MONEY Taxes

For Some Retirees, April 1 is a Crucial Tax Deadline

If you recently reached your 70s and aren't yet drawing money from your tax-deferred retirement accounts, you need to act fast.

For anyone who turned 70½ last year and has an individual retirement account, April 15 isn’t the only tax deadline you need to pay attention to this time of year.

With a traditional IRA, you must begin taking money out of your account after age 70½—what’s known as a required minimum distribution (RMD). And you must take your first RMD by April 1 of the year after you turn 70½. After that, the annual RMD deadline is December 31. After years of tax-deferred growth, you’ll face income taxes on your IRA withdrawals.

Figuring out your RMD, which is based on your account balance and life expectancy, can be tricky. Your brokerage or fund company can help, or you can use these IRS worksheets to calculate your minimum withdrawal.

Failure to pull out any or enough money triggers a hefty penalty equal to 50% of the amount you should have withdrawn. Despite the penalty, a fair number of people miss the RMD deadline.

A 2010 report by the Treasury Inspector General estimated that every year as many as 250,000 IRA owners miss the deadline for their first or annual RMD, failing to take distributions totaling some $350 million. That generates potential tax penalties of $175 million.

The rules are a bit different with a 401(k). If you’re still working for the company that sponsors your plan, you can waive this distribution rule until you quit. Otherwise, RMDs apply.

“It’s becoming increasingly common for folks to stay in the workforce after traditional retirement age,” says Andrew Meadows of Ubiquity Retirement + Savings, a web-based retirement plan provider specializing in small businesses. “If you’re still working you can leave the money in your 401(k) and let compound interest continue to do its work,” says Meadows.

What’s more, with a Roth IRA you’re exempt from RMD rules. Your money can grow tax-free indefinitely.

If you are in the fortunate position of not needing the income from your IRA, you can’t skip your RMD or avoid income taxes. You may want to reinvest the money, gift it, or donate the funds to charity, though a law that allowed you to donate money directly from an IRA expired last year and has not yet been renewed. Another option is to convert some of the money to a Roth IRA. You’ll owe income taxes on the conversion, but never face RMDs again.
Whatever you do, if you or someone you know is 70-plus, don’t miss the April 1 deadline. There’s no reason to give Uncle Sam more than you owe.

 

MONEY Ask the Expert

How to Max Out Social Security Benefits for Your Family

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q. Does the family maximum benefit (FMB) apply only to one spouse’s individual’s work history or to both spouses in a family? That is, assume two high-earning spouses both delay claiming a benefit till, say, 70. Would the FMB rules limit their overall family benefits? Or does the FMB include just the overall family benefits derived from the earnings record of one particular worker? —Steve

A: Kudos to Steve for not only knowing about the family maximum benefit but having the savvy to ask how it applies to two-earner households. The short answer here is that Social Security tends to favor, not penalize, two-earner households in terms of their FMBs.

To get everyone else up to speed, the FMB limits the amount of Social Security benefits that can be paid on a person’s earnings record to family members—a spouse, survivors, children, even parents. (Benefits paid to a divorced spouse do not fall under the FMB rules.) The amount may include your individual retirement benefit plus any auxiliary benefits (payouts to those family members) that are based on that earnings record.

Fair warning: the FMB is far from user-friendly. Few Social Security rules are as mind-bendingly complex as the FMB and its cousin, the combined family maximum (CFM). And Social Security has a lot of complex rules. Unfortunately, you need to do your homework to claim all the family benefits you are entitled to receive.

To address Steve’s question, these FMB calculations may be based on the combined earnings records of both spouses. More about this in a bit, but first, here are the basics for an individual beneficiary.

The ABCs of the FMB

The FMB usually ranges from 150% to 187% of what’s called the worker’s primary insurance amount (PIA). This is the retirement benefit a person would be entitled to receive at his or her full retirement age. Even if you wait until 70 to claim your benefit, it won’t increase the FMB based on your earnings record.

Now, I try to explain Social Security’s rules as simply as possible—but there are times when the system’s complexity needs to be seen to be believed. So, here is the four-part formula used in 2015 to determine the FMB for an individual worker:

(a) 150% of the first $1,056 of the worker’s PIA, plus

(b) 272% of the worker’s PIA over $1,056 through $1,524, plus

(c) 134% of the worker’s PIA over $1,524 through $1,987, plus

(d) 175% of the worker’s PIA over $1,987.

Let’s use these rules for determining the FMB of a worker with a PIA of $2,000. It will be $3,500, which equals (a) $1,584 plus (b) $1,273 plus (c) $620 plus (d) $23. The difference between $3,500 and $2,000 is $1,500—that’s the amount of auxiliary benefits that can go to your family. Got that?

And here’s a key point that trips up many people: Even if the worker claimed Social Security early, which means his benefits were lower than the value of his PIA, it would not change the $1,500 limit on auxiliary benefits. However, when the worker dies, the entire $3,500, which includes the PIA amount, becomes available in auxiliary benefits.

