Converting Savings into Retirement Income

Transcription

1 Vanguard Financial Education Series retirement income How to turn retirement savings into retirement income

2 You ve been saving for retirement for years. Now that your retirement is near, how will you convert your savings into regular income to help pay your bills? You can combine your retirement plan savings with other sources of retirement income, such as Social Security or a pension, to create a long-lasting stream of income.

3 Understand your distribution options When you retire, you ll decide what to do with a lifetime of retirement savings. We ll discuss your options with both a pension plan and a defined contribution plan, which is better known as a 401(k). If you have a pension, you ll probably be offered an annuity. An annuity is a stream of payments, typically guaranteed for your lifetime (plus the lifetime of your spouse if you choose a joint-and-survivor payout option). A second option that might be offered is to take a lump-sum distribution. Basically this means taking your money in a single withdrawal. This distribution could be rolled over to a new employer s retirement plan or to an IRA to preserve its tax-advantaged status. From an IRA, some or all of a distribution could be used to purchase an annuity from a private insurance company. Alternatively, a lump-sum distribution could be taken in cash. Just keep in mind that could trigger a big tax bill. When taking withdrawals from a tax-deferred account before age 59½, you may have to pay ordinary income tax plus a 10% federal tax penalty. Retirement Income > 3

4 Map out your distribution options Circle the type of plan that you have. Under each type of plan, you can see various distribution options. Not every plan offers every option you see. Circle the distribution options available to you. Retirement plans Defined benefit (Pension) Defined contribution (401(k), 403(b)) Annuity Lump sum Roll to IRA Leave in plan Take installments Take in cash Single life Joint and survivor Roll to defined contribution plan Take in cash Roll to IRA Invest and manage all Invest some and purchase income annuity Purchase income annuity with all

5 With defined contribution plans (better known as 401(k) or 403(b) plans), you usually have these four options: 1. Roll over to an IRA. Any earnings would continue to grow without being taxed, just as with your plan. However, with an IRA, you would have more investment options. For instance, you could consider using a portion of your money to purchase an annuity, which could provide lifelong income.* 2. Leave your money in the plan. You can usually leave your money in the plan if you have a balance of at least $5,000. Any earnings on your plan investments would remain tax-deferred until you make withdrawals. However, your investment and distribution options are limited to those in your employer s plan. 3. Take your money in installment payments. You might be able to receive your savings in regular payments (annual, semiannual, quarterly, or monthly) based on your life expectancy. 4. Take a lump sum in cash. If you have less than $1,000 in your plan, you may receive the proceeds in a check from your employer. You might be tempted to keep the money, but you would owe income taxes, plus a possible 10% federal penalty tax if you are under age 59½. You can avoid taxes and penalties by rolling over the money to an IRA within 60 days. *Subject to the claims-paying ability of the insurance company. Retirement Income > 5

6 Case study: Jim and Barbara Jim and Barbara adopt a systematic withdrawal plan Jim, an engineer, is retiring at age 66; his wife, Barbara, a teacher, is 62. Jim has looked forward to retiring and started saving in his company s 401(k) plan in the first year it was offered. Barbara qualifies for a pension. Jim plans to retire at the end of the year, and Barbara wants to continue working to earn income, but plans to shift to a part-time schedule. Jim and Barbara start by writing down their regular and variable sources of retirement income: Jim has $200,000 in a 401(k) invested equally in stocks and bonds. Barbara has a pension that will pay $950 a month. Jim will receive $1,900 a month in Social Security retirement benefits. Barbara will receive $700 a month from Social Security. Barbara will earn $450 a month as a substitute teacher for a few years. Because Jim and Barbara will have lifetime income from their Social Security benefits and her pension, they decide to keep Jim s savings in his 401(k) plan. This can provide them with income, plus the flexibility to meet emergencies. The day he retires, Jim withdraws 4% of his 401(k) balance, or $8,000, and deposits it into a taxable money market fund outside his 401(k) plan. From there, he arranges automatic monthly transfers of $667 to his checking account. When this money is combined with Social Security and Barbara s pension and teaching income, Jim and Barbara will have $4,667 a month in income the first year of retirement. 6 < Financial Education Series

7 As the years go by, Jim increases his initial withdrawal amount by the rate of inflation. The chart below shows how he adjusts his withdrawals to keep up with the rising cost of living. Staying flexible Jim plans to increase his withdrawals by the rate of inflation unless his account balance falls in a sharp market downturn. If the market were to drop, say, 10%, Jim might omit his inflation adjustments until it recovered. If the market fell 20%, he might reduce his withdrawals to help preserve his savings. For example, he could reset his withdrawal rate to 4% of his new, lower account balance. Each year when he makes his withdrawal, Jim also rebalances his 401(k) account to maintain his desired asset allocation of 50% stocks and 50% bonds. He does this by taking his withdrawal from the higherperforming investment category. For example, if his stock funds were up 10%, Jim would take his withdrawal from his stock funds. If Jim adheres to this disciplined withdrawal plan, his 401(k) could provide a steady stream of retirement income for more than 30 years. Of course, this hypothetical example does not represent the return on any particular investment. Please note that all investing is subject to risk, including the possible loss of the money you invest. Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer s ability to make payments. Calculation Withdrawal amount Inflation rate Year one $200,000 x 4% = $8,000 3% Year two $8,000 x 1.03 = $8,240 2% Year three $8,240 x 1.02 = $8,405 4% Year four $8,405 x 1.04 = $8,741 Retirement Income > 7

