Landmarks on the Road to Retirement

EDITOR'S NOTE: This article, originally published in the January 2010 issue of Kiplinger's Retirement Report, has been updated in March 2010.To subscribe, click here.

You may have thought the big milestone birthdays were behind you. After becoming a teenager at 13, it only got better. As the years passed, you could legally drive, vote and hail in each New Year with a glass of bubbly.

The road to retirement has its own milestones, starting at age 59 1/2, when you can take penalty-free withdrawals from your retirement plans. Although these landmarks are not as thrilling as those earlier ones, they're just as important. Your financial security could depend on watching out for these signposts.

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Penalty-Free Withdrawals at 59 1/2

On the day you turn 59 1/2, you can tap a traditional IRA without incurring a 10% early-distribution penalty. You will still owe income tax on any distribution.

Roth IRA owners who are 59 1/2 are free of the 10% penalty on withdrawn earnings (those earnings are also tax-free as long as owners have held at least one Roth for five years). Converted amounts held for less than five years are freed, too, from the penalty when an account owner reaches 59 1/2.

Owners of Roth and traditional 401(k) accounts who are 59 1/2 don't pay the penalty, either. But not all companies allow withdrawals if you're still working. If you leave your employer at age 55 or older, you can withdraw money from your employer plan without paying the early-distribution penalty.

Even though you can dip into your accounts penalty-free doesn't mean you should. The longer the money can stay in a tax shelter, the more it can grow. You won't be subject to any other penalties until you're required to take minimum distributions in 11 years. "The IRS doesn't care what you do with your money from 59 1/2 to 70 1/2," says Larry Rosenthal, president of Financial Planning Services, in Manassas, Va.

The Social Security Dilemma at 62

Deciding on when to start claiming benefits depends on a number of factors: your life expectancy, your marital status and whether you're still working. If you were born between 1943 and 1954, you can collect full benefits starting at 66. You're eligible to start claiming benefits at 62, but your benefit will be permanently reduced by a certain percentage for each month you claim before your full retirement age.

Claim at 62 and your benefits will be reduced by 25%. For each year you delay claiming benefits between 66 and 70, your benefit will increase by 8%.

The decision is easy for some. If you need the income to make ends meet, take your benefits early. If you plan to continue working, delaying makes sense. Otherwise, you will lose $1 in benefits for each $2 you earn over the earnings limit of $14,160 in 2010 -- plus you take a permanent benefit cut. The earnings limit disappears at full retirement age.

Whether you take smaller benefits earlier or larger benefits later, at some point you break even, meaning that you would have received the same amount of benefits no matter when you started. If you're single and have significant health issues that will likely shorten your life expectancy, it may make sense to claim early.

However, a lot depends on your other sources of income. Henry Hebeler, creator of AnalyzeNow.com, says a single person who collects at 62 is more likely to run out of money at an earlier age than someone with the same savings who waits until 66. You can use a free program on his site to make your own calculations.

For married couples, the decision is more complex. Taking benefits early can hurt your spouse, particularly if he or she is much younger and earns less.

Let's say a wife earned less than her husband. She is entitled to a benefit based on her own earnings or a spousal benefit that's worth up to 50% of her husband's benefit. A spouse can collect her own benefit at 62, but she can't collect a spousal benefit until her husband files for his benefit.

If he dies first, she's entitled to a survivor benefit equal to 100% of her husband's benefit, as long as she waits until 66 to collect the survivor benefit. A priority for many married couples should be to increase the benefit for the surviving spouse. If the higher-earning husband delays until 70, his survivor will get an extra 32%, plus cost-of-living adjustments.

For many couples, a husband should claim at 70, while the lower-earning spouse should start collecting at 62, according to a study by Boston College's Center for Retirement Research. Because the husband is likely to die first, the study says, he will increase the value of the survivor benefit. The authors figured that the wife's reduced benefit will be temporary because she will eventually get the higher survivor benefit.

You can run many calculations on the Social Security Web site (www.socialsecurity.gov). Also, learn about a number of little-known strategies by reading Boost Your Social Security Benefits.

Government Health-Care Coverage at 65

When you turn 65, Medicare coverage could be the best gift of all. But you will need to plan ahead. Enrollment periods vary among coverage plans, and you can get zinged by permanent late fees if you miss deadlines.

There are two main choices for getting Medicare. You can enroll in traditional Medicare, which includes Part A inpatient coverage and Part B physician services. If you go this route, you can choose a private Part D drug plan and supplemental insurance to cover co-payments and deductibles. The other choice is a private Medicare Advantage plan, which provides all-in-one coverage. With an Advantage plan, you don't need supplemental insurance, and most offer drug coverage.

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Most people are eligible for premium-free Part A if they or their spouse have paid Medicare payroll taxes or are eligible for Social Security benefits. You'll be automatically enrolled if you're already receiving Social Security benefits. Otherwise, you'll need to sign up. You should contact the Social Security Administration three months before you turn 65. If you're not entitled to free Part A benefits, you may be able to buy them.

Because you must pay a premium for Part B, you can turn it down. You have seven months to sign up for Part B (as well as for Part A if you have not started receiving Social Security benefits). The seven-month period begins three months before the month of your 65th birthday and ends three months after your birthday month. If you enroll one to three months before age 65, coverage will begin the month you turn 65.

If you don't sign up during this initial enrollment period, you will have to wait until the general enrollment period from January 1 to March 31. Your monthly premium may rise permanently 10% for each 12-month period you wait beyond the initial enrollment period. New Part B beneficiaries will pay a premium of $110.50 a month in 2010, although higher-income beneficiaries will pay a bigger premium (read A Roth Conversion Boosts Medicare Costs).

