7 Strategies If The Stretch IRA is Eliminated

Posted On July 26, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning /

On May 31, I sent a newsletter about US House of Representatives approving the SECURE Act and six changes it would create for retirement plans. To pay for the cost of new rules, like extending the RMD age from 70 1/2 to 72, the legislation proposes to eliminate the Stretch IRA starting in 2020. While the Senate has yet to finalize their own version of this legislation, odds are good that something is going to get passed. And if the Stretch IRA manages to survive this time, it will likely be back on the chopping block in the near future.

A Stretch IRA, also known as an Inherited IRA or Beneficiary IRA, allows the beneficiary of an IRA to continue to enjoy the tax-deferred growth of the IRA and only take relatively small Required Minimum Distributions over their lifetime. Congress has recognized that while they want to encourage people to contribute to IRAs to save for their retirement, they’re not as happy about the IRAs being used as an Estate Planning tool.

If you have a large IRA, one million or more, you might have more in assets than you will need to spend. If you leave it to your spouse, they can still roll it into their own IRA and treat it as their own. Once the Stretch IRA is eliminated, and you leave the IRA to someone other than a spouse, they will have to withdraw the entire IRA within 10 years. Those distributions will be treated as ordinary income and there could be substantial taxes on a seven-figure IRA.

Now is the time to start planning for the end of the Stretch IRA. There are ways that could potentially save many thousands in taxes on a million dollar IRA. But these methods may take years to work, so it pays to start early. Here are seven considerations:

1. Charitable Beneficiary. If you are planning to leave money to a charity (a church, arts organization, university, or other charity), make that bequest through your IRA rather than from your taxable estate. The charity will receive the full amount and as a tax-exempt organization, not owe any taxes on the distribution. It will be much more tax efficient to leave taxable assets to individual beneficiaries and IRA assets to charities than the reverse.

2. QCD. Better than waiting until you pass away, you can donate up to $100,000 a year in Qualified Charitable Distributions after age 70 1/2 that count towards your RMD. This reduces your IRA but preserves a tax benefit today, which is even better than leaving it as an inheritance. Plus you get to see the good your donation can make while you are still alive. (And you don’t have to itemize your tax return; the QCD is an above the line deduction.)

3. Start withdrawals at age 59 1/2. The traditional approach to IRAs was to avoid touching them until you hit 70 1/2 and had to start RMDs. With today’s lower tax brackets, if you have a very large IRA, it may be preferable to start distributions as early as 59 1/2 and save that money in a taxable account.

For a married couple, the 24% tax bracket goes all the way up to $321,450 (2019). Those rates are set to sunset after 2025. Additionally, while any future growth in an IRA will eventually be taxed as ordinary income, IRA money that is withdrawn and invested in ETFs now will become eligible for the preferential long-term capital gains rate of 15%. Your future growth is now at a lower tax rate outside the IRA.

4. If you’re going to take annual distributions and pay the tax gradually, an even better way is through Roth Conversions. Once in the Roth, you will pay no tax on future growth and you heirs can receive the Roth accounts income tax-free. Conversions don’t count as part of your RMD, so the best time to do this may be between 59 1/2 and 70 1/2. Look at gradually making partial conversions that keep you within a lower tax bracket.

5. A lot of owners of large IRAs want to leave their IRA to a Trust to make sure the funds are not squandered, mismanaged, or taken by a child’s spouse. Unfortunately, Trust taxes are very high. In fact, Trusts reach the top tax rate of 37% once they hit just $12,750 in taxable income. In the past, trust beneficiaries were able to still use the Stretch IRA rules even with a Trust. However, if the Stretch IRA is eliminated, most of these IRA Trusts are going to pay an egregious amount of taxes.

One alternative is to establish a Charitable Remainder Trust (CRT). This would allow for annual income to be provided to your beneficiaries just like from a Stretch IRA, but once that beneficiary passes away, the remainder is donated to a charity. This preserves significant tax benefits as the initial IRA distribution to the CRT is non-taxable. The downside is that there are no lump sum options and the payments will not continue past the one generation named as beneficiaries.

Still, if you have a Trust established as the beneficiary of your IRA, you will want to revisit this choice very carefully if the Stretch IRA is eliminated.

6. Life Insurance. I usually recommend Term Insurance, but there is a place for permanent life insurance in estate planning. If the Stretch IRA is repealed, it may be more efficient to use your IRA to pay for $1 million in life insurance than to try to pass on a $1 million IRA. Life insurance proceeds are received income tax-free by the beneficiary.