It’s quite common for family claims to exceed the FMB cap. When this happens, anyone claiming on his record (except the worker) would see their benefits proportionately reduced until the total no longer exceeded the FMB. If, say, those claimed auxiliary benefits actually totaled $3,000, or double the allowable $1,500, all auxiliary beneficiaries would see their benefits cut in half.

How CFM Can Boosts Benefits

Enter the combined family maximum (CFM). This formula can substantially increase auxiliary benefits to dependents of married couples who both have work records—typically multiple children of retired or deceased beneficiaries.

The children can be up to 19 years old if they are still in elementary or secondary school (and older if they are disabled and became so before age 22). Because each child is eligible for a benefit of 50% or even 75% percent of a parent’s work PIA, even having only two qualifying auxiliary beneficiaries—say a spouse and a child, or two children—can bring the FMB into play.

But with the CFM, the FMBs of each earner in the household can be combined to effectively raise the benefits to children that might otherwise would be limited by the FMB of just one parent. Under its rules, Social Security is charged with determining the claiming situation that produces the most cumulative benefits to all auxiliary beneficiaries.

Using our earlier example, let’s assume we now have two workers, each with PIAs of $2,000 and FMB’s of $3,500. A qualifying child would still be limited to a benefit linked to the FMB of a single parent. But the CFM used to determine the size of the family’s benefits “pool” has now doubled to $7,000 a month, permitting total auxiliary benefits of up to $3,000.

Well, they would have totaled this much—except there’s another Social Security rule that puts a cap on the CFM. For 2015, that cap is $4,912. Subtracting one of the $2,000 PIAs from this amount leaves us with up to $2,912 in auxiliary benefits for this family. That’s not $3,000 but almost.

So it’s quite possible that three, four, or possibly more children would get their full child benefits in this household. Even if they totaled 200% of one parent’s FMB, they would add up to a smaller percentage of the household’s CFM, and either wouldn’t trigger benefit reductions, or at least much small ones.

And if eligible children live in a household where one or both of their parents also has a divorced or deceased spouse, even more work records can come into play. This is complicated stuff, as borne out in some thought-twisting illustrations provided by the agency.

Before moving ahead with family benefit claims, I recommend making a face-to-face appointment at your local Social Security office. Bring printouts of your own earnings records, which you can obtain by opening an online account for each person whose earnings record is involved. I’d also print out the contents of the Social Security rules, which are linked in today’s answer, or at the very least, write down their web addresses so the Social Security representative can access them.

Good luck!

Philip Moeller is an expert on retirement, aging, and health. He is co-author of The New York Times bestseller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and a research fellow at the Center for Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: Why Social Security Rules Are Making Inequality Worse

MONEY Health Care

Proposed Medicare ‘Doc Fix’ Comes at a Cost to Seniors

A measure designed to head off big cuts in payments to doctors asks Medicare recipients to foot part of the bill.

Congress is headed toward a bipartisan solution to fix a Medicare formula that threatens to slash payments to doctors every year. The so-called “doc fix” would replace the cuts with a multipronged approach that will be expensive and will have Medicare beneficiaries pay part of the bill.

Congress has repeatedly overridden the payment cuts, which are mandated under a formula called the Sustainable Growth Rate (SGR), which became law in 1997, that is a way of keeping growth in physician payments in line with the economy’s overall growth. This year, unless Congress acts, rates will automatically be slashed 21 percent.

In a rare instance of bipartisan collaboration, House Speaker John Boehner and Minority Leader Nancy Pelosi are pushing a plan to replace the SGR with a new formula that rewards physicians who meet certain government standards for providing high quality, cost-effective care. If they can get the plan through Congress, President Barack Obama has said he will sign it.

The fix will cost an estimated $200 billion over 10 years. Although Congress has not figured out how to pay the full tab, $70 billion will come from the pocketbooks of seniors.

There are better places to go for the money, such as allowing Medicare to negotiate drug prices with pharmaceutical companies and tightening up reimbursements to Medicare Advantage plans. But there’s no political will in Congress for that approach.

And the doc fix needs to be done. Eliminating the SGR will greatly reduce the risk that physicians will get fed up with the ongoing threat of reduced payments and stop accepting Medicare patients. “Access to physicians hasn’t been a big problem, but if doctors received a 21 percent cut in fees, that might change the picture,” says Tricia Neuman, senior vice president and director of the Program on Medicare Policy at the Kaiser Family Foundation.

Here’s what the plan would cost seniors:

Medigap reform

Many Medicare enrollees buy private Medigap policies that supplement their government-funded coverage (average annual cost: $2,166, according to Kaiser). The policies typically cover the deductible in Part B (outpatient services), which is $147 this year, and put a cap on out-of-pocket hospitalization costs.

Under the bipartisan plan, Medigap plans would no longer cover the annual Part B deductible for new enrollees, starting in 2020, so seniors would have to pay it themselves. Current Medigap policyholders and new enrollees up to 2020 would be protected.

The goal would be to make seniors put more “skin in the game,” which conservatives have long argued would lower costs by making patients think twice about using medical services if they know they must pay something for all services they use.

Plenty of research confirms that higher out-of-pocket expense will reduce utilization, but that doesn’t mean the reform will actually save money for Medicare.

