Preparing for Your Retirement: A Tax-Deferred Annuity (TDA) Review

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1 Preparing for Your Retirement: A Tax-Deferred Annuity (TDA) Review How much of your earning power will be available for your use when you retire? What will happen to your standard of living when your income ceases at retirement? Are you currently saving for retirement on a tax-advantaged basis? Table of Contents Page Your Earning Power 2 Sources of Retirement Income 2-3 Important Facts About Social Security Retirement Benefits 3 If You Wait You Lose! 4 A Potential Solution Using a TDA 4-5 The Power of Pre-Tax Dollars and Tax-Deferred Growth 5 Understanding TDAs 6 TDA Taxation: Regular TDAs 7 TDA Taxation: Roth Accounts 8 Important Information 9

2 Your Earning Power Your earning power your ability to earn an income is your most valuable asset. Your Income Earning Power: Other Income Few people realize that a 30-year-old couple will earn 3.5 million dollars by age 65 if their total family income averages $100,000 for their entire careers, without any raises. Investment Income Spouse s Income Years to Age 65 How Much Will You Earn in a Lifetime? Your Future Earning Power If Your Family Income Averages: $50,000 $100,000 $250,000 $500, $2,000,000 $4,000,000 $10,000,000 $20,000, ,750,000 3,500,000 8,750,000 17,500, ,500,000 3,000,000 7,500,000 15,000, ,250,000 2,500,000 6,250,000 12,500, ,000,000 2,000,000 5,000,000 10,000, ,000 1,500,000 3,750,000 7,500, ,000 1,000,000 2,500,000 5,000, , ,000 1,250,000 2,500,000 How much of your earning power do you pay in taxes? What will happen to your standard of living when your income ceases at retirement? Sources of Retirement Income When you retire and your earning power ceases, you will have to depend on three primary sources for your retirement income: Social Security According to the Social Security Administration, the average retired worker in 2015 receives an estimated $1,328 monthly benefit, about 40% of average pre-retirement income. As pre-retirement income increases, however, the percentage replaced by Social Security declines. Tax-Deferred Annuity Review Page 2 of 9

3 Employer-Sponsored Plans and IRAs Home Ownership and Personal Retirement Savings You may be eligible to participate in a retirement plan established by your employer and receive pension income at your retirement. You may also be able to contribute to an individual retirement account (IRA) to supplement Social Security and pension benefits. For many people, there is a gap between the retirement income they can expect from Social Security and employer-sponsored plans/iras and their retirement income objectives. Home equity can be used to bolster retirement security. Personal retirement savings, including bank and brokerage accounts and insurance and annuity contracts, can be used to bridge a retirement income gap. If sufficient retirement income is not available, will you defer your retirement age, or will you choose to reduce your standard of living? Important Facts about Social Security Retirement Benefits The Social Security Normal Retirement Age, currently age 66 for those people born between 1943 and 1954, is gradually increasing to age 67 for persons born after Early retirement results in a permanent reduction in the Social Security retirement benefit. For example, the Social Security retirement benefit of a worker born between 1943 and 1954 who retires early at age 62 will be reduced by 25%. According to the Social Security Administration: The maximum Social Security retirement benefit for a worker retiring at full retirement age in 2015 is $2,663 monthly. The average Social Security benefit for all retired workers in 2015 is an estimated $1,328. The Social Security spousal retirement benefit is limited to a maximum of 50% of the retired worker s benefit. The spousal retirement benefit is reduced if the worker retires before his or her normal retirement age. How much do you want to rely on a source of retirement income over which you have no control? Consider this quote from a Time magazine article titled "Social Insecurity": For government to pay pensions to the advancing tide of baby boomers will almost certainly require stunning benefit reductions or huge tax increases. Most likely both. After years of fiscal and political fecklessness, an explosive conclusion. Question: Answer: When was this article published? March 12, 1995, although the same statement could easily apply today, in the absence of any reform to the Social Security system. Tax-Deferred Annuity Review Page 3 of 9