For example, a healthy 70 year old male could purchase a Guaranteed Universal Life Policy with a $1 million death benefit for as little as $24,820.40 a year. Take the RMD from your $1 million IRA and use that to pay the life insurance premiums. Now your heirs will receive a $1 million life insurance policy (tax-free) in addition to your $1 million IRA. This policy and rate are guaranteed through age 100. If you don’t need income from your IRA, this could greatly increase the after-tax money received by your heirs.

7. If you are an unmarried couple, you might want to consider if it would be beneficial to be married so that one spouse could inherit the other’s IRA and be able to treat it as their own.

The elimination of the Stretch IRA has been proposed repeatedly since 2012. In some ways, its repeal is a new inheritance tax. Billionaires typically have little or insignificant IRA assets compared to the rest of their wealth and have access to complex trust and legal structures. However, working professionals who have diligently created a net worth of $1 to 4 million, likely have a substantial amount of their wealth in their retirement accounts. And these are the families who will be impacted the most by the elimination of the Stretch IRA.

If you are planning on leaving a substantial retirement account to your beneficiaries, let’s talk about your specific situation and consider what course of action might be best for you.

6 Changes Congress Wants to Make to Your Retirement Plan

Posted On July 12, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning / 1 Comment

In a rare bipartisan vote of 417-3, the House of Representatives approved the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The Act now goes to the Senate, which may make modifications, but is likely to still pass and reconcile a version of this legislation.

The version passed by the House has provisions which will indeed enhance 401(k)s, IRAs, and other retirement plans for all Americans. Hopefully, this will get more people saving and starting their contributions at a younger age. There are also provisions which will help retirees and people over age 70.

Here’s a partial list of the changes in the legislation:

Pushing back the age for Required Minimum Distributions (RMDs) from 70 1/2 to 72.
Allowing workers over age 70 1/2 to continue to contribute to a Traditional IRA.
Allowing up to $5,000 in penalty-free withdrawals from IRAs to cover birth or adoption expenses for parents (taxes would still apply, but the 10% penalty would be waived).
Allowing up to $10,000 in withdrawals from 529 College Savings Plans to pay off student loans.
Requiring 401(k) statements to show participants how much monthly income their balance could provide.
Eliminating the “Stretch IRA”, also known as the Inherited or Beneficiary IRA. Currently, a beneficiary can take withdrawals over their lifetime. Instead, they will be required to withdraw all the money – and pay taxes – within 10 years.

The first two reflect the reality of how poorly prepared some Baby Boomers are for retirement and that more people are working well into their seventies today. Pushing back the RMD age will help people save for longer and reflects that life expectancy has gone up significantly since the original RMD rules were established decades ago.

Cut Expenses, Retire Sooner

Posted On May 31, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning /

While we use robust retirement planning software to carefully consider retirement readiness, many of these scenarios end up strikingly close to the familiar “four percent rule”. The four percent rule suggests that you can start with 4% withdrawals from a diversified portfolio, increase your spending to keep up with inflation, and you are highly likely to have your money last for a full retirement of 30 years or more. (Bengen, 1994, Journal of Financial Planning)

Under the four percent rule, If you have one million dollars, you can retire and withdraw $40,000 a year in the first year. If you need $5,000 a month ($60,000 a year), you would want a nest egg of at least $1.5 million. If your goal is $8,000 a month, you need to start with $2.4 million.

We spend a lot of time calculating your finish line and trying to figure out how we will get there. Once we have that target dollar amount for your portfolio, then we can work backwards and figure how much you need to save each month, what rate of return you would need, and how long it would take. Is your investment portfolio likely to produce the return you require? If not, should we change your allocation?

What we should be talking about more is How can you move up your finish line? When you reduce your monthly expenses, you can have a smaller nest egg to retire and could consider retiring sooner. In fact, under the four percent rule, for every $1,000 a month you can reduce your needs, we can lower your finish line by $300,000. Think about that! For every $1,000 a month in spending, you need $300,000 in assets!

If you can trim your monthly budget from $5,000 to $4,000, you’ve just reduced your finish line from $1.5 million to $1.2 million. It’s not my place to tell people to cut their “lifestyle”, but if you come to the conclusion that it is in your best interest to reduce your monthly needs, then we can recalculate your retirement goals and maybe get you started years earlier.
Cutting your expenses is easier said than done, but let’s start with five key considerations.

