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Link to special CCH Tax Briefings on key topics from 2006:
 

• Tax Increase Prevention and Reconciliation Act
  
  
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Boomers, Start Planning Now to Make Sure Retirement Isn't a Bust

(RIVERWOODS, ILL., January 2007) – In 2006, the first of the baby boomers turned 60 and for millions of Americans retirement suddenly went from long-term planning to a real-time concern: What assets do I have, what can I accumulate between now and when I retire and will I have enough? As baby boomers begin answering these questions, they may be in for a bit of a shock, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and pension law information, software and services (CCHGroup.com).

Retirement doesn’t come cheap: Boomers will have expenses, they will have to pay taxes and many may very well need to either cut down drastically on spending or try to find work to boost their income during retirement. This is particularly concerning for the millions of people who are planning on some type of pension benefit during retirement, but who face the expectation that their planned pension benefit may not be fully delivered given the increase in pension plan terminations and freezes.

“Without careful planning, many people will not be able to maintain the lifestyle they enjoyed while working,” said CCH Employee Benefits Analyst Ross Spencer. “They may save on wardrobe and commuting costs, but they will likely have increasing health care costs, as well as other expenses that will continue to climb with inflation.”

While personal savings, pension benefits and retirement savings from 401(k) plans and IRAs are among the greatest sources of retirement income, Spencer added that potential income from a home can help to bridge the gap. Additionally, baby boomers who find their income coming up short will want to better understand new phased-in retirement rules that will allow them to stay employed, while not jeopardizing their pension benefits.

Tapping the Family Home for Retirement Funding

For many baby boomers, their home is their most valuable asset, and they plan to tap into this asset to help fund their retirement, generally by downsizing to a smaller home. This option may be attractive to some people, but others may find it emotionally difficult to move away from friends and familiar surroundings.

“If you are 50 years old, have a house full of teenagers and a sink full of dishes, you may be longing for the day when you can downsize. But 20 years from now, when everyone’s moved out and all your memories are in that house, you may not be so willing to sell,” said Spencer. “As a result, as you near retirement, the single best thing you can do related to your home is pay off your mortgage, so that any income you are realizing in retirement is not going to pay off this type of debt. You will need a larger lump sum to continue to pay off the mortgage than you would to simply pay off the remainder of the principal.”

Retirees who are beginning to run out of income from savings and 401(k) assets, but are reluctant to sell their homes may decide to take out a reverse mortgage to start tapping equity from their house. Reverse mortgages generally require that you are at least age 62 and you have no mortgage. If you die, sell or move out of your home, the reverse mortgage must be paid off. If it is not, the lender will own your home.

“Reverse mortgages shouldn’t be looked at as a first source of income, but rather for those in more advanced years of retirement because equity in a home will not last forever, and you do not want to find yourself without income and without housing,” said CCH Senior Federal Tax Analyst John W. Roth, JD, LLM.

Married couples that decide to sell their home currently can exclude up to $500,000 of gain from taxation from the sale of their principal residence ($250,000 for single filers). To qualify for the gain exclusion, you must have owned and used the home as a principal residence for at least two of the five previous years. Short, temporary absences for vacations or seasonal absences are counted as periods of use even if you rent out the property during those periods.

Additionally, if you become physically or mentally incapable of caring for yourself, you are deemed to have used the principal residence during the time in which you were residing in a licensed care facility. However, this special treatment only applies to time in a licensed care facility. It would not, for example, count the time in which an elderly parent moves in with an adult child, even if professional healthcare workers are hired.

When the home sale exclusion went into effect in 1997, the $250,000/$500,000 exclusion seemed generous in many parts of the country. However, the run up in home prices over the past decade, coupled with inflation, means many long-time homeowners will be over the exclusion limit and will have to pay capital gains tax on some of their home sale profits, which currently has a maximum tax rate of 15 percent.

Boomers who are looking to eventually downsize into their vacation home, can give cottage living a try and still qualify for the exclusion before letting go of their initial home. For example, they could move into their vacation home, convert it to their principal residence and still have up to three more years to sell their old principal residence and still qualify for the exclusion. If after converting the cottage to their principal residence and living in it for the past two years they find cottage living wasn’t what they had expected, they could decide to reconvert their original home to their principal residence and sell the cottage, with the cottage now eligible for the exclusion.

Assessing IRA and 401(k) Contributions

The good news for baby boomers is that the Pension Protection Act of 2006 made permanent many of the temporary retirement savings incentives first enacted in 2001 for defined contribution plans like IRA and 401(k) plans, and income limits are now indexed for inflation. The act also made permanent catch-up contributions for those 50 or older, although these contributions are not indexed for inflation. The maximum someone can contribute to an IRA for 2006 or 2007 is $4,000, with those 50 or older allowed to make an additional $1,000 catch-up contribution.

The bad news is that despite the more liberal rules, most individuals are not even coming near the contribution limits. CCH’s Roth encourages individuals at the very least to contribute up to their employer’s matching contribution, assuming their employer offers this – even if it means cutting back on other types of investments, including saving for your children’s education.

“For many baby boomers paying their children’s college tuitions competes with saving for their own retirement. It’s a tough call, but some parents are choosing to focus on saving for retirement and having their children take out student loans,” said Roth. “Those with teens in high school also may choose to focus on adding to their 401(k) plans as money in retirement plans isn’t reported as income for financial aid and some scholarship purposes.”