Numerous studies show that exposure to higher out-of-pocket costs results in people using fewer services, Neuman says. If seniors forgo care because of the deductible, Medicare would achieve some savings. “The hope is people will be more sensitive to costs and go without unnecessary care,” she says. “But if instead, some forgo medical care that they need, they may require expensive care down the road, potentially raising costs for Medicare over time.”

High-income premium surcharges

Affluent enrollees already pay more for Medicare. Individuals with modified adjusted gross income (MAGI) starting at $85,000 ($170,000 for joint filers) pay a higher share of the government’s full cost of coverage in Medicare Part B and Part D for prescription drug coverage. This year, for example, seniors with incomes at or below $85,0000 pay $104.90 per month in Part B premiums, but higher income seniors pay between $146.90 and $335.70, depending on their income.

The new plan will shift a higher percentage of costs to higher-income seniors starting in 2018 for those with MAGI between $133,500 and $214,000 (twice that for couples). Seniors with income of $133,000 to $160,000 would pay 65 percent of total premium costs, rather than 50 percent today. Seniors with incomes between $160,000 and $214,000 would pay 80 percent rather than 65 percent, as they do today.

Everyone pays more for Part B

Under current law, enrollee premiums are set to cover 25 percent of Medicare Part B spending, so some of the doc fix’s increased costs will be allocated to them automatically. Neuman says a freeze in physician fees is already baked into the monthly Part B premium for this year, so she expects the doc fix to result in a relatively modest increase in premiums for next year, although it’s difficult to say how much because so many other factors drive the numbers.

MONEY Health Care

This Scary Retirement Expense Just Got Even Scarier

150326_RET_SCARIERCOSTS
GIPhotoStock—Getty Images/Cultura RF

The estimated tab for health care costs in retirement is huge—and getting bigger every year, according to a new study.

If you’re worried about paying for your health care in retirement, get ready to worry more.

A healthy couple retiring this year at age 65 will pay $266,589 for health care in retirement, according to the 2015 Retirement Healthcare Costs Data Report by health data provider HealthView Services. That’s a 6.5% jump from HealthView’s projections a year ago.

If medical costs continue their rapid rise, the tab will be even larger in the near future: Expected lifetime health care expenses will rise to $320,996 for a couple retiring in 10 years at age 65, the study found.

And that’s just what you’ll pay for Medicare Parts B and D, which cover routine medical care and prescription drugs, and a Medicare supplemental insurance policy, which most Medicare recipients buy to help with co-pays and deductibles. It doesn’t include all the out-of-pocket costs that traditional Medicare doesn’t cover, including dental, vision, and hearing services, and co-pays.

When you factor in those expenses, projected retirement health care costs rise to $394,954 for a couple retiring this year at age 65 and $463,849 for a couple retiring in 10 years. And those numbers don’t even count long-term care, which can add tens of thousands of dollars if you need extensive help at home or in a nursing home.

To put those costs in perspective, HealthViews estimates that a couple retiring today will spend 67% of their Social Security benefits on health care costs over their lifetimes. For a couple retiring in 10 years at age 65, medical care will suck up 90% of their Social Security income. That’s troubling considering that for many, Social Security makes up the majority of their retirement income. Even for middle income and wealthier families, Social Security accounts for about one-third of retirement income.

But Social Security benefits won’t be able to keep up with health care inflation. Social Security benefits have averaged a 2.6% annual cost of living increase over the past decade (and just 1.4% the past four years), while health care costs have risen more sharply. According to the Centers for Medicare and Medicaid, health care costs will rise 5% to 7% over the next eight years.

HealthView numbers are higher than other surveys on health care retirement costs. In Fidelity Benefits Consulting’s annual retirement health care costs report for 2014, a 65-year-old couple retiring today will need an average of $220,000 to cover medical expenses throughout retirement.

Counterintuitively, estimates of total lifetime health care costs are lower for people in poor health at retirement. HealthView’s estimates show that total retirement health care costs will be lower on average for someone with diabetes because of a shorter life expectancy. The total health care costs for a typical 55-year-old male with Type II diabetes will be approximately $118,000, compared to $223,000 for his healthy counterpart, primarily because the 55-year-old with diabetes has an expected longevity of 76, vs. 86 for a healthy male.

Of course, these are just averages. You can’t know exactly what your health will be after you retire, how much medical treatments will cost you, or how long you will live.

That said, even a rough guide can be a useful planning tool. So take a look at your insurance coverage. Consider the likelihood for each type of expense, as well as the average Medicare costs by age, to come up with an estimate of the savings you’ll need to fund these costs. Kaiser recently published a study on Medicare costs by age, which breaks down Medicare spending into its main components—hospitals, doctors, and drugs—and measures how much Americans spend on these services at different ages.

To prepare for that spending in advance, take a look at your sources of your retirement income. If you have a health savings account, do everything you can not to touch it now but let it grow tax free. It is an excellent vehicle for funding future medical expenses. Ditto for a Roth IRA, which lets your money grow tax free. For more tips on planning for retirement health care costs, check out MONEY’s stories here, here, and here.

