It is 3 a.m. and you lie awake again with anxious thoughts swirling through your mind about the fate of your retirement. Because you have not pinned down when, where and how you plan to retire, you can’t help but worry about whether you will have saved enough to satisfy those still indistinct yet looming goals. If this is you, when will you begin to formulate a clear and precise vision of whatever it is that you will call your retirement? Later is not good enough unless you enjoy those middle-of-the-night anxiety-ridden self-conversations. You need to start now.
Part one of the series reviewed the first two ages – 50 and 59½ – on a life timeline that can help you prepare for the day you embark on the longest vacation of your life. In this second and final part of the series, we will finish by examining the issues surrounding ages 65 and 70½ on that timeline.
This is the age most qualified retirement plans define as normal retirement age. Interestingly, this age was first used in German retirement plans at a time when life expectancy was barely age 65, so the plan did not expect to pay much out in benefits. That is also the way it was when the Social Security system was inaugurated. Things have really changed.
Your checklist for age 65, if you have completed the tasks earlier in the timeline, may be somewhat shortened. For example:
- Make a determination regarding taking or not taking Social Security benefits. While there is no reduction in benefits based on earned income beginning at normal retirement age, for example, age 65, there is a bonus of sorts if you delay taking benefits until after 65 years old. The inflation increase varies based on your year of birth, but the increase now is 8% per year, or almost an equity-like rate of return on your fixed government pension. Your spouse, however, does not get that increase if the spouse’s benefit is based on your earnings. If you do not need the money and you and your spouse are in good health, you may choose to delay takings benefits beyond age 65. My advice is to work with a retirement planning specialist to understand your options, and to build them into your retirement planning model before you make a final decision.
- If you have not done so already, you should be making sure your retirement plan beneficiary designations are in order.
- Consider the process of consolidating your assets into fewer accounts to simplify your life. If that means consolidating advisors to do so, then so be it. Pick the one who best understands you not just as an investor, but as a whole person who is someday soon going to trade a salary job for a commission job (i.e., living off your investments). My advice is do not get cheap here; sometimes the best advice with the most value to you and to your spouse in retirement may not be the least expensive. It certainly will cost more than a monthly subscription to Money magazine or Barron’s, or the cable-TV cost for CNBC or MSNBC. These can be helpful but they are impersonal and fickle. For example, an advisor who charges you a 1% management fee on your assets, and who prevents you from panic-selling out of equities when they are down 20% – thereby avoiding your turning a temporary decline into a real loss – arguably has earned his or her fee. Your retirement security net needs consistency, objectivity and a high degree of personal involvement. If you can do this on your own, fine. If not, get professional help.
- If your qualified plan at work or your spouse’s plan at work contains highly-appreciated employer stock, and you are considering rolling those assets out to an IRA, you may want to investigate NUA possibilities. NUA stands for “net unrealized appreciation,” and it allows one to roll out the employer stock to a non-qualified brokerage account at the same time you roll over your pre-tax qualified plan assets to your traditional IRA.
You are taxed on the cost basis of the stock, at ordinary income tax rates when you roll out the stock. But, and here is a major benefit to you, your tax on the difference between fair market value and cost basis (i.e., the unrealized appreciation), is only at capital gains rates, currently at 15%, but only when you sell the stock. For example, you hold employer stock worth $100,000, with a cost basis of $10,000. If you elect NUA treatment, and you are in a 35% tax bracket, you would pay $3,500 of ordinary income tax ($10,000 cost basis X 35%), and later on when you sell the stock, $13,500 in capital gains taxes ($90,000 X 15%), or a total tax cost of only $17,000 on the $100,000.
For simplicity, I have ignored the impact of state income taxes as they vary considerably, and any gain registered after you roll out the stock also is taxed at capital gain when you eventually sell. If the stock had been rolled to the traditional IRA along with the pre-tax qualified plan assets, when withdrawn it would have then been taxed at 35%, or more than double the tax on the NUA. This tax strategy can be extremely meaningful where its niche applies.
- If you continue to work after age 65, and your practice employs 20 or more employees, full or part-time, or you work at a large hospital, your medical plan at work will still be your primary plan and Medicare will be secondary, so you do not need Medicare Parts B or D (unless your employer drug plan is inferior to Medicare D). However, if you employ less than 20 full or part-time employees, then Medicare is primary and your work plan is secondary, so you need to at least sign up for Medicare Part B. Do not forget to do this.
Check with your broker who handles your health plan for advice here to avoid the trap of not applying for Medicare B because you think your medical plan is primary, then finding out too late that Medicare is primary, you have not applied for Part B and your medical bills go unpaid. A significant unpaid medical liability may derail your retirement portfolio, irrevocably. Be sure to make clear your employee status – true employee or 1099 consultant – as that can make a difference as to how you are classified for benefit purposes. Again, watch out for this one.
- By now, unless you are independently wealthy, you should be converting your invested assets to the type of allocation that emphasizes income with (moderate) growth potential. Many retirees opt for a starting retirement allocation of 70% equities-30% fixed income, or perhaps 60% equities-40% fixed income and cash. Yours may be similar or different, but make sure it is a comfortable allocation such that you will not lose sleep in a market decline (and there will be many during your retirement), but then again not too conservative that your portfolio can’t keep up with inflation during your retirement.
Consider limiting your downside risk while generating guaranteed retirement income for life (see age 59½ and older in the first part of the series). Doing so will help you avoid the disaster that might occur if the sequence of returns you experience at the outset of retirement resembles those we saw from 2000 to 2002. There early losses combined with the start of portfolio withdrawals acted like a double-whammy to degrade and endanger portfolio values down the road. You can avoid this result by protecting your portfolio with income guarantees.