The Pension Protection Act also changed the rules to allow direct plan to Roth IRA rollovers, which, beginning in January 2008, will let individuals make a direct rollover from a qualified retirement plan, tax sheltered annuity or a governmental plan to a Roth IRA. This eliminates the need to first roll over the amount to a traditional IRA, and then convert it to a Roth IRA. Additionally, starting in 2010, the Act eliminates income limits for IRA to Roth IRA rollovers, enabling individuals more options for tax-free income during retirement.

Understanding Risks of Counting on Pension Plans

Currently about 35 million Americans are enrolled in or receive benefits from traditional pension plans. These defined benefit plans pay participants a fixed benefit for a certain number of years. However, some plans are financially strapped and could be terminated, meaning the government – in the form of the Pension Benefit Guaranty Corporation (PBGC) – will have to take them over and payouts will be capped.

Even more plans are being frozen by employers, either restricting additional employees from participating while still allowing active participants to accrue benefits or completely frozen where no new participants can be added and active participants can no longer accrue benefits.

“If you’re 50 years old and in a plan that has a complete freeze, you are going to have a reduced pension because your income level is likely lower than it would be 10 years from now and you haven’t accrued 10 years worth of benefits,” said Spencer. “So you will have to scramble to start saving for your retirement either by putting money into a 401(k) or IRA.”

Boomers who are worried that their pension plans are not on solid ground should contact their plan administrators. Administrators of PBGC-insured pension plans are required to notify participants if the plan has been less than 80 percent funded for the past year or two years and less than 90 percent funded for several years.

Higher-paid baby boomers in plans taken over by the PBGC may also be surprised to learn that the benefits they receive are not as high as they expect as each year the PBGC sets maximum benefit guarantees. For example, for individuals who are age 65 in 2007, PBGC’s maximum pension benefit is $4,125 per month (straight life annuity) or $3,712.50 per month (joint and 50-percent survivor annuity). The maximum payout is less for those under age 65.

Additionally, the PBGC does not cover other benefits that an employer may offer to retired employees, including health and welfare benefits, severance benefits, lump sum benefits for a death that occurs after the date of plan termination and disability benefits for a disability that occurs after the date of the plan termination.

Preserving Income and Protecting Assets through Annuities and Long-term Care Insurance

Individuals who are about to retire may also want to consider taking some of their retirement savings and rolling it over into an annuity that will pay them a guaranteed lifetime of income. Those concerned about protecting their assets should they require prolonged medical care also may want to evaluate long-term care life insurance.

“With people living longer and fewer covered by pensions or employer-provided comprehensive health-care plans, there’s a growing fear that you can outlive your retirement income,” said Spencer.

When it comes to annuities, however, some people don’t like the idea that any money left in their annuity after they die is money that isn’t available to be passed on to heirs.

“In considering an annuity, you have to balance your options: Have less money available to pass on to your children should you die younger than expected, or become a financial burden to your children should you live well past your anticipated life expectancy and run out of retirement savings,” said Spencer.

As the life expectancies of Americans lengthen, more also are considering long-term care insurance to help ensure for care in their older years. Long-term care insurance has to meet specific IRS criteria, including being guaranteed renewable and not paying for expenses that would be reimbursed under Medicare. All long-term care policies sold after December 31, 1996 must be identified as “tax qualified” or “non-tax qualified”, while all plans sold before this are is automatically qualified. Benefits paid under non-tax qualified plans are not tax deductible and any benefits paid may be taxable income.

The maximum amount of the long-term care premium that can be deducted from income is based on the covered individual’s age. For example, for the 2006 tax year, this ranges from a maximum deduction of $280 for individuals under 41 to $3,530 for individuals over 70. An exception is made for the self employed: They are not subject to these limits and can deduct 100 percent of their long-term care premiums.

Phased-in Retirement: Generating Work Income in Retirement

For those boomers that will need to continue earning a paycheck in retirement or just aren’t ready to officially cut the cord, the Pension Protection Act has relaxed the rules related to phased retirement for pension plans.

Previously the rules governing pension plans stipulated that in order to be a qualified plan, the benefits had to be benefits to retirees. To get around this, employees that wanted to cut back their hours, while at the same time start to get pension distributions, had to quit their job and then be hired back as consultants, which generally meant losing their health coverage and other benefits. Under the Pension Protection Act’s revised rules, employers are allowed to provide in-service benefits to employees that move to part-time employee status starting at age 62.

However, companies aren’t required to offer their employees a phased retirement option and employees that want to continue part-time with employers after they retire need to make sure that their employer has revised the pension plan so that the employee will not be penalized for continuing to work.

For example, most pension plans base their payments on the income an employee earns in his last three to five years of employment, which generally are the highest income-earning years. However, if an employee reduces his hours by 40 percent, and his pay reduces accordingly, he will receive a lower pension unless the plan is amended to address phased retirement situations. For example, the company could change the payout to be based on the five highest paid years out of the last 10 or 15 years to accommodate these workers.

“The law allowing companies to offer phased retirement is now on the books, but what remains to be seen is whether companies will amend their plans,” said Spencer. “Those companies in industries that have a shortage of skilled workers are probably most likely to do so, realizing the cost and availability of replacing these workers out-strip the costs of administering the revised plan.”

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax and accounting law information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market-leading products are The ProSystem fx® Office, CCH® Tax Research NetWork™, Accounting Research Manager® and the U.S. Master Tax Guide®. CCH is based in Riverwoods, Ill.

Wolters Kluwer is a leading global information services and publishing company. The company provides products and services for professionals in the health, tax, accounting, corporate, financial services, legal and regulatory, and education sectors. Wolters Kluwer has annual revenues (2005) of €3.4 billion, employs approximately 18,400 people worldwide and maintains operations across Europe, North America, and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands. Its shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. For more information, visit www.wolterskluwer.com.

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