MONEY Ask the Expert

The Surefire Way Not to Lose Money on Your Bond Investments

Ask the Expert Retirement illustration
Robert A. Di Ieso, Jr.

Q: I am leaning toward buying individual bonds and creating a bond ladder instead of a bond fund for my retirement portfolio. What are the pros and cons?—Roy Johnson, Troy, N.Y.

A: If you’re worried about interest rates rising—and many people are—buying individual bonds instead of putting some of your retirement money into a bond fund has some definite advantages, says Ryan Wibberley, CEO of CIC Wealth in Gaithersburg, Maryland. There are also some drawbacks, which we’ll get to in a moment.

First, some bond background. Rising interest rates are bad for fixed-income investments. That’s because when rates rise, the prices of bonds fall. That can cause short-term damage to bond funds. If rates spike and investors start pulling their money out of the fund, the manager may need to sell bonds at lower prices to raise cash. That would cause the net asset value of the fund to drop and erode returns.

By contrast, if you buy individual bonds and hold them to maturity, you won’t see those daily price moves. And you’ll collect your interest payments and get the bond’s face value when it comes due (assuming no credit problems), even if rates go up. So you never lose your principal. “You are guaranteed to get your money back,” says Wibberley. But with individual bonds, you will need to figure out how to reinvest that money.

One solution is to create a laddered portfolio. With this strategy, you simply buy bonds of different maturities. As each one matures, you can reinvest in a bond with a similar maturity and capture the higher yield if interest rates are rising (or accept lower yield if rates fall). All in all, it’s a sound option for retirees who seek steady income and want to protect their bond investments from higher rates.

The simplest and cheapest way to create a bond ladder is through government bonds. You can buy Treasury securities for free at TreasuryDirect.gov. You can also buy Treasuries through your bank or broker, but you’ll likely be charged fees for the transaction.

Now for the downside of bond ladders: To get the diversification you need, you should hold a mix of not only Treasuries but corporate bonds, which can be more costly to buy as a retail investor. Generally you must purchase bonds in minimum denominations, often $1,000. So to make this strategy cost-effective, you should have a portfolio of $100,000 or more.

With corporates, however, you’ll find higher yields than Treasuries offer. For safety, stick with corporate bonds that carry the highest ratings. And don’t chase yields. “Bonds with very high yields are often a sign of trouble,” says Jay Sommariva, senior portfolio manager at Fort Pitt Capital Group in Pittsburgh.

An easier option, and one that requires less cash, may be to build a bond ladder with exchange-traded bond funds. Two big ETF providers, Guggenheim and BlackRock’s iShares, now offer so-called defined-maturity or target-maturity ETFs that can be used to build a bond ladder using Treasury, corporate, high-yield or municipal bonds.

Of course, bond funds have advantages too. You don’t need a big sum to invest. And a bond fund gives you professional management and instant diversification, since it holds hundreds of different securities that mature at different dates.

Funds also provide liquidity because you can redeem shares at any time. With individual bonds, you also can sell when you want, but if you do it before maturity, you may get not get back the full value of your original investment.

There’s no one-size-fits all strategy for bond investing in retirement. A low-cost bond fund is a good option for those who prefer to avoid the hassle of managing individual bonds and who may not have a large sum to invest. “But if you want a predictable income stream and protection from rising rates, a bond ladder is a more prudent choice,” Sommariva says.

Do you have a personal finance question for our experts? Write to AskTheExpert@moneymail.com.

Read next: Here’s the Retirement Income Mistake Most Americans Are Making

MONEY retirement planning

The Smart Way to Choose a Retirement Community

The decision to move to a retirement community is never easy. But new pricing information can help you plan.

Moving into a retirement community is a complex and often emotional decision, especially if health issues are a reason. Figuring out the finances of this move adds to the challenge. But by understanding the expenses you’ll need to pay, seniors and their families can make the best possible choices.

The good news is more cost data is now available. A Place for Mom, a senior community placement service, just released what it claims is the first pricing survey of these residences—one that is does not rely primarily on data reported by the communities themselves. Its Senior Living Price Index is based on reports from seniors it has placed. The company works with 20,000 residences around the country and advises an average 50,000 families a month.

The prices are listed by category of residence—independent living, assisted living and memory care (for those with dementia) —as well as by region. (The prices for independent living do not include health care expenses, but they are included for assisted living and memory care.) The survey only covers larger communities—those with more than 20 residential units.

Here are the top-level results for each type of community by region, showing average monthly prices:

  • Independent Living — $2,520 (U.S.); $2,532 (West); $2,362 (Midwest); $2,765 (Northeast); $2,587 (South)
  • Assisted Living — $3,823 (U.S.); $3,771 (West), $3,825 (Midwest); $4,315 (Northeast); $3,562 (South)
  • Memory Care — $4,849 (U.S.); $4,787 (West); $4,958 (Midwest); $5,779 (Northeast); $4,345 (South)

Clearly, senior living can be expensive. But keep in mind, these are averages covering a wide range of prices, says Edward Nevraumont, chief marketing officer at A Place for Mom. So look at these figures as just a starting point. And be sure to consider future price hikes, which are likely to outpace inflation, thanks to rising demand for living units.

