If you are eligible for the NRECA R&S Plan, you MUST consider the tax scenarios when deciding whether to take the lump sum option or the annuity option. You essentially have a winning lottery ticket and just like a real lottery ticket, the IRS is waiting for their piece of the action.
None of that money has ever been taxed! Always remember we can't avoid paying taxes but we can CONTROL when and how we pay them. One of my jobs as a retirement planner is to make sure we pay as little tax on that money as legally possible.
Let's be honest, taxes suck. They are complicated and they are boring, but that doesn't change the fact that they WILL affect your retirement plan. Let's look at an example of a real tax situation from a former cooperative employee that is currently a client of mine. We'll call him Mr. Smith.
Mr. Smith worked for his cooperative for 35 years. After reviewing his options, he decided he was either going to take a lump sum of $1.3 million or the 50% Joint & Spouse annuity which would pay him $7,000 per month until he dies and then it would pay his surviving spouse $3,500 per month until she dies. Mr. Smith is 62 and for simplicity's sake we are going to assume that Mr. Smith will live in retirement for 20 years and that he and Mrs. Smith file a joint return.
Mr. & Mrs. Smith meet with me and after reviewing their unique financial situation we come to the follow conclusions:
Total income needed per month for them to live comfortably = $7,000 per month or $84,000 per year
Total Social Security he and his wife will collect at age 62= $3,000 per month or $36,000 per year
Total needed from his retirement portfolio to make up that difference = $4,000 per month ($7000-$3000).
Right off the bat, I can see that if Mr. & Mrs. Smith take the annuity option they will have more than enough money to live comfortably in retirement. But what I also see is that they will be paying more taxes than they have to legally.
If they take the annuity option their total income will be $120,000 (SS plus the annuity) per year but remember they only actually need $84,000 per year to live comfortably. The tax difference between these two scenarios is about $5,500 per year. That means every year they will be paying the IRS $5,500 extra in income taxes than they need to. And over the remainder of his life he will have paid $100,000 more in taxes than he needed to legally.
I ask Mr. & Mrs. Smith if it would be ok with them if I helped them not pay that much in taxes to which they agree.
I recommend that they take the lump sum of $1.3 million and roll that over to an IRA aka an Individual Retirement account that they own. This is a non-taxable event.
I then recommend that we pull a monthly income from that IRA of $4,000 per month or $48,000 per year from their portfolio which added to the $36,000 per year from Social Security will give them the income they said they needed of $84,000 per year ($48,000 + $36,000).
Now instead of paying the IRS $11,500 per year in income tax they will be paying $5,000 per year in income tax. But that's only part of the story.
They not only lowered their yearly tax bill they now also have $1.3 million in their IRA that they can use for whatever they want to in retirement. They are drawing $48,000 per year from a portfolio containing $1,300,000. That's a withdrawal rate of 3.7% ($48,000/$1,300,000 = 3.7%).
Now while they are drawing that income from their portfolio of $48,000 per year, I am going to create an investment strategy for them. I'm going to make sure they always have 3-5 years of income in cash and I'm going to strategically invest the rest of that money into 2,000 of the best companies in the world.
I've now created a situation where their money will continue to grow, they have the income they need to live, and they are in a situation where they will die with more than the $1.3 million they started with. You think that type of money can change a family's legacy? You bet it can!
If they would've chosen the annuity option they would've paid more taxes than they needed and when they die they would have nothing to show for it because with the 50% Joint Spouse option, after the spouse dies, the money stops. Their family gets none of it!
I simplified this example as best I could, but what I want you to take from this is taxes matter and so does planning for them in retirement. Don't just pick one of the annuity options because you think it is "safe." Based on this example, there is nothing "safe" about picking the annuity option. There are situations where the annuity option could make more sense than the lump sum but please explore both options thoroughly before you choose. Because you don't get a second chance. Once you make the decision it's final!
You Need A Plan
A goal of retiring - without a tax plan - is simply a plan to pay too much in tax. At 80/20 Financial Services we work to insure you pay no more taxes than you legally have to.
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80/20 Financial Services is an Independent Registered Investment Advisor (RIA) registered in the state of Missouri (CRD# 300772). Being independent allows us to work exclusively for YOU.
80/20 Financial Services is the legal name of our Registered Investment Advisory Firm (RIA). Electric Cooperative Retirement Planning is what we do.
There are different types of "financial advisors". We recommend you work with a Registered Investment Advisor (RIA). It doesn't have to be us. Read more about the different types of advisors here.
Our specialty is retirement planning for electric cooperative employees within planning for retirement or already retired.
*We will also work with the families of cooperative employees.
Our mission is to turn your NRECA 401k and R&S Pension into a plan that will provide you lifetime income and can change your family's legacy. (while paying as little income tax as legally possible)
Our planning process not only benefits you while you're alive, it benefits the people you care about after you're gone.
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