by Denise Appleby ,CISP, CRC, CRPS, CRSP, APA.
Adding amounts to your retirement nest egg is only a preliminary step towards a financially secured retirement. Additional steps must be taken to preserve and grow your nest egg, as well as protect it from avoidable taxes and penalties. The following are a few tips that can be used to achieve these goals.
Plan for Healthcare Expenses
According to the Center for Disease Control (CDC), the average life expectancy of Americans is now 78.5 years, an increase of almost 8-years from 1970 when it was 70.8. Living longer increases the chance of experiencing chronic illnesses; and depending on the nature and length of the illness, the associated costs can take a big bite out of your retirement savings if you do not have adequate health insurance in place.
Consider that health expenditures in the United States neared $2.6 trillion in 2010, over ten times the $256 billion spent in 1980[i]. The cost of long term care compounds this issue; and depending on the type of care or service needed, the cost can amount to thousands of dollars per day. It is therefore not unreasonable to assume that if you are forced to use your retirement savings to pay for health care, the chance of you outliving your retirement savings increases.
Work with your financial advisor to determine whether you should purchase long term care insurance, and ensure that you have adequate medical insurance coverage.
Penalties can eat away at your savings, but can be avoided if you manage your contributions and distributions effectively. Doing so includes ensuring that you do the following:
- Taking your required minimum distribution (RMD) by the deadline: You are generally required to take an RMD amount from your IRA by December 31 of every year, beginning the year you reach age 70½.An exception applies to the year that you reach age 70½, which allows you to defer taking that year’s RMD until April 1 of the following year. If you miss your RMD deadline, you will owe the IRS an excess accumulation penalty of 50% of the RMD amount not taken by the deadline.
- Avoid taking early distributions: Distributions taken before you reach age 59½ are subject to a 10% early distribution penalty, unless you qualify for an exception. If taking early distributions is unavoidable, check to determine if you qualify for any of the exceptions.
- Avoid adding ineligible amounts to your IRA: Ineligible contributions, including rollovers, create excess in your IRA and must be corrected by removing the amount by your tax filing deadline, plus any extensions, along with any net income attributive (NIA) to the excess. Failure to correct the excess by the deadline will result in you owing the IRS a 6% excise tax on the amount for every year it remains in your IRA.
Depending on the amounts involved, these penalties can add up to significant amounts. In some cases, the IRS will waive the excess accumulation penalty; however there is no provision under which the other penalties can be waived, if the amounts are subject to them in the first place.
Optimize Your Investments
When it comes to choosing investments, there is no one-size-fits-all solution. Instead, your investment portfolio must be customized to suit your investment profile, which takes factors into consideration such as your retirement horizon and your risk tolerance. An unsuitable investment portfolio can mean that you do not make sufficient earnings/growth, or that you risk experiencing market losses without having sufficient time to recover such losses.
What may be suitable for someone who has 30-years until their target retirement date, might not be suitable for someone who plans to retire in five-years. Choosing the wrong type of investments can either result in significant and detrimental market losses, or provide growth that is not sufficient to meet your projected financial needs for retirement. Your investment portfolio should provide for sufficient growth and income as needed, and include guarantees against market losses if necessary.
Consideration should also be given to how well you are able to handle market losses.As a result, an investment portfolio that is recommended for one person might not be suitable for someone who is of the same age, has the same retirement horizon and the same amount of savings and projected expenses. If you find it difficult to handle investment losses, you might have a low risk tolerance. However, your risk tolerance is often paired or balanced with your risk capacity, which may necessitate ignoring a low risk tolerance to some degree, so as to ensure that your investment portfolio is adequately designed to meet your financial needs.
Working with a financial advisor, who takes these and other factors consideration, can help to ensure that your investment portfolio is suitable, and updated and rebalanced as needed.
Work with a Financial Advisor Who Understands IRAs
IRAs benefit from tax favorable provisions that are not available to other types of savings or investment accounts. However, in order to benefit from these provisions, the IRA activity must conform to a strict set of rules and regulations.Failure to follow these rules can result in the IRA losing these tax favorable benefits. One way to help ensure that your IRAs conform to these rules is to work with a financial advisor who is knowledgeable about IRAs. Such an advisor can help to ensure that you avoid penalties, minimize taxes, and provide invaluable distribution and estate planning guidance for you and your beneficiaries.
Conclusion: Plan Now to Avoid Failure Later
Unfortunately, many IRA owners play the ‘contribute and forget it’ game with their IRA, which can lead to irreparable damages. An ‘effective’ IRA requires careful administration from all angels, and often necessitates working with a financial advisor who can provide you the necessary guidance that can help to grow and protect your IRA.Please contact us to help you manage your IRA operations.