Prices don’t tell you everything you need to know about a residence—other factors can be just as important, though harder to compare. There are communities geared to a wide range of preferences, budget levels, and health status. Some provide a full range of food services and on-site healthcare. Some are tightly regulated (nursing homes), while others are less so (independent living). “In our space, people have no idea of what they’re even looking for,” says Nevraumont.

That’s largely because families tend to wait till the last minute to start planning a move—typically when an aging family member is having health issues. The average person working with A Place for Mom adviser is 80 years old vs. 77 a few years ago. Of the clients the company helps place, five of every eight are single women, while two are men, and one is a couple. The average length of stay is 20 months.

For those considering a senior community, Nevraumont offers these tips:

Start shopping before a move is needed. Aside from the research that you’ll need to do, many residences have waiting lists that are months long. You’ll also need to have a conversation with all the affected family members to avoid potential conflicts.

Expect the move to take time. You may think you’ll be able to get Uncle Matt into a new apartment in a couple of weeks. The actual process takes an average of three months—or longer, if you’re on a waiting list.

Keep cash on hand. No getting around it—senior living communities are costly, especially for those with serious health care needs. So you’ll need to build a cash cushion to tap for those bills. “For both your emotional sanity and your financial sanity,” Nevraumont said, “figuring out this stuff early is really important.”

For more advice on choosing a retirement community, take a look at this checklist from AARP.

Philip Moeller is an expert on retirement, aging, and health. He is co-author of The New York Times bestseller, “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” and a research fellow at the Center for Aging & Work at Boston College. Reach him at moeller.philip@gmail.com or @PhilMoeller on Twitter.

Read next: The Secrets to Making a $1 Million Retirement Stash Last

MONEY retirement income

Here’s the Retirement Income Mistake Most Americans Are Making

money with "guaranteed" stamps on it
Andrew Unangst—Getty Images

Retirees want steady income yet few buy annuities—probably because they don't understand how they work. Here's a plain-English guide.

A recent TIAA-CREF survey found that 84% of Americans want guaranteed monthly income in retirement, yet only 14% have actually bought an annuity. One reason may be that most people don’t really understand how the damn things work. Here’s a plain-English explanation.

People preparing for retirement like the concept of an annuity: an investment that generates income you can count on as long as you live no matter how badly the financial markets are misbehaving. But they’re less than enthusiastic when it comes to purchasing them. Economists call this disconnect “the annuity puzzle.”

There are any number of possible explanations for this puzzle. Some people are turned off by the lofty fees some annuities charge. Others may simply prefer following the 4% rule or withdrawing money from their savings on an “as needed” basis. But I can’t help but think that some of the reluctance to “annuitize” is because many people don’t have a clue about how annuities work.

If you think you might want more assured income than Social Security alone will provide, but the blue fog that surrounds annuities is holding you back, here’s a (relatively) simple, (mostly) non-technical explanation of what goes on under the hood of an immediate annuity.

Steady Lifetime Payout

Imagine for a moment that you and a bunch of your friends, all age 65, would like at least some of your savings to generate steady income that you can rely on throughout retirement. So you all decide to kick in the same amount of money—say, $100,000—to an investment account. For monthly income, you then divide among the group whatever money your pooled funds earn that month.

You also agree, however, to return a portion of each group member’s original principal every month so that you have more than just investment earnings to spend. Since you want to be sure this money lasts even if you live beyond life expectancy, however, you’re careful not to tap into the principal too deeply each month.

Then you and your fellow retirees set one more condition: Each time someone in your little group dies, the monthly investment gains and share of principal that would have gone to that person is split among the remaining members. This amounts to an extra bit of income that no one in the group would have been able to get by investing on his or her own.

The scenario I’ve described pretty much explains how an immediate annuity—or an income or payout annuity as it’s sometimes known—works, with some important differences.

To begin with, people can’t create immediate annuities on their own. You need an insurance company to create an annuity (although you may end up buying the annuity from a broker, financial planner or other adviser, or from your bank.) Another difference: the example above involved a small group of people of the same age investing the same amount of money. In fact, insurers’ annuities are purchased by thousands of people of different ages (although they tend to be older) investing a range of sums.

And while the monthly payments the group received in the scenarios above could vary from month to month based on investment earnings and whether or not someone died, an insurer’s immediate annuity states in advance how much you’ll receive each month (although some immediate annuities may increase their payments based on the inflation rate or other factors). Insurers are able to tell you how much you’ll receive because they hire actuaries to project how many annuity owners will die each year, and the companies’ investment analysts forecast investment returns.

An Income Boost

But what really differentiates an immediate annuity from the example above is that no group of people pooling their assets can guarantee that they’ll receive a scheduled payment as long as they live. Investment returns could plummet. The group members could distribute too much principal early on, requiring a reduction in payments later to avoid running out of money. Or maybe enough hardy members live so long that the pool of assets simply runs dry while they’re still alive.

When insurers set payment levels for an immediate annuity, by contrast, state regulators require that they set aside reserves to assure they can make scheduled payments even if their actuaries’ and investment analysts’ projections are off.

