in the long-term despite additional potential interest rate increases.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What to expect from the next Fed meeting

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The Federal Reserve System’s US Federal Open Market Committee (FOMC) meets 8 times each year to decide on the short-term interest rate – the next meeting is July 26th. We’ve seen market volatility prior to and following each of these rate increases. The table below shows the last ten increases out of the last twelve meetings. Most pundits expect a small rate increase either in July or/and September and we expect market volatility.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Inherited IRA Beneficiary Rule – A brief overview

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An inherited IRA from a loved one used to be a gift to beneficiaries that was easy to implement with little tax impact and a lifetime of reward. In the last four years, the rules have changed dramatically and now inheriting an IRA can result in a surprisingly large tax liability. It now requires detailed understanding of the rules to ensure the correct ones are applied without additional tax liability.

Below are the rules and the process that we follow with inherited IRAs. We first separate beneficiaries into three large categories: (1) eligible designated beneficiary, or (2) a non-eligible designated beneficiary or (3) a non-designated beneficiary.

Once we know the type of beneficiary we can drill down and verify by using decedent details (below is a chart for non-spousal beneficiaries).

Why is this important? Because the amount of tax liability is at much higher rates if the withdrawals are forced in 5 rather than in 10 years or over your lifetime. In addition, the custodian needs to be encouraged and educated on the nuances of the applicable rules to your situation so that they don’t choose to use the default 5-year worst case scenario. Sometimes we’ve needed to use legal advice to ensure that the correct beneficiary distribution is implemented by the custodian particularly when the beneficiary is a trust.

The take home message is to make sure beneficiaries are clearly delineated in the IRA account form and that inherited IRA transfers follow the correct inherited IRA beneficiary rules.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

SECURE Act 2.0

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The first “Setting Every Community Up for Retirement Enhancement” Act (SECURE Act) was passed December 2019 eliminating the ‘stretch IRA’ for non-spouse and changing the RMD (Required Minimum Distribution) age to 72. These were changes that impacted everyone across the board. With the Secure Act 2.0, congress appears to be reversing its prior leanings and instead allowing Roth conversions. The reversal towards ‘Rothification’ (encouraging ROTH savings/conversions) appears to be with the goal of increasing tax revenues today. It is fair to say that no single provision made by the SECURE Act 2.0 appears to have the same impact across so many as the elimination of the stretch, which now requires many inherited distributions to complete within 10 years, rather than spreading distributions over the entire beneficiary’s lifetime. Even so, 2.0 has so many more detailed provisions that it will impact most in some way. It is already evident that implementation will take more effort than the first SECURE Act.

Some of the new provisions included in SECURE Act 2.0 will be implemented over the next two years and require preparation in 2023. We will explore the provisions that may be relevant to your specific situation during our meetings this year. Let us know if you have any questions.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Fed Action and Your Portfolio

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The last Jackson Hole meeting was hugely anticipated, and Federal Reserve Chairman Jerome Powell reiterated that he would stay true to the current approach to tame inflation. The market reacted with a sharp sell off. Why? Because some were expecting the Fed to return to a loose monetary policy at the slightest economic weakening. January 4th, we heard from the Feds that any pivot prediction is misguided.

It is important to recognize that there are more important factors that drive stock prices than Fed policy – corporate earnings and greed actually impact prices far more!

While I agree that the Fed policy can and does impact economic activity, it is company earnings, economic growth, geopolitics, sentiment, innovation, and global economic trends that will certainly play a bigger role in our economic future and support higher lasting market valuations.

It appears that the media and market participants are fixating on every Fed utterance. Do not follow their lead. We are expecting a cool market over the next months, but inflation appears to be responding. If we stay the course and not return to easy money, we may recover without stagflation and the economic downturn associated with it.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com