The Ins and Outs of Navigating Retirement
By Lisa Haberman, MBA, MAM, ChFC, CLU
A retirement plan is one of the most influential benefits that an employer may offer. One question that employers may ask is “How can we help participants get the most out of our retirement plan?” First, they need to make it personal. Employers can help participants understand their retirement goals considering their unique personal circumstances. Participants have different significant concerns as they near retirement, including the cost of health care. Second, employers need to clearly communicate the plan’s features. Employers can help participants fully comprehend the type of contributions that they have made (e.g., pretax deferrals or designated Roth contributions) and how these assets may be managed in relation to other financial vehicles, such as individual retirement arrangements (IRAs). It’s also important for employers to discuss with participants how and when to distribute their accumulated assets.
Make it Personal
Social Security Statement
Employers should encourage participants to review their personal Social Security statements on an annual basis. Workers aged 60 and older will receive their statement in the mail three months before their birthday, as long as they’re not yet receiving Social Security benefits and have not created a personal online account.
Personal my Social Security accounts may be created at any time. Once created, individuals can download their respective Social Security statement and sign up to receive e-mail reminders when the statement has been updated. Creating an online account also allows individuals access to a retirement planning tool, which can estimate a future Social Security benefit. Different scenarios can be estimated by adjusting the age at retirement, average future annual salary, and whether to include a spouse in the benefit determination. The Social Security Administration also provides these informative Fact Sheets as an additional resource for employers to guide their employees.
Review the Plan’s Design
Pretax Deferrals vs. Designated Roth Contributions
Employers may permit participants to make pretax deferrals and designated Roth contributions. But not every employer offers both options and not every participant understands the difference between these two types of contributions. Pretax deferrals are not included in the participant’s taxable income in the year the deferral is contributed, but will be taxed along with all their earnings upon distribution. The opposite holds true for designated Roth contributions, which are included in the participant’s income when contributed, but will be distributed tax-free, and whose earnings will be distributed tax free if certain conditions are met. Participants need to understand this distinction and then determine which type of contribution works best for their individual tax situation.
Designated Roth Contributions vs. Roth IRAs
Plan participants may also establish a Roth IRA, independent of their contributions to an employer retirement plan. Participants should understand that there are several differences between contributing to and taking distributions from a designated Roth account versus a Roth IRA. The designated Roth contribution limits are higher than those for a Roth IRA. For tax year 2022, plan participants may contribute up to $20,500 to a designated Roth account (plan permitting). Contributions to a Roth IRA are limited to $6,000 for tax year 2022 and may be phased down or eliminated altogether depending on the account owner’s tax filing status and adjusted gross income. Individuals aged 50 or older may also make catch-up contributions to either a designated Roth account (plan permitting) or to a Roth IRA. There are no income restrictions for eligibility to make designated Roth contributions to an employer plan that offers this option.
One thing to keep in mind is that employer plan participants must have a “distributable event” (defined in the plan document) in order to take a distribution. Common distributable events include attaining age 59½, terminating employment, or attaining normal retirement age. Roth IRA owners, on the other hand, may request a distribution at any time. One additional factor to remember is that Roth IRAs are not subject to required minimum distributions (RMDs); this gives Roth IRA owners more flexibility in deciding if and when to distribute these funds.
RMD Requirements
While we’re on the subject of RMDs, let’s review how they pertain to employer retirement plans and Traditional IRAs, which can receive contributions on both a pretax and after-tax basis. RMDs must be taken by the account owner’s required beginning date (RBD). The RBD is generally defined as April 1 of the year following the calendar year in which the account owner turns 72*. Employer plans may also permit a delayed RBD, which would extend the RBD to April 1 of the year following the calendar year in which the participant retires if after age 72. This is an option not available to any participant who owns more than five percent of the company sponsoring the plan. Remember, Roth IRA owners are not subject to the RMD requirements; but Roth IRA beneficiaries will be required to take RMDs upon the account owner’s death.
RMDs are generally calculated by dividing the previous year’s December 31 balance by the applicable distribution period for the current year. For example, 2022 RMDs are calculated dividing the December 31, 2021, balance by the applicable distribution period for 2022. Note that any change in investment return during the year will not change the RMD amount for that year.
IRA owners who have multiple IRAs may aggregate their RMDs for distribution purposes, but they must calculate their RMDs separately for each IRA. Once the RMDs are separately calculated, IRA owners may remove the total amount from any one or more of their Traditional or SIMPLE IRAs. This flexibility permits an IRA owner to review investment factors of each Traditional and SIMPLE IRA and then determine which account or accounts it is the most advantageous to take a distribution from. This option is not permitted for assets invested in an employer retirement plan. If a participant has assets invested in more than one retirement plan, they must generally calculate and satisfy the RMDs separately for each plan and withdraw that amount from the plan. An exception would be 403(b) plans, which permit RMD aggregation on the same basis as IRAs.
As you can see, employers can enhance the value of providing a retirement plan by making it personal and communicating the features of the plan. Participants can maximize this significant benefit by understanding their options when making contributions and how these decisions will affect their distribution options as they reach retirement.
* The Setting Every Community Up for Retirement Act (2019) increased the RMD age from 70½ to 72. For individuals born before July 1, 1949, the RBD is April 1 of the year following the year they turn 70½. For individuals born on or after July 1, 1949, the RBD is April 1 of the year following the year they turn 72.