That’s not to say that an insurer can’t fail. But such failures are rare. And you can largely protect yourself against that small possibility by diversifying—i.e., spreading your money among annuities from several insurers—sticking to insurers with high financial-strength ratings and limiting the amount you invest with any single insurance company to the maximum coverage provided by your state’s insurance guaranty association.

In short, an immediate, or payout, annuity gives you more current income than you could generate on your own taking comparable investing risk plus a very high level of assurance that the income will continue as long as you live. (You can also opt for payments to continue as long as either you or your spouse is alive.)

That assurance comes with a condition: You give up access to the money you invest in an immediate annuity. (Some annuities allow you to get at least some of your investment but you’ll receive a lower payment and erode the benefit of buying an annuity in the first place.) There’s simple way to deal with that condition, though: invest only a portion of your assets in an immediate annuity and leave the rest in a portfolio of stocks, bonds and cash.

Bottom line: If you would like to have a reliable source of lifetime income beyond what you’ll get from Social Security, it makes sense to at least think about putting some (but not all) of your savings in an immediate annuity. You can go to an annuity calculator like the one in RDR’s Retirement Toolbox to see how much income you might receive given your age, gender and the amount you’re willing to invest.

This explanation is probably more than any sane person wants to know about annuities. But if you for whatever reason have an appetite to delve even deeper into the world of annuities, I suggest you take a look at this paper by Wharton professor David Babbel and BYU prof Craig Merrill. And then consider whether a comprehensive retirement income plan that combines Social Security, an immediate annuity and a portfolio of stock and bond funds is right for you.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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For an upcoming story, MONEY wants to hear from Boomers about how they approach money in romantic relationships. We want to know when you and your partner had the money talk and what questions you both raised; if you’re not partnered up, we want to hear what financial criteria you think are important for people to consider as they approach a new relationship. We’ll be in touch for more information if we’re considering your story for publication.

MONEY Taxes

How to Make Tapping a $1 Million Retirement Plan Less Taxing

adding machine printing $100 bill
Sarina Finkelstein (photo illustration)—Mike Lorrig/Corbis (1); iStock (1)

With a seven-figure account balance, you have to work extra hard to minimize the tax hit once you starting taking withdrawals.

More than three decades after the creation of the 401(k), this workplace plan has become the No. 1 way for Americans to save for retirement. And save they have. The average plan balance has hit a record high, and the number of million-dollar-plus 401(k)s has more than doubled since 2012.

In the first part of this four-part series, we laid out how to build a $1 million 401(k) plan. Part two covered making your money last. Next up: getting smart about taxes when you draw down that $1 million.

Most of your 401(k) money was probably saved pretax, and once you start making withdrawals, Uncle Sam will want his share. The conventional wisdom would have you postpone taking out 401(k) funds for as long as possible, giving your money more time to grow tax-deferred. But retirees must start making required minimum distributions (RMDs) by age 70½. With a million-dollar-plus account, that income could push you into a higher tax bracket. Here are three possible ways to reduce that tax bite.

1. Make the Most of Income Dips

Perhaps in the year after you retire, with no paycheck coming in, you drop to the 15% bracket (income up to $73,800 for a married couple filing jointly). Or you have medical expenses or charitable deductions that reduce your taxable income briefly before you bump back up to a higher bracket. Tapping pretax accounts in low-tax years may enable you to pay less in taxes on future withdrawals, says Marc Freedman, a financial adviser in Newton, Mass.

2. Spread Out the Tax Bill

Taking advantage of low-tax-bracket years to convert IRA money to a Roth can cut your tax bill over time. Just make sure you have cash on hand to pay the conversion taxes.

Say you and your spouse are both 62, with Social Security and pension income that covers your living expenses, as well as $800,000 in a rollover IRA. If you leave the money there, it will grow to nearly $1.1 million by the time you start taking RMDs, assuming 5% annual returns, says Andrew Sloan, a financial adviser in Louisville.

If you convert $50,000 a year to a Roth for eight years instead, paying $7,500 in income taxes each time, you can stay in the 15% bracket. But you will end up paying less in taxes when RMDs begin, since your IRA balance will be only $675,000. Meanwhile, you will have $475,000 in the Roth. Another benefit: Since Roth IRAs aren’t subject to RMDs, you can pass on more of your IRAs to your heirs.

3. Plot Your Exit from Employer Stock

Some 401(k) investors, often those with large balances, hold company stock. Across all plans, 9% of 401(k) assets were in employer shares at the end of 2013, Vanguard data show—for 9% of participants, that stock accounts for more than 20% of their plan.

Unloading those shares at retirement will reduce the risk in your portfolio. Plus, that sale may cut your tax bill. That’s because of a tax rule called net unrealized appreciation (NUA), which is the difference between the price you paid for the stock and its market value.

Say you bought 5,000 shares of company stock in your 401(k) at $20 a share, for a total price of $100,000. Five years later the shares are worth $50, or $250,000 in total. That gives you a cost of $100,000, and an NUA of $150,000. At retirement, you could simply roll that stock into an IRA. But to save on taxes, your best move may be to stash it in a taxable account while investing the balance of your plan in an IRA, says Jeffrey Levine, a CPA at IRAhelp.com.

