Four Things Affluent Individuals Need to Know About Transitioning Into Retirement (Part One in a Series)

real estate as part of financial plan

To shift from earning a steady income to living off your assets in retirement can be unsettling. From having walked hundreds of families through the process, we know retirement raises the kinds of questions that can keep you up at night – questions that involve the cost of health care in retirement, how taxes might change, when to take social security and even how or where your assets should be invested as you seek to preserve rather than grow your wealth.

The good news is that, with professional guidance, you can find answers to these questions. Prudent retirement planning has the added benefit of allowing you to live a simplified financial life, with more time to enjoy retirement.

In this first of a series on transitioning into retirement, we suggest four things to keep in mind as you consider your financial picture in retirement.

1. Health care – in particular insurance - in retirement may be your most significant expense.

What you pay for Medicare depends on your modified adjusted gross income (MAGI).

For many retirees, the cost of health care in retirement is primarily the cost of Medicare Parts B and D plus MediGap supplemental insurance. And, of course, the cost of coverage increases with inflation. Fortunately, there are strategies for limiting this expense.

By creating an income plan, you may be able to keep your MAGI below the threshold that would bump you into a higher premium bracket for Medicare Parts B (medical insurance) and D (prescription drug coverage).

For example, withdrawals from a Roth IRA or Roth 401(k), from certain life insurance policies or from reverse mortgages are not calculated into MAGI. A qualified charitable distribution is also not counted, but is figured into your required minimum distribution (RMD), which is the amount you must begin withdrawing annually from your retirement accounts when you reach age 70½. In this way, a qualified charitable distribution allows you to meet RMD requirements without increasing MAGI.

Another key strategy in managing health care expenses is to apply for Medicare at the right time and to secure the previously mentioned MediGap policy, since not all costs are covered by Medicare.  We have recently begun working with a firm that specializes in helping our clients throughout the Medicare application and evaluation process. We are more than happy to make an introduction.

2. Your retirement tax burden can be significantly reduced through withdrawals and charitable giving

Without a well-planned strategy, taxes can erode your investment portfolio’s value at a pace that’s faster than necessary – or prudent. The challenge is to manage portfolio funds to take optimum advantage of the right withdrawals at the right times from the right accounts.

For example, the traditional approach to liquidating a portfolio has been to deplete the taxable brokerage account first and allow the tax-deferred IRA and 401(k) funds to continue to compound.  But the consequence of that strategy is the risk that the IRA grows so large that RMDs push retirees into higher tax brackets.

This risk can be mitigated through systematic partial Roth conversions (see item three, below) and/or with qualified charitable distributions. Up to $100,000 of your RMD can be donated to a qualified charity; it’s not considered realized income and therefore is not taxed. You satisfy RMD, without increasing your tax burden.

3. Systematic partial Roth conversions can be a key strategy in managing your tax burden.

As your IRA and 401(k) grow, so do the demands of RMDs. So while it’s good news if you’ve built substantial tax-deferred accounts, the bad news is that you’ll be required to withdraw a certain percentage when you turn 70½. Depending on the size of your IRA or 401(k), these RMDs can get hefty enough to increase your income tax.   

For some retirees, a Roth IRA can be a great tool for preventing this. By systematically converting some of the funds from your traditional IRA into a Roth IRA, you reduce the size of the traditional IRA – and future RMDs – and allow your investments to continue to grow tax-free.

We look for opportunities where clients are in very low tax brackets or have no tax due. This can happen during early retirement years before RMDs begin and/or before Social Security payments commence.

A Roth IRA is also a better asset to pass on to your children and grandchildren since its value won’t be diminished by income tax.

4. When and how to take Social Security can have a substantial impact on your portfolio.

If you take Social Security before full retirement age (67), and you are above certain income thresholds, you’ll have to pay a penalty on the amount of Social Security benefits you receive. During 2017, if you’re under full retirement age and you earn over $16,920, you will forfeit $1 for every $2 of Social Security income. Also, during 2017 and prior to full retirement age, if you earn more than $44,880, $1 for every $3 received in Social Security is forfeited. These penalties can get so high that you could end up paying all your Social Security benefits back to the government.

Even though you may have paid tax into the Social Security system throughout your life, the Social Security benefits you receive during retirement may still be taxable. For a married couple filing jointly, provisional income between $32,000-$44,000 results in 50% of Social Security benefits subject to ordinary income tax rates. If you’re provisional income is higher than $44,000 then 85% of your Social Security benefits are subject to ordinary income tax rates.

The decision on when to take Social Security is complicated by other factors as well. You’ll need to consider your health, financial need and other retirement savings.  If you’re married or have been married, you have numerous benefit receipt options.

In all, the Federal government has issued 2,728 rules governing Social Security benefits, so the process to making a wise decision can be daunting.  

Also, the value of delaying benefits has to be weighed against the funds that you spend out of your investment portfolio to sustain your lifestyle in the meantime. There is often value in leaving these funds invested and that should be factored into your decision as well.

Let Smith & Howard Wealth Management help you sort it out

Whether it’s weighing your Social Security options, working out retirement fund allocations or tackling your Medicare planning, we can guide you in making the decisions that best suit your particular retirement situation. Feel free to call or email me, Cecil Staton at 404-874-6244, to discuss any questions you have about funding your retirement.  

Your Family’s CFO

Whether it’s advice on the best way to trim your tax bill, develop a financial plan or develop a long-term investment approach, Smith & Howard Wealth Management strives to support you in making the best possible financial decisions to serve your family’s particular situation and goals and bring you financial peace of mind.

We are an Atlanta-based wealth management firm serving affluent clients since 1999. Our team of experienced, knowledgeable and approachable experts serve as your family CFO, helping you make wise, well-informed decisions about your financial life.

Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.