8 Making your retirement savings last If you want your savings to last for 30 years or more, consider withdrawing no more than 4% of your retirement savings in the first year. After the first year, you might choose to increase your annual withdrawal each year by the rate of inflation. That way your spending power would keep up with the rising cost of living. But be flexible too. If a sharp market decline reduces the value of your portfolio (say by 10% or more), consider tightening your belt. You might skip inflation increases for a year or two, for example, or even reduce your withdrawal amount. This might help to prolong your retirement savings, although there are no guarantees. Retirees who undertake a systematic withdrawal plan like this should consider keeping some of their savings in a diversified mix of investments, including stocks and bonds. Stocks do have sharp price swings. But, compared with bonds and shortterm reserves, they have also 8 < Financial Education Series

9 shown greater potential for longterm growth, which may help to sustain your savings over a lengthy retirement. Just keep in mind that diversification does not ensure a profit or protect against a loss in a declining market. Create a cash reserve You might think of your retirement savings as divided into two broad categories: Long-term money, which remains invested in the markets (for example, in stock and bond mutual funds) to capture earnings and growth opportunities. A cash reserve your spending money for the next year or two which belongs in a low-risk money market fund or other liquid account. Your goal should be to protect the money you need for short-term expenses from the possibility of market declines. Deriving income from your retirement savings is a process of gradually transferring money from your long-term investments to a short-term spending account. You can move the amount you expect to need for 12 months into your money market fund at one time. That way you won t have to worry that market swings will affect your immediate spending needs. For convenience, you can link your money market fund electronically to your bank account, so you can easily move money to your checking or debit accounts. You could also set up automatic monthly transfers to your checking account to re-create the cash flow of a regular monthly paycheck. Retirement Income > 9

10 You will owe taxes on your withdrawals You have probably saved pre-tax dollars in your retirement plan, meaning the money you contributed to the plan wasn t taxed. In retirement, the tax bill comes due. If you withdraw pretax contributions and earnings from your retirement accounts, you will owe income taxes on the withdrawal amount. Consider setting aside a portion of each withdrawal to meet your income tax obligation. Many plan providers are required to withhold 20% of the withdrawal for federal taxes. (Your actual tax bill may be higher or lower.) After age 70½, you must take required minimum distributions (RMDs) from tax-deferred retirement savings.* If you don t, you could owe a substantial penalty tax on the amount you should have withdrawn and paid taxes on. In addition, you must still withdraw the correct amount and pay taxes on it. *If you are still working at age 70½, you can postpone taking withdrawals from your employer s plan, but not from a traditional IRA or pre-tax savings in a previous employer s plan. Take your withdrawals in a tax-efficient order If you have different types of retirement accounts, you may be able to prolong your savings by withdrawing money in the most tax-efficient order: 1. Spend from your taxable accounts first before taking withdrawals from tax-advantaged accounts. 2. Next, consider withdrawing money from tax-deferred accounts, such as an employer s plan or a traditional IRA.** 3. Finally, withdraw money from tax-free accounts, such as qualifying Roth contributions made to an IRA or your employer s plan. **As previously mentioned, you are required to take taxable distributions from tax-deferred accounts (such as an employer s plan or traditional IRA) after age 70½ or face a 50% federal penalty tax on the amount that should have been withdrawn. 10 < Financial Education Series

11 Free Vanguard RMD service After you reach age 70½, Vanguard can calculate required minimum distributions for your Vanguard IRA and any retirement plan accounts that offer the service. If your money is in a Vanguard IRA, call to have Vanguard send your RMD checks to you automatically. If you ve kept your money in your employer s retirement plan, call us at How to obtain additional regular income For many, Social Security provides a steady floor of support, and withdrawals from savings add flexibility. But if you re concerned about running out of money, consider using a portion of your retirement savings to purchase an annuity. An annuity is an insurance contract. In return for a single up-front payment, you receive regular payments that are guaranteed by the insurance company that sold you the annuity. The income can last for as long as you live, as long as you or your spouse lives, or for a specific number of years.* There s no hard-and-fast rule for retirees about how much of their savings they should annuitize, though 30% is a reasonable limit. Keep in mind that you typically lose access to whatever money you spend on an annuity and thereby lose some flexibility to respond to emergencies. If you re thinking of purchasing an income annuity, consider Vanguard Annuity Access, powered by the Income Solutions platform, which you can access at vanguard.com /income. In just a few minutes, you ll get customized online quotes from several highly rated insurance companies. *Product guarantees are subject to the claimspaying ability of the issuing insurance company. Retirement Income > 11