All rollover IRA withdrawals will be taxed at your income tax rate, which can be as high as 39.6%. When you take company stock out of your 401(k), though, you owe income tax only on the original purchase price. Then, when you sell, you’ll owe long-term capital gains taxes of no more than 20% on the NUA.

Of course, these complex strategies may call for an accountant or financial adviser. But after decades of careful saving, you don’t want to jeopardize your million-dollar 401(k) with a bad tax move.

MONEY 401k plans

The Secrets to Making a $1 Million Retirement Stash Last

door opening with Franklin $100 staring through the crack
Sarina Finkelstein (photo illustration)—Getty Images (2)

More and more Americans are on target to save seven figures. The next challenge is managing that money once you reach retirement.

More than three decades after the creation of the 401(k), this workplace plan has become the No. 1 way for Americans to save for retirement. And save they have. The average plan balance has hit a record high, and the number of million-dollar-plus 401(k)s has more than doubled since 2012.

In the first part of this four-part series, we laid out what you need to do to build a $1 million 401(k) plan. In this second installment, you’ll learn how to manage that enviable nest egg once you hit retirement.

Dial Back On Stocks

A bear market at the start of retirement could put a permanent dent in your income. Retiring with a 55% stock/45% bond portfolio in 2000, at the start of a bear market, meant reducing your withdrawals by 25% just to maintain your odds of not running out of money, according to research by T. Rowe Price.

150320_MIL_TameMix
Money

That’s why financial adviser Rick Ferri, head of Portfolio Solutions, recommends shifting to a 30% stock and 70% bond portfolio at the outset of retirement. As the graphic below shows, that mix would have fallen far less during the 2007–09 bear market, while giving up just a little potential return. “The 30/70 allocation is the center of gravity between risk and return—it avoids big losses while still providing growth,” Ferri says.

Financial adviser Michael Kitces and American College professor of retirement income Wade Pfau go one step further. They suggest starting with a similar 30% stock/70% bond allocation and then gradually increasing your stock holdings. “This approach creates more sustainable income in retirement,” says Pfau.

That said, if you have a pension or other guaranteed source of income, or feel confident you can manage a market plunge, you may do fine with a larger stake in stocks.

Know When to Say Goodbye

You’re at the finish line with a seven-figure 401(k). Now you need to turn that lump sum into a lasting income, something that even dedicated do-it-yourselfers may want help with. When it comes to that kind of advice, your workplace plan may not be up to the task.

In fact, most retirees eventually roll over 401(k) money into an IRA—a 2013 report from the General Accountability Office found that 50% of savings from participants 60 and older remained in employer plans one year after leaving, but only 20% was there five years later.

Here’s how to do it:

Give your plan a shot. Even if your first instinct is to roll over your 401(k), you may find compelling reasons to leave your money where it is, such as low costs (no more than 0.5% of assets) and advice. “It can often make sense to stay with your 401(k) if it has good, low-fee options,” says Jim Ludwick, a financial adviser in Odenton, Md.

More than a third of 401(k)s have automatic withdrawal options, according to Aon Hewitt. The plan might transfer an amount you specify to your bank every month. A smaller percentage offer financial advice or other retirement income services. (For a managed account, you might pay 0.4% to 1% of your balance.) Especially if your finances aren’t complex, there’s no reason to rush for the exit.

Leave for something better. With an IRA, you have a wider array of investment choices, more options for getting advice, and perhaps lower fees. Plus, consolidating accounts in one place will make it easier to monitor your money.

But be cautious with your rollover, since many in the financial services industry are peddling costly investments, such as variable annuities or other insurance products, to new retirees. “Everyone and their uncle will want your IRA rollover,” says Brooklyn financial adviser Tom Fredrickson. You will most likely do best with a diversified portfolio at a low-fee brokerage or fund group. What’s more, new online services are making advice more affordable than ever.

Go Slow to Make It Last

A $1 million nest egg sounds like a lot of money—and it is. If you have stashed $1 million in your 401(k), you have amassed five times more than the average 60-year-old who has saved for 20 years.

But being a millionaire is no guarantee that you can live large in retirement. “These days the notion of a millionaire is actually kind of quaint,” says Fredrickson.

Why $1 million isn’t what it once was. Using a standard 4% withdrawal rate, your $1 million portfolio will give you an income of just $40,000 in your first year of retirement. (In following years you can adjust that for inflation.) Assuming you also receive $27,000 annually from Social Security (a typical amount for an upper-middle-class couple), you’ll end up with a total retirement income of $67,000.

In many areas of the country, you can live quite comfortably on that. But it may be a lot less than your pre-retirement salary. And as the graphic below shows, taking out more severely cuts your chances of seeing that $1 million last.

150320_MIL_Withdrawals
Money

What your real goal should be. To avoid a sharp decline in your standard of living, focus on hitting the right multiple of your pre-retirement income. A useful rule of thumb is to put away 12 times your salary by the time you stop working. Check your progress with an online tool, such as the retirement income calculator at T. Rowe Price.