1. Determine your fixed expenses and variable expenses. Start with your fixed expenses – those you pay every month. Housing, car payments, insurance, and memberships are key areas to look for savings. Personally, I like to see people enter retirement having paid off their mortgage and being debt free. In many cases, it may be helpful to downsize as well, which can reduce your monthly costs or free up equity to add to your portfolio. Downsizing or relocating often also lowers your taxes, insurance, utilities, and maintenance costs.

Your house is a liability. It is an ongoing expense. Often, it is your largest expense and therefore the biggest demand on your retirement income needs. (And now 90% of taxpayers don’t itemize and don’t get a tax break for their mortgage interest or property taxes.)

2. Insurance costs are surprisingly different from one company to another. Unfortunately, it does not pay to be loyal to one company. If you’ve had the same home and auto policy for more than five years, you may be able to reduce that cost significantly. If you’d like a referral to an independent agent who can compare top companies for you and make sure you have the right coverage, please send me a reply and I’d be happy to make an introduction.

3. When creating your retirement budget, make sure to include emergencies and set aside cash for maintenance and upkeep of your home and vehicles. Just because you didn’t have any unplanned expenses in the past 12 months doesn’t mean that you can project that budget into the future.

You will need to replace your cars and should plan for this as an ongoing expense. If you can go from being a two or three car family to a one car family in retirement, that could also be a significant saving. If you only need a second car a few days a month, it may make sense to ditch the car and just use Uber when you need it.

7 Ways for Women to Not Outlive Their Money

Posted On March 31, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning /

Once a month, my brass quintet goes to a retirement home/nursing home and plays a concert for the residents. Over the past 15 years, I’ve visited more than 100 locations in Dallas. They run the gamut from Ritz-Carlton levels of luxury to places that, well, aren’t very nice and don’t smell so great.

What all these places do have in common is this: 75 to 80 percent of their residents are women. Women outlive men, and in many marriages, the husband is older. Wives are outliving their husbands by a substantial number of years. While no one dreams of ending up in a nursing home, living alone at that age is even more lonely, unhealthy, and perilous.

For women who have seen their own mother, aunt, or other relative live to a grand old age, you know that there are many older women who are living in genuine poverty in America today. Husbands, you may not worry about your old age or what happens to you, but certainly you don’t wish to leave your wife in dire financial straits after you are gone.

Longevity risk – the risk of outliving your money – is a primary concern for many women investors. A good plan to address longevity begins decades earlier. Here are some of the best ways to make sure you don’t outlive your money.

1. Delay Social Security benefits. Social Security is guaranteed for life and it is often the only source of guaranteed income that will also keep up with inflation, through Cost of Living Adjustments. By waiting from age 62 to age 70, you will receive a 76% increase in your monthly Social Security benefit. For married couples, there is a survivorship benefit, so if the higher earning spouse can wait until 70, that benefit amount will effectively apply for both lives. Husbands: even if you are in poor health, delaying your SS benefit will provide a higher benefit for your wife if she should outlive you.Read more: Social Security: It Pays to Wait

2. Buy a Single Premium Immediate Annuity (SPIA) when you retire. This provides lifetime income. The more guaranteed income you have, the less likely you will run out of money to withdraw. While the implied rate of return is not terribly high on a SPIA, you could consider that purchase to be part of your allocation to bonds. Read more: How to Create Your Own Pension

3. Delay retirement until age 70. If you can work a few more years, you can significantly improve your retirement readiness. This gives you more years to save, for your money to grow, and it reduces the number of years you need withdrawals by a significant percentage. Read more: Stop Retiring Early, People!

4. Don’t need your RMDs? Look into a QLAC. A Qualified Longevity Annuity Contract is a deferred annuity that you purchase in your IRA. By delaying benefits (up to age 80), you get to grow your future income stream, while avoiding Required Minimum Distributions.Read more: Longevity Annuity

5. Invest for Growth. If you are 62 and retiring in four years, your time horizon is not four years, you are really investing for 30 or more years. If your goal is to not run out of money and to maintain your purchasing power, putting your nest egg into cash might be the worst possible choice. Being ultra-conservative is placing more importance on short-term volatility avoidance than on the long-term risk of longevity.

