Jen and I recently taught a class at Cape Cod Community College on how to build a sound retirement system. It’s a popular class we teach throughout the year. The class examines numerous planning questions, such as income, investment, distribution, and estate strategies for people nearing or already in retirement. The goal of this class is to help folks manage both their tax liability and risk as they move through the distribution phase of their retirement lifecycle.
A good portion of the class deals with the best ways to spend down your retirement assets such as traditional 401(k)s and IRAs (Individual Retirement Accounts). As one of our students commented during this discussion, “it seems like timing seems to be everything.” She was spot on—properly timing when and how to turn your qualified retirement accounts into income can significantly increase your chance of having a successful retirement. For insurance, in many cases it makes sense to employ strategies to convert retirement accounts into future tax-free income to reduce your tax liability and further increase your income. One of the goals for this class is for students to come away with an awareness of how taxation, IRS rules, and managing downside risk play significant roles in their personal retirement withdrawal strategy.
One of the things I really like about this class is that the students bring real-world, practical examples and challenges that many of us face in retirement planning. So this week, with our time together, I thought I would share some examples that came up during our recent class.
Deborah and Tom and Social Security. Deborah and Tom came to the class focused on learning more about the best time for them to start taking monthly Social Security benefits. Tom is 60 and still working, while Deborah just retired at age 62 and is now eligible to receive Social Security. Their income had gone down because Deborah was no longer getting a regular paycheck, but they were still relatively comfortable living on Tom’s solo income. While a little bit of extra income would be nice, they didn’t feel like they needed anything close to the additional Social Security money Deborah would be eligible for at her current age of 62. This was a good situation to be in, because it meant that every year they wait to take Social Security, their benefit amount will increase by 8 percent until age 70. Where else can you get a guaranteed 8 percent increase these days?
Because they had a sizeable amount of assets in a 401(k) plan and IRA, they have a planning opportunity which would allow them to take income from those accounts until they began Social Security at age 70. They would pay ordinary income taxes on these funds but would avoid the 10 percent IRS penalty now that they are past age 59½. This is sometimes referred to as filling up your available “tax bucket.” This strategy may have two benefits. For people in Deborah’s and Tom’s age range, using traditional IRA and 401(k) withdrawals during this phase can help defer starting Social Security and let them ultimately receive a higher monthly benefit when they do start. Also, people using this strategy may be able to lower their later RMDs and taxes.
Andre and Converting to a Roth IRA. Andre came to the class interested in learning more about a Roth IRA conversion. The benefit of a Roth IRA is that you don’t owe taxes on income distributions, and RMDs are not required during your lifetime. You can convert funds from a traditional IRA to a Roth IRA and pay the taxes due at today’s relative low tax rates, but then have the assurance that these funds can be withdrawn in retirement tax-free (assuming the account has been open at least five years and you are 59½ or older). Andre is 63 and semiretired, taking on the occasional consulting work. Because his income is now lower as well as his tax bracket, he is interested in converting either part or all of his traditional IRA to a Roth IRA to have more tax-free income once he fully retires in his 70s. Andre isn’t sure if he will need any of the IRA money for income in retirement, so one of his secondary goals is to maximize what he passes on to his kids and grandkids. A Roth conversion can accomplish both of these goals.
Margaret and Charity. Margaret is turning 72 this summer and is single with no children. She is very involved with charities in her hometown, from feeding the hungry to rocking babies in the local hospital. She wants to leave money to some nieces and nephews, but most of her estate is earmarked for her favorite charities. She has a sizeable IRA and knows she needs to take her first RMD by next April 1. Her concern is that taxes on future RMDs were going to reduce the amount she will be able to leave to the causes she cares most about. Because Margaret has already accounted for the income she needs in retirement through Social Security and other assets, we talked about how she might look at a QCD (Qualified Charitable Deduction) to meet the dual goals of charitable giving and less taxes.
For people with significant assets who are charitably inclined, they have the option of making QCDs from their traditional IRA. If you’re over 70½, you can make a charitable contribution to a qualified charity of up to $100,000 or $200,000 for couples. These contributions are considered part of your RMD and do not count as taxable income. To make sure this is done correctly, it’s important that the charitable contribution go directly from the IRA to the charity.
Now while these classes often deal with minimizing taxes and maximizing retirement income, we also address the importance of incorporating downside risk mitigation in any retirement or investment plan. This includes everything from having the proper investment systems in place that account for the timing of your retirement, to anticipating how long you might live and estimating your income needs during your lifetime.
Teaching these classes is a lot of fun, and they energize both Jen and I. We get to pass on some of what we know, but just as importantly we meet a lot of interesting folks with great stories of their own.
So as always—be vigilant and stay alert, because you deserve more!