An Annual Checkup Can Keep Your Retirement Plan Healthy

Retirement

When you see your doctor for your annual physical exam, you’ll nearly always begin with a blood pressure test. That’s a vital sign that shows whether your body is operating as it should. Following similar logic, periodic meetings with your financial advisor should include a checkup on your retirement plan. If you discover symptoms that your plan is going off the rails, you can ask for the right prescription to get back on track.

As is the case for many pre-retirees, it’s natural for you to want to know “the number”: the amount you must have saved in order to move from paychecks to palm trees. Many advisors can answer that question, but just as your blood pressure won’t necessarily reveal all there is to know about your physical health, so a single goal — to keep saving until you have $XYZ — may not be a complete formula for a comfortable retirement.

Other key questions might focus on the flexibility of the retirement date, the flexibility of your savings target or the flexibility of your retirement spending goals. Let’s say you plan to retire at 65 with $750,000 in your IRA, but a month before, you’re not quite there. Do you still retire? What happens when the market goes down? What is a reasonable living standard regardless of the circumstances?

This framework is fine in your 40s, but when you get within five years of retirement, you’ll want to get much more specific. Here are some thoughts to help you get deeper when you’re close.

Which Account, When?

You’ll need cash flow to fund your lifestyle after you stop working. Which accounts should you be tapping, and in which order?

Many people retire with an account in a tax-deferred plan such as a 401(k). You also may have non-qualified accounts with banks and brokerage firms and mutual fund companies; these are known as taxable accounts because this investment income is taxed each year. Increasingly, retirees also have after-tax accounts (Roth IRAs, Roth 401[k]s) that generate no upfront tax benefits but can provide you with completely tax-free cash after you reach age 59 and-a-half.

Conventional wisdom calls for tapping these accounts in a specific order. First, you might draw down your taxable accounts early in retirement so your tax-deferred plans will have more time to accumulate potential compound earnings. Once you reach age 70 1/2, required minimum distributions (RMDs) typically start for tax-deferred plans, so taking them is often step two. Roth accounts should remain intact as long as possible to possibly maximize tax-free withdrawals.

Unconventional Wisdom

This 1-2-3 approach has some appeal, but modifications may save tax in the long run. Among the reasons: deferring distributions from your traditional IRAs and 401(k)s may cause them to grow much larger if investment earnings compound significantly. Such larger pre-tax accounts could generate larger taxable RMDs after you reach age 70 1/2 years of age.

Thus, you might consider taking some money from your tax-deferred accounts before you reach 70 1/2 years of age when RMDs begin. Keeping those withdrawals within your current tax bracket can hold down the resulting income tax while trimming future taxable RMDs.

If you have Roth accounts, refraining from withdrawals often makes sense, but there are exceptions. In some situations, using tax-free Roth dollars can help you avoid tax traps. (See the discussion of mixing Social Security benefits with IRA withdrawals below.)

Other Questions For Your Advisor 

Retirement dollars may come from sources other than investment and savings accounts. Ask your advisor:

• If you’re married, should you choose a joint pension or a single-life version with a higher payout?

• About the tax benefits from rental property income.

• About drawing down a home equity line of credit; the interest you pay might be tax-deductible.

And then there is Social Security. In 2019, the payout for someone starting benefits at full retirement age (66) can be over $34,000 a year, depending on your lifelong earnings. If you start Social Security at 62 years of age, you’ll reduce each monthly payment by 25% versus starting at age 66. You can start as late as 70 and lock in a 76% increase over the age 62 benefit amount. Make sure you consider your health and income needs when choosing a Social Security starting date.

Married couples should pay special attention to deciding when to claim Social Security because an astute choice might produce a huge boost in lifetime payouts. In some cases, it pays for the lower-earning spouse to start early while the higher earner delays to maximize the monthly check. Therefore, a key question for married couples to ask their advisor during a retirement checkup is when each spouse should start Social Security. Request a look at numbers to back up the advisor’s recommendation.

Mixing It Up 

Ask your financial advisor about the interaction among multiple income streams in retirement. For example, you might take non-required distributions from a pre-tax account during your 60s to use a relatively low tax bracket. This cash flow could help pay the bills, so you can wait to start Social Security and lock in a larger lifelong benefit. A larger Social Security benefit for a surviving spouse also could result.

This tactic could work, but tapping a pre-tax IRA while collecting Social Security may trigger adverse reactions, such as higher taxes on those benefits and on long-term capital gains. Here, a cash need might be better satisfied with an untaxed Roth IRA distribution or a drawdown of a home equity line of credit.

Reviewing The Results

If you ask your advisor the right retirement planning questions, you’ll have some assurance about your financial future. On the other hand, if your checkup raises warning signals, you might reconsider the amount you’re saving, the accounts you are using and your planned starting date for Social Security. A healthy dose of reality can put you on the proper path to a rewarding retirement.

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