- I am asked all the time about the “correct” order in which you should spend down your assets in retirement. I answer by stating that retirement distributions and spending should be a personalized matter based on the individual’s needs for income.
There is a general pattern of liquidating assets from various parts of your overall portfolio that makes sense in the majority of cases. It is called the tax efficient order of spending. It goes like this – first spend down your taxable (non-qualified) assets, including capital gains assets; second, your tax-deferred assets such as IRAs, deferred annuities, qualified plans, non-deductible IRAs, etc.; and finally your Roth IRAs. There are certainly exceptions to these rules, based on individual circumstances and possible liquidity needs, but the progression I have indicated is ordinarily the best way to proceed.
- If you have prepared well in advance for the day you retire, then retiring at or near age 65 will be a simple transition. In fact, your plans may have involved slowing down somewhat or significantly prior to actually walking away from your everyday professional responsibilities.
I remember George Burns talking about retirement. After taking a puff on his ever-present cigar, he commented, “Retirement at age 65 is ridiculous. When I was 65, I still had pimples.”
Then there is George Foreman, former boxer but current entrepreneur, who weighs in on his plan for retirement, “The question is not what age I want to retire, it is at what income.” So, at age 70½, many of you will be fully extracted from your medical practice and retired; some others will not. Some will be working by choice; others will be working because they did not plan early enough and well enough. Which will you be?
One would think that by age 70½, there are no major retirement issues left to discuss. But there are and here is the short list:
- With regard to the order of distribution of your assets, at age 70½, you have no choice but to begin removing money from your IRAs and other qualified plans (for exceptions, see below). The rules are not too complicated and space does not permit me to explain all the details. However, suffice it to say that you must take your first required mandatory distribution no later than April 1 of the year after you turn age 70½ (instead of during the year you turn age 70½). If you do elect to delay the first year’s distribution, then in the second year, you must take two distributions. Therefore, unless your income will reduce dramatically in year two, you may want to take that first age 70½ distribution in the year you actually turn 70½.
- One exception to this required mandatory distribution rule is if you continue to work and have a 401(k) plan or 403(b), and you are not a 5% owner. In that case, you can delay taking mandatory distributions as long as you continue to work. This exception does not apply to IRAs or other qualified plans, but to 401(k)s and 403(b)s. Check with your financial or tax advisor for specific details, including Section 457 governmental plans.
- If you have worked in a hospital or other non-profit organization and you have been saving money in a 403(b) plan since before the mid-1980s, then you may have some grandfathered amounts in those accounts that permit the required mandatory distributions to be delayed for those grandfathered assets only, until age 75. Check with your 403(b) provider for details on this possible tax break.
- If the ideal withdrawal rate for your portfolio in retirement is 4%, and the majority of your retirement assets are in IRAs and other qualified plans, then it is important to be aware that the required mandatory distributions increase in percentage each year, beginning at 3.65% at age 70½, increasing to 4% at age 73, 5% at age 79, 6% by age 83, and 7% by age 86. Then as long as you reinvest the after tax surplus, you may not endanger the integrity of the retirement portfolio. However, if your income needs are not at the same level as the distribution requirements, and you reinvest the after-tax surplus, then you may delay the inevitable.
Keep an eye on those required mandatory distributions later on as they may affect your portfolio integrity. Also, newer variable annuity contracts are “required mandatory distribution-friendly,” meaning they have riders that guarantee a withdrawal rate that is the greater of the required mandatory distribution percentage, or 5%, for life, as an example.
- A final planning pointer, and a subtle contradiction to the order of distribution (age 65) of your retirement assets, involves the scenario where you do not need your IRA required distribution for living expenses, and never will. Further, you have significant assets that surely will cause an estate tax liability.
Lastly, you have heirs you would like to benefit from your lifelong accumulation of assets. One solution is to use distributions from the IRA to seed an irrevocable trust funded with life insurance. The required mandatory distributions are taxable anyway, as is the balance of the IRA payable to non-spouse beneficiaries who elect not to stretch out the IRA, and the insurance in the irrevocable trust funded with life insurance can escape both income and federal estate taxes at your death.
It is a way to convert taxable assets into tax-free assets to maximize the amount of your wealth which those heirs could receive from your estate (and your spouse’s estate). There are many variations of this tax conversion opportunity – such as the so-called “municipal bond rescue plan” – so check with your financial advisor or insurance broker to determine if such a strategy could work for you.
The life timeline I have outlined in this series is certainly not exhaustive. If you send me an e-mail request, I will send you a copy of the brochure, “Improving Retirement Readiness – Laying the Groundwork for a Financially Secure Retirement.” In the final analysis, Wall Street Journal columnist Jonathan Clements best describes the concept of retirement. He said, “Retirement is like a long vacation in Las Vegas. It is good to enjoy it to the fullest, but not so fully that you run out of money.”
Will you be prepared for the longest vacation of your life?
For more information:
- Part one of series “Retirement: Planning for the Longest Vacation of Your Life” can be read in the November 15th issue of O&P Business News.
- Kenneth W. Rudzinski is a registered representative of the Lincoln National Advisors Corp. Securities and advisory services are offered through Lincoln Financial Advisors Corp., a broker/dealer (member SPIC), and registered investment advisor. Insurance is offered through Lincoln affiliates and other fine companies. Rudzinski is located at 2036 Foulk Rd., Ste. 104, Wilmington, DE 19810; (866) 529-1320; fax (302) 529-1324; or e-mail Kenneth.Rudzinski@lfg.com.
- Lincoln Financial Advisors Corp., or its representatives, do not give tax or legal advice. The information in this article is from sources deemed reliable. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.