You won't pay a late penalty if you or a spouse still work and you're covered by a group health plan. You can sign up for Medicare during the eight-month period that begins the month after the employment ends or the group coverage ends, whichever comes first. If you have COBRA coverage, you must enroll during the eight-month period that begins the month after the employment ends.

You must have Parts A and B to buy supplemental insurance, known as a Medigap policy. Insurers can only sell federally standardized plans. Costs can vary. After you sign up for Part B, you have six months to buy a Medigap policy and you can't be turned down, regardless of your health. After six months, insurers can reject you if you have a medical condition.

You are eligible for a Part D drug plan if you have Part A or Part B, or both. You can sign up during the seven-month initial enrollment period for Parts A and B. You can also join between November 15 and December 31 each year. You may pay a permanent penalty if you do not sign up when you are first eligible. You can avoid the penalty if you can prove you have had coverage that's comparable to a Part D benefit.

Those interested in Medicare Advantage can enroll during the same seven-month initial enrollment period as Part B enrollees, or between November 15 and December 31. Late enrollment penalties also apply.

Not all Advantage plans work the same way. And unlike traditional Medicare, you may be limited in the doctors and hospitals you can visit. Your costs could be higher or lower than traditional Medicare, depending on the plan you choose.

If you have employer or retiree health coverage, call the administrator before making any changes. If your spouse needs your workplace coverage, there's a chance you could lose those benefits if you drop your own coverage or enroll in Medicare Advantage or Part D. Also, many employer and retiree plans will drop full coverage if you're eligible for Medicare.

You can get more information at Medicare.gov, where you can compare Advantage, Part D and Medigap plans.

Required Distributions Begin at 70 1/2

Age 70 1/2 heralds in required minimum distributions for owners of traditional IRAs, 401(k)s and other defined-contribution retirement plans. Roth 401(k) owners are also subject to RMDs at this age, but Roth IRA owners are not.

Generally an RMD must be taken by year-end. First-timers can choose to delay taking a distribution until April 1 of the year following the year they turn 70 1/2. Jim Gavin, a retired executive for General Motors, turned 70 1/2 in February and plans to wait to take his first RMD until the following year. “The object was to leave the IRA alone as long as possible,” says Gavin, of Estero, Fla. “Right now, we can survive without it.”

The April 1 after your 70 1/2 year is called your required beginning date. For example, if your 70th birthday is February 15, 2010, you would hit 70 1/2 in August. Therefore, your required beginning date is April 1, 2011. If your 70th birthday is later in the year, perhaps December 15, 2010, you wouldn't turn 70 1/2 until 2011. In that case, you would be required to take your first distribution by April 1, 2012.

There is a downside to delaying that first RMD: You'll also have to take your second distribution that same year. After the first RMD, every subsequent RMD must be taken by December 31. That means Gavin will take his first and second distributions in 2011. "You don't get a free pass," says Gregory Ostrowski, a certified financial planner at Scarborough Capital Management, in Annapolis, Md.

Before planning to double up on distributions, figure the impact on your taxes. If doubling up pushes you into a higher tax bracket for that year, you probably should take your first distribution in the year you turn 70 1/2. Deferring could make sense if your tax rate will be lower the following year or if your IRA needs more time to recover from the bear market, says Gordon Bernhardt, president of Bernhardt Wealth Management, in McLean, Va.

While the government waived RMDs for 2009, required minimum distributions from retirement accounts are back for the 2010 tax year. Those who would have had to take their first RMD in 2009 (or by April 1, 2010) will take only one distribution in 2010.

An RMD is easy to calculate. The distribution equals your account value on December 31 of the previous year divided by a factor based on your age. Factors can be found in the Uniform Lifetime Table in IRS Publication 590. (If your spouse is your beneficiary and is more than ten years younger than you, you'll use a different table.)

The factor you use is determined by the age you turn that year. For example, say in 2010 you turn 70 and hit age 70 1/2. For your first RMD, you'll use the factor, called an "applicable divisor," for age 70, which is 27.4 (the factor is based on your life expectancy). If you had $200,000 in your IRA at the end of 2009, your first RMD will be $7,299 -- $200,000 divided by 27.4. (Also, for a 2010 RMD, you can use our online RMD calculator.)

Say you turn 70 in 2010 but hit 70 1/2 in 2011. Your first distribution year is 2011, with a delayed required date of April 1, 2012. In that case, your RMD will be based on your account value at the end of 2010 and your birthday in 2011, which will be 71.

If you decide to delay taking your first RMD until April 1 of the following year, you would still calculate the first RMD the same as if you had taken it in the year you turned 70 1/2. So if you end up taking two distributions in the same year, the amount of the distributions will be based on account values for two different years.

If you have multiple IRAs, add up your total account values and then calculate your RMD. You can take your total RMD from one IRA or spread the withdrawal over two or more IRAs, says Dean Barber, president of Barber Financial Group, in Lenexa, Kan. A separate RMD must be taken from each employer plan, such as a 401(k), that you own.

Unless you're a first-timer who delayed and has an April 1 deadline, an RMD can be taken at any time of the year. Many people wait until later in the year to let the money grow tax-deferred longer. If you want, you could withdraw the required amount in regular installments or as you need the money. Your account custodian can likely set up automatic withdrawals.

However you choose to take your RMD, get the ball rolling at least two weeks before the deadline to ensure your plan's custodian completes the transaction in time. If you don't take out the required amount, you will owe a 50% tax on any shortfall.

If you're still working at 70 1/2, you'll have to take your RMDs from your IRAs and any defined-contribution plans from former employers. But, as long as you don't own 5% or more of the company, you won't have to take an RMD from your current employer's plan.

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