By Philip Rousseaux for Baltimore Post-Examiner
Many Maryland baby boomers have enjoyed long careers with the federal, state, or local governments of Maryland. As a result of Baltimore’s close proximity to Washington, D.C., many retirees are “Shadow Millionaires.”
What is a Shadow Millionaire
Michael DiPaula, a financial representative with the Everest companies, is one of these lucky individuals. He is enjoying his second career as a result of the freedom that his pension offers. DiPaula retired after serving more than 35 years with the Baltimore County Police Department. He retired as a commander, and his pension now pays him more than $100,000 a year and will continue to do so for the rest of his life.
When he retired from law enforcement he was 54 years old. For financial firms to be able to offer this type of guaranteed lifetime income to a retiree, they would need to have about $3 million. That’s right; you would need to invest $3 million to generate that amount of lifetime income. And that amount doesn’t necessarily account for inflation, market fluctuations, or unanticipated emergencies.
Many retirees and pre-retirees don’t realize that the state and federal pension systems offer very strong retirement benefits that the private sector simply does not have. With these benefits come a unique set of challenges that retirees must consider. What pension payout benefit should you select for your income? Should you select a joint and survivor payout with a 50 percent reduction? Should you take the full amount and buy term insurance with the difference to replace the income if you pass away? What do you do with your employer sponsored retirement plan such as a TSP, DROP, 401k, or 403(b)?
Many retirees don’t realize that there is a lien on their retirement plan. The federal government owns up to 50 percent of your IRA or employer sponsored plan. I ask retirees if they are OK with losing half of their account value overnight. Many people don’t realize that this is essentially what happens when they pass away. If we don’t put a plan in place while they are still alive, their family could lose half of the assets in their tax deferred accounts when they pass away.
Retirees must act during the early years of retirement and begin to establish strategies to cut the government out of the equation. One of the successful ways to accomplish this is by enacting Roth IRA conversions each year. I tell my clients to ask themselves if they believe that tax brackets will be higher or lower in their retirement years than they are today. If they answer higher, then they may benefit from strategically moving their assets into Roth IRA’s. This allows them to pay the taxes now, avoid RMDs (required minimum distributions), and eliminate the federal or state income taxes that would otherwise be due at death. In many cases it is beneficial to move small amounts over time to reduce your tax liabilities and ensure that you don’t move into the next higher marginal tax bracket.
Another popular solution is taking the required minimum distribution and purchasing a second life insurance policy. By insuring two lives you can insure an otherwise uninsurable person, lower the cost of the insurance, and in turn buy more insurance. For example, let’s say you have a $250,000 IRA. If you decided to take out 4 percent of your account each year and use that money to pay for your life insurance, you could buy a $500,000 life insurance policy. Keep in mind that life insurance is tax free, so in order for your IRA to provide the same death benefit it would need to grow to over $1,000,000.
The key to retiring as a Shadow Millionaire is making the correct choices before you retire. Before DiPaula retired from the police department, he knew he needed professional help, so he called us. Today, DiPaula isn’t just a client; he is one of our financial professionals
Read at: Baltimore Post-Examiner