4 If You Wait You Lose! The eighth wonder of the world is compound interest. -- Albert Einstein Delaying retirement savings can keep you from realizing your retirement dreams! If $100 a month is saved, what will the savings be worth at age 65, assuming a hypothetical 5% annual rate of return*? $196,792 $148,856 $81,870 $40,746 $20, Age When You Begin to Save $100 a Month * This is a hypothetical illustration only and is not indicative of any particular investment or investment performance. It does not reflect the fees and expenses associated with any particular investment, which would reduce the performance shown in this hypothetical illustration if they were included. In addition, rates of return will vary over time, particularly for long-term investments. A Potential Solution Using a TDA The employees of public school systems and 501(c)(3) non-profit organizations can participate in tax-deferred annuity or account (TDA) plans established by their employers. These plans are also known as tax-sheltered annuity and tax-sheltered account (TSA) plans. A TDA has tax-favored status. Specifically: Pre-Tax Dollars The amount contributed to a TDA is not reported as income*, which means that your taxable income is reduced by the amount of your TDA contributions. Tax-Deferred Annuity Review Page 4 of 9

5 Tax-Deferred Growth The earnings on your TDA contributions compound tax-deferred until withdrawn*, providing you with a double tax benefit. * Ordinary income taxes are due upon withdrawal. Withdrawals may also be subject to a 10% penalty tax if taken before age 59-1/2. While many plans can help you save for a financially-secure retirement, the tax advantages of a TDA may enable you to accumulate more funds at a faster rate than would otherwise be possible! The Power of Pre-Tax Dollars and Tax-Deferred Growth Those who qualify for a TDA can use pre-tax dollars that would otherwise be paid in taxes to establish a retirement fund that grows tax deferred until received. Results for Each $100 Monthly Before Taxes* 5% Hypothetical Annual Rate of Return / 25% Income Tax Bracket WITH A TDA WITHOUT A TDA $ 100 monthly contribution $ taxes - 25 $ 100 amount invested $ % rate of return* 5.00% -0.00% taxes -1.25% 5.00% after-tax rate of return 3.75% RESULTS IN 20 YEARS: $ 40,746 total fund $ 26,643-10,187 ** taxes at surrender - 0 $ 30,559 *** 15% MORE! $ 26,643 *** * This is a hypothetical illustration only and is not indicative of any particular investment or performance. It does not reflect the fees and expenses associated with any particular investment, which would reduce the performance shown in this hypothetical illustration if they were included. In addition, rates of return will vary over time, particularly for longer-term investments. Depending on the performance of your investments, it is also possible to lose money. ** Assumes the surrender takes place at or after age 59-1/2. Withdrawals or surrenders taken before age 59-1/2 may be subject to an additional 10% penalty tax. *** These results do not include any investment fees or charges that may apply. Tax-Deferred Annuity Review Page 5 of 9

6 Understanding TDAs Eligibility: Employees of public school systems or of organizations operated exclusively for religious, charitable, educational, scientific, literary or other purposes described in IRC Sect. 501(c)(3) can participate in TDA plans established by their employers. Contributions: TDA contributions must be made by the employer on the employee s behalf. The contributions can come from employee salary reductions (elective deferrals) or, less commonly, can be made by the employer in lieu of a salary increase (additional contribution). If the plan allows, all or a portion of the elective deferral can be designated as a Roth contribution, in which case the contribution is included in income for tax purposes. Excludable Amount: (2015) The maximum amount that can be excluded from an employee's income in 2015 is equal to: Salary reduction only: The maximum elective deferral is equal to the lesser of $18,000 or 100% of compensation. Salary reduction and additional contribution: The salary reduction/elective deferral portion cannot exceed the lesser of $18,000 or 100% of compensation and the total excludable amount (elective deferral plus additional contribution) cannot exceed the lesser of $53,000 or 100% of compensation. Additional Elective Deferral: (2015) An individual participating in a TDA plan who is age 50 or older in 2015 can contribute an additional elective deferral equal to the lesser of $6,000 or the amount of the participant's compensation reduced by any other elective deferrals for the year. Deductibility: The excludable amount and any additional elective deferral are not included in the income reported on the employee s Form W-2, unless all or a portion of the elective deferral is designated as a Roth contribution, in which case the Roth contribution is reported as income on the employee's W-2. Allowable Investments: Annuities (fixed or variable; individual or group), insurance company products with incidental life insurance protection and/or custodial accounts that invest in mutual funds. In addition, a TDA must be nonforfeitable and must contain provisions that make it nontransferable. Tax-Deferred Annuity Review Page 6 of 9