12 Important considerations when evaluating an annuity When shopping for an income annuity, you should seek a highly rated insurance company, which means that it is considered financially strong enough to honor its obligations. You may also want to purchase a policy with an inflation rider to preserve your spending power over a lengthy retirement. Insurance companies calculate annuity payments based on average life expectancies. The longer you expect to live, the more economic sense an annuity purchase may make. However, an income annuity purchase is typically irrevocable, so you do give up flexibility in return for guaranteed payments. What you re buying is a stream of regular income, but it s not generally an asset that you can pass along to heirs or cash in for emergencies. 12 < Financial Education Series

13 Vanguard Variable Annuity with a lifetime withdrawal benefit If you re looking for income for life but want to retain access to your investment, consider the Vanguard Variable Annuity with the Guaranteed Lifetime Withdrawal Benefit (GLWB) rider. Here are some features of the GLWB: You don t have to irrevocably surrender money as you do with immediate annuities. Your withdrawals can go up if the markets rise, but will never go down (unless you exceed your annual withdrawal amount, which could reduce or eliminate the benefit provided by the rider). You have access to your money at all times.* Your income is guaranteed by the issuer.** You can invest in one of three designated low-cost Vanguard portfolios. Unlike with many similar products, you can purchase the GLWB at any time before age 90 either when you buy the Vanguard Variable Annuity or sometime down the road when you re ready for an income stream. Learn more at vanguard.com or call *If you take withdrawals from a variable annuity prior to age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax. **Product guarantees are subject to the claimspaying ability of the issuing insurance company. The underwriting risks, financial obligations, and support functions associated with the products are the responsibility of the issuing insurance company. The issuing insurance company is responsible for its own financial condition and contractual obligations. Retirement Income > 13

14 Your action plan Map out your retirement savings distribution options (page 4). To make your savings last, consider withdrawing no more than 4% of your savings in the first year of retirement (page 8). In subsequent years, consider increasing your withdrawals by the rate of inflation to maintain purchasing power (page 8). In the event of a market drop of 10% or more, consider skipping inflation adjustments or reducing your withdrawals (page 8). Consider keeping one to two years of expenses in a cash reserve so your spending money is not at risk in the markets (page 9). Try to take your withdrawals in a tax-efficient order (page 10). Remember to take your required minimum distributions after you reach age 70½ to avoid a potential tax penalty (pages 10 11). You can replace a portion of your income with an annuity (pages 11 13). 14 < Financial Education Series

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16 Institutional Investor Group P.O. Box 2900 Valley Forge, PA Connect with Vanguard retirementplans.vanguard.com > For more information about any fund or Vanguard variable annuity products, visit vanguard.com to obtain fund and variable annuity contract prospectuses. Investment objectives, risks, charges, expenses, and other important information about the product are contained in the prospectus; read and consider it carefully before investing. You can also write Vanguard at P.O. Box 2900, Valley Forge, PA An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money by investing in such a fund. Vanguard offers annuities through nonaffiliated insurance companies. Vanguard Annuity Access is offered in collaboration with Hueler Investment Services, Inc., through the Income Solutions platform. Income Solutions is a registered trademark of Hueler Investment Services, Inc., and used under license. United States Patent No. 7,653,560. Vanguard Annuity Access is provided by Vanguard Marketing Corporation, d/b/a VMC Insurance Services in California. The Vanguard Variable Annuity is a flexible-premium variable annuity issued by Monumental Life Insurance Company, Cedar Rapids, Iowa (NAIC No ), and in New York State only, by Transamerica Financial Life Insurance Company, Harrison, New York (NAIC No ). Form No. VVAP U 1101 (in Florida, Form No. VVAP U 1101 (FL), in Oregon, Form No. VVAP U 1101 (OR) (R), and in New York VVA NY 0208). GLWB Rider Form No. RGMB (in Florida, RGMB (SI)(FL), RGMB (JT)(FL), in Oregon RGMB (SI) (OR), RGMB (JT)(OR), and in New York RGMB (SI)(NY)(REV), RGMB (JT)(NY)(REV)), without agent representation. Policy and rider form numbers may vary by state and may not be available in all states. The Vanguard Group administers the Vanguard Variable Annuity for the issuer. Its variable annuity and investment costs rank among the lowest in the industry, according to Morningstar, Inc., December The Vanguard Group, Monumental Life Insurance Company, and Transamerica Financial Life Insurance Company do not provide tax advice. Investors are encouraged to consult a tax advisor for information on how annuity taxation applies to their individual situations The Vanguard Group Inc. All rights reserved. Vanguard Marketing Corporation, Distributor of the Vanguard Funds. BBBBFPYX