Retirement Income Blog

Most people think about charitable bequests as part of their will or trust to be consummated when they die.  However, you will miss some senior tax breaks if you wait until death.   If you attend to these charitable giving issues while alive, there are some big tax breaks available and a decent income for life.

Charities are happy to pay you money if you help them. It’s called a charitable gift annuity and here’s how it works. You make a single contribution and based on the amount of that contribution, your age and current interest rates, you receive a set income for life.  Think of this like making any other retirement income investment.  You invest and get a lifetime income.

Don’t shop around with charities for the highest rate of return, though, because most large U.S. charities offer yields set annually by the American Council on Gift Annuities in Dallas. This benign collusion among charities, which began casually about 70 years ago, was finally legalized by Congress.

A gift annuity’s yield varies according to your age and the date you make your gift (see table below effective 1/1/09). Since a portion of your income will be considered a return of principal, part of your annual income will be tax-free. How much depends on your age. Additionally, you get a tax deduction for your gift as shown on the above table.

Age                  Payout Rate Deduction as % of gift
65                         5.7                34.2
70                         6.1                38.4
75                         6.7                43.4
80                         7.6                48.3
85                         8.9                51.9
90 and over         10.5 

If you have charitable intentions but want to retain income from your donation, most any charity will show you how to set up a charitable gift annuity.  Your donation does not need to be cash—you could donate appreciated securities or land that currently pays you nothing and also save on capital gains tax.

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Let’s first state three fundamental principles and then add the details.

1.      Start retirement with sufficient retirement savings

2.      Protect your retirement savings from erosion due to taxes and inflation

3.      Never lose money

Start with your desired retirement income and expenses.  Then, you can use a retirement income calculator to determine how much retirement savings you will need. You need to know how large of a nest egg is required for a comfortable retirement.  Most people don’t like to do this rigorous exercise of charting your expenses and income over time.  If you won’t do it, then hire a retirement planner who will.  I highly recommend the retirement planning software from J&L planners as it allows you to account for detailed changes in your income and expenses year by year.  Only by doing the math do you know how much you need and when you are able to retire. 

Next, you need to take advantage of as much tax shelter as possible.  For most retirees, that means using your unsheltered money first (e.g. your non-IRA, non-401k funds) .  You want to let your tax sheltered money grow as long as possible.  The caveat here is the uncertainty of future tax rates. Future income tax rates may be higher than today. You can have a retirement planner calculate for you the tax rate at which it is better to use your sheltered funds first.  In fact, understand that the plans you make at the beginning of retirement can change because of changes in tax rates or other variables.  That’s why smart retirees will update their retirement plan every 24 months.

Last, you need to be sure your principal never declines.  That would seem impossible based on the advice in the retirement-Income.net web site that recommends you keep 50% of your funds in stocks and everyone knows stocks go up as well as down.  BUT, you will never rely on these stocks for retirement income.  Your money will always be in at least 2 baskets—your liquidity basket from which you make withdrawals for your living expenses and your growth basket which replenishes your liquidity basket at long intervals.  You will never take funds from your growth basket to live on and the long intervals create a very high probability that you will only have gains in your growth basket between transfers to your liquidity basket.  Consider for example that over the last 80 years, when stocks have been left alone for 10 year time intervals, they gained in value 97% of the time.

Of course, in terms of protecting your retirement savings, there may be other asset protection measures such as trust and estate planning that you do for your heirs.

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Seniors who are in a cash flow bind because of increasing expenses or a drop in their investment income may want to look into tapping one of their most valuable assets: their homestead.

There are several ways to do this.  Homeowners could sell the home, but they would have to move.  Or they could take out a loan against it, which would leave them with payments to make each month.  The third choice is a reverse mortgage.   

A reverse mortgage is a non-recourse loan that lets homeowners over 62 years old convert the equity in their house into cash.  Yet it allows them to still live there, and retain title and ownership.  The lender will give the payout all at once, as a fixed monthly income (up to lifetime), as a line of credit, or as a combination of these.

The money will have to be paid back with interest when your clients die, sell the home, or permanently move out.  But they or their heirs have the option to pay off the reverse mortgage at anytime and keep the house.  And the amount that must be repaid can never exceed the value of the home.  Furthermore, if the sales price exceeds the amount owed, the excess will go to the homeowner or their estate.

There is no income or medical requirement to qualify for a reverse mortgage.  And borrowers can use the money any way they wish, for example, to pay daily living costs, medical bills, or travel expenses. 

The size of the reverse mortgage depends on several factors, including the youngest homeowner’s age, the home’s value, and current interest rates.  The money they receive will be tax-free and will not affect Social Security or Medicare benefits.  However, it could influence Medicaid qualification. 

Take for example, Bill and Marge, ages 65 and 63 respectively.  They own their home, which is valued at $250,000.  Bill had to close his part-time consulting business because of health problems, and the loss of this income forced them to cancel a once-in-a-lifetime cruise that they had been planning for the past year.  A reverse mortgage offered Bill and Marge the following options:¹          

            Single lump sum or line of credit - $140,285

            Lifetime monthly income - $784

 They chose the line of credit and took out enough to pay for their cruise and single-pay LTC insurance policies. They’ll keep the balance of the available cash for another vacation, for an emergency, or to supplement their income in the future.

More information and a list of reverse mortgage lenders in your state are available from the National Reverse Mortgage Lenders Association.  This source of retirement income promises to become more common as baby boomers with inadequate retirement savings tap whatever home equity they have.

 
¹ http://www.rmaarp.com/estimates.htm

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There are three big areas on which to focus your attention in your pre-retirement years.

Sufficient Retirement Capital
You likely need more than you think to provide sufficient retirement income. There are lots of “rules of thumb” you may hear like “you need 70% of your pre-retirement income.
Don’t rely on these simplistic rules. If you want to do it right, get a copy of J&L Retirement Planner software (about $100) and go through the painstaking task of entering all of the numbers permitted. This robust software allows you to enter year by year events such as the world cruise for your 65th birthday, or the fact that your deferred compensation starts when you reach age 67.5 or that you plan to move to a condo at age 72 and thereby free up $300,000 for investments and eliminate your mortgage payment. Take the time to get your pre-retirement planning done with as much precision as possible (or hire a retirement planning professional). If it’s too much of a bother, then don’t complain if you run out of money at age 85 and live on food stamps for 15 more years.

If you start your calculations and you don’t have enough for your targeted retirement date, you will find that tightening your belt pre-retirement to save and invest more has a much smaller impact than working another one or two years. During that extra work time, your retirement investments continue to grow rather than be consumed. This additional growth is likely to be much more money than you can put away in additional savings. Don’t worry about retirement investing at this point. Get to the retirement “starting line” before reallocating your portfolio to live in retirement.

Retirement plan Options
Prior to retirement, you will be asked by your employer to make choices about how to distribute your 401k or receive pension payments. This area is so fraught with rules you are unlikely to know, get the help of a retirement professional. IRS has constructed a minefield of rules and waits for you to step in the wrong place and blow up.

Health Insurance and Health Care
You may feel great now but it is naive to assume everyone else becomes an old codger but not you. You too may be shuffling across the intersection trying to beat the countdown before the traffic light changes color. Therefore, take the probability of illness and aging seriously. Not only do you need comprehensive health insurance but also long term care insurance, both of which you want to get pre-retirement. Many health insurance plans are regional and not national so before you retire, be sure you are content to remain living in the area in which you retire. Your health plan may not be portable. Buy long term health care coverage. If you don’t know anything about long term care insurance, talk to your retirement planner or do your Internet research.

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