Why high earners need to aim higher. Anyone earning more will need to save even more, since Social Security will make up less of your income, says Wharton finance professor Richard Marston. A couple earning $200,000 should put away 15.5 times salary. At that level, $3 million is the new $1 million.

MONEY retirement planning

This Is the Best State for Retirement

Historic buildings on Lincoln Highway, West 16th Street in downtown Cheyenne, Wyoming
Ian Dagnall—Alamy Historic buildings on Lincoln Highway, West 16th Street in downtown Cheyenne, Wyoming

No, it's not Florida.

If you could choose any place in America to retire, which locale would be best? Florida perhaps? Or somewhere with a lot of culture, like New York or San Francisco? Not according to one new report, which finds the best U.S. state for retirees is…Wyoming.

According to Bankrate’s annual “Best and Worst States to Retire” ranking, released on March 23, the “Equality State” state is the best place for seniors to settle down. The ranking is based on six different factors—cost of living, crime rate, community well-being, health care quality, tax rate, and weather—and weights the importance of each using a national survey on what Americans value in retirement.

Arkansas comes in last, with poor marks in everything but living expenses, while Wyoming gets the crown for its top-10 low crime and good weather, low tax burden, and a cost of living and well-being scores in the top 20.

Wyoming’s biggest weak spot? Health care, where the state comes in a humble 37. Minnesota, the state ranked as has having the best healthcare in the country, is listed number 11 overall.

That might make some readers balk, but Chris Kahn, who has spearheaded the report for years, has become accustomed to criticism.

“I get a lot of letters saying this should be most important, that should be most important, there isn’t consensus there,” says Kahn. “I guess the one thing I’ve learned from all this is I’m never going to make a ranking that’s going to please everyone.”

Related: MONEY’s Best Places to Retire

If critics don’t like the list, they have only their fellow Americans to blame. Respondents to Bankrate’s survey ranked health care third on the list of retirement location priorities, behind crime and cost of living. In another surprise, more people (40%) said they would rather live near mountains, rivers, and other outdoor recreation than said they wanted access to a beach (25%), and only a quarter of respondents said being close to family was the most important factor in deciding where to retire.

“I consider this ranking a conversation starter,” says Kahn. “Don’t just go where you think you ought to go or where you had a good vacation. You should really be thinking about things like the cost of living, the health care system, the taxes—all that data is out there.”

Here’s the full list:

State Overall rank Cost of living Crime rate Community well-being Health care quality Tax rate Weather
Wyoming 1 19 5 20 37 1 8
Colorado 2 30 25 6 14 19 3
Utah 3 7 22 19 7 23 6
Idaho 4 3 2 27 21 27 7
Virginia 5 22 4 15 13 21 10
Iowa 6 11 12 4 5 22 39
Montana 7 27 19 8 24 13 9
South Dakota 8 26 11 31 15 3 29
Arizona 9 32 41 2 22 17 5
Nebraska 10 9 20 16 11 26 21
Minnesota 11 33 15 5 1 45 48
Maine 12 38 3 28 4 37 27
North Dakota 13 29 10 23 16 15 43
Kansas 14 10 32 13 25 25 17
Vermont 15 41 1 3 10 42 35
New Hampshire 16 39 7 17 6 7 49
Wisconsin 17 25 13 21 3 46 46
Massachusetts 18 43 21 22 2 40 11
Delaware 19 37 42 7 8 36 18
Michigan 20 18 29 14 17 30 45
Pennsylvania 21 34 16 36 23 41 22
Washington 22 36 36 9 19 24 40
Texas 23 14 38 37 41 4 23
North Carolina 24 28 33 30 30 34 19
South Carolina 25 24 48 26 35 (tie) 9 16
Illinois 26 21 24 32 32 38 36
Nevada 27 35 44 45 43 8 4
Florida 28 31 39 18 35 (tie) 20 28
Indiana 29 5 30 34 40 29 34
Tennessee 30 2 47 40 38 (tie) 6 24
California 31 46 31 10 34 47 2
Maryland 32 40 34 11 27 44 13
Georgia 33 15 35 33 42 16 20
Ohio 34 17 27 41 31 33 37
Alabama 35 12 43 35 33 10 41
Mississippi 36 1 23 44 47 11 42
New Mexico 37 13 50 38 48 14 1
Rhode Island 38 42 18 46 9 43 12
Connecticut 39 48 6 24 12 48 14
Oklahoma 40 4 40 29 49 12 26
Oregon 41 44 28 12 29 35 31
Missouri 42 16 37 39 38 (tie) 18 38
Kentucky 43 6 9 49 45 (tie) 28 33
Hawaii 44 50 26 1 20 31 32
New Jersey 45 45 8 43 18 49 15
Louisiana 46 20 49 48 45 (tie) 5 44
West Virginia 47 23 14 50 50 32 47
Alaska 48 49 46 25 28 2 50
New York 49 47 17 42 26 50 25
Arkansas 50 8 45 47 44 39 30

Read next: The Complete Guide to Retiring Abroad

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