7 TDA Taxation: Regular TDAs During Life: Contributions: Made on a pre-tax basis. Not included in the income reported on the employee s Form W-2, up to the maximum excludable amount. In 2015, the maximum excludable amount is equal to: Salary reduction only: The maximum elective deferral is equal to the lesser of $18,000 or 100% of compensation. Salary reduction and additional contribution: The salary reduction/elective deferral portion cannot exceed the lesser of $18,000 or 100% of compensation and the total excludable amount (elective deferral plus additional contribution) cannot exceed the lesser of $53,000 or 100% of compensation. Additional elective deferral: An individual who is age 50 or older in 2015 can contribute an additional elective deferral equal to the lesser of $6,000 or the participant's compensation reduced by any other elective deferrals for the year. Growth: Earnings accumulate tax-deferred until distributed. Distributions: Since contributions are made on a pre-tax basis and all earnings accumulate tax free, distributions are taxed as ordinary income in the year received. In addition: Premature distributions made prior to age 59-1/2 are subject to a 10% excise or penalty tax in addition to the regular income tax on the amount of the distribution. There are, however, exceptions under which there is no penalty tax. The exceptions include distributions made on account of death, disability, separation from service after attaining age 55, or made after separation from service in a series of substantially equal periodic payments over the taxpayer s life expectancy. Minimum distributions must begin by April 1 of the year after the year in which the taxpayer attains age 70-1/2, or a 50% excise tax is levied on the difference between what was paid out and what should have been paid out under minimum distribution rules. Rollovers: Distributions may be rolled over from a regular TDA to a Roth IRA or to a Roth account within the TDA plan (if the plan permits), where they will continue to grow on a taxdeferred basis. While qualified distributions from a Roth IRA or Roth account are received free of income tax, federal income tax must be paid on the amount that is rolled over to the Roth IRA or Roth account in the year the rollover takes place. At Death: Estate Taxation: The value is included in the gross estate of the deceased owner. Income Taxation: TDA distributions to a beneficiary generally are taxed in the same manner as if received by the TDA owner, meaning that regular TDA distributions received by a beneficiary will generally be taxed as ordinary income in the year received. Tax-Deferred Annuity Review Page 7 of 9

8 TDA Taxation: Roth Account TDA plans can offer a Roth account for elective deferrals. If the plan allows, participants can designate all or a portion of their elective deferrals as Roth contributions. In addition, a plan can allow participants to roll over qualified distributions into a Roth account that is inside the TDA plan. During Life: Contributions: If the plan allows, all or a portion of any elective deferral can be designated a Roth contribution, in which case it is included in income. Growth: Roth contributions accumulate tax free. Distributions: Qualified distributions from a Roth account are received free of income tax. A qualified distribution is one that is made at least five years after the first contribution to the Roth account and after the individual is age 59-1/2, disabled, deceased or the funds are used to purchase a first home ($10,000 lifetime limit). Rollovers: Distributions may be rolled over from a regular TDA to a Roth IRA or to a Roth account within the TDA plan (if the plan permits), where they will continue to grow on a tax-deferred basis. While qualified distributions from a Roth IRA or Roth account are received free of income tax, federal income tax must be paid on the amount that is rolled over to the Roth IRA or Roth account in the year the rollover takes place. At Death: Estate Taxation: The value is included in the gross estate of the deceased owner. Income Taxation: Distributions from a Roth account to a beneficiary generally are taxed in the same manner as if received by the TDA owner, meaning that distributions made to a beneficiary from a Roth account will generally be received income tax free. Tax-Deferred Annuity Review Page 8 of 9

9 Important Information The information, general principles and conclusions presented in this report are subject to local, state and federal laws and regulations, court cases and any revisions of same. While every care has been taken in the preparation of this report, neither VSA, L.P. nor The National Underwriter Company is engaged in providing legal, accounting, financial or other professional services. This report should not be used as a substitute for the professional advice of an attorney, accountant, or other qualified professional. U.S. Treasury Circular 230 may require us to advise you that "any tax information provided in this document is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor." VSA, LP All rights reserved (VSA 1a2-07 ed ) Tax-Deferred Annuity Review Page 9 of 9

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