6. Don’t blow up your investments. Here’s what we suggest:

Don’t buy individual stocks. Don’t chase the hot fad, whether that is today’s star manager, sector or country fund, or cryptocurrency. Don’t get greedy.
No private investments. Yes, some are excellent, but the ones that end up being Ponzi schemes also sound excellent. Seniors are targets for fraudsters. (Like radio host Doc Gallagher arrested this month in Dallas for a $20 million Ponzi scheme.)
Determine a target asset allocation, such as 60% stocks and 40% bonds (“60/40”), and either stick with it, or follow the Rising Equity Glidepath.
Use Index funds or Index ETFs for your equity exposure. Keep it simple.- Get professional advice you can trust.

7. Consider Long-Term Care Insurance. Why would you want that? Today’s LTCI policies also offer home care coverage, which means it might actually be thing which saves you from having to move to an assisted living facility. These policies aren’t cheap: $3,000 to $5,000 a year for a couple at age 60, but if you consider that assisted living would easily be $5,000 a month down the road, it’s a policy more people should be considering. Contact me for more information and we can walk you through the process and offer independent quotes from multiple companies.

There is no magic bullet for longevity risk for women, but a combination of these strategies, along with saving and creating a substantial retirement nest egg, could mean you won’t have to worry about money for the rest of your life. The best time to start planning for your future is today.

7 Missed IRA Opportunities

Posted On March 31, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning /

Individual Retirement Account (IRA) is the cornerstone of retirement planning, yet so many people miss opportunities to fund an IRA because they don’t realize they are eligible. With the great tax benefits of IRAs, you might want to consider funding yours every year that you can. Here are seven situations where many people don’t realize they could fund an IRA.

1. Spousal IRA. Even if a spouse does not have any earned income, they are eligible to make a Traditional or Roth IRA contribution based on the household income. Generally, if one spouse is eligible for a Roth IRA, so is the non-working spouse. In some cases, the non-working spouse may be eligible for a Traditional IRA contribution even when their spouse is ineligible because they are covered by an employer plan and their income is too high.

2. No employer sponsored retirement plan. If you are single and your employer does not offer a retirement plan (or if you are married and neither of you are covered by an employer plan), then there are NO income limits on a Traditional IRA. You are always eligible for the full contribution, regardless of your household income. Note that this eligibility is determined by your employer offering you a plan and your being eligible, and not your participation. If the plan is offered, but you choose not to participate, then you are considered covered by an employer plan, which is number 2:

3. Covered by a employer plan. Here’s where things get tricky. Anyone can make a Traditional IRA contribution regardless of your income, but there are rules about who can deduct their contribution. A tax-deductible contribution to your Traditional IRA is greatly preferred over a non-deductible contribution. If you cannot do the deductible contribution, but you can do a Roth IRA (number 4), never do a non-deductible contribution. Always choose the Roth over non-deductible. The limits listed below do not mean you cannot do a Traditional IRA, only that you cannot deduct the contributions.

If you are covered by your employer plan, including a 401(k), 403(b), SIMPLE IRA, pension, etc., you are still be eligible for a Traditional IRA if your Modified Adjusted Gross Income (MAGI) is below these levels for 2018:

Single: $63,000
Married filing jointly: $101,000 if you are covered by an employer plan
Married filing jointly: $189,000 if your spouse is covered at work but you are not (this second one is missed very frequently!)

Your Modified Adjusted Gross Income cannot be precisely determined until you are doing your taxes. Sometimes, there are taxpayers who assume they are not eligible based on their gross income, but would be eligible if they look at their MAGI.

4. Roth IRA. The Roth IRA has different income limits than the Traditional IRA, and these limits apply regardless of whether you are covered by an employer retirement plan or not. (2018 figures)

Single: $120,000
Married filing jointly: $189,000

5. Back-door Roth IRA. If you make too much to contribute to a Roth IRA, and you do not have any Traditional IRAs, you might be able to do a “Back-Door Roth IRA”, which is a two step process of funding a non-deductible Traditional IRA and then doing a Roth Conversion. We’ve written about the Back Door Roth several times, including here.

6. Self-Employed. If you have any self-employment income, or receive a 1099 as an independent contractor, you may be eligible for a SEP-IRA on that income. This is on top of any 401(k) or other IRAs that you fund. It is possible for example, that you could put $18,500 into a 401(k) for Job A, But this is more like a series of popular online friv games than what is described above. contribute $5,500 into a Roth IRA, and still contribute to a SEP-IRA for self-employed Job B.

There are no income limits to a SEP contribution, but it is difficult to know how much you can contribute until you do your tax return. The basic formula is that you can contribute 20% of your net income, after you subtract your business expenses and one-half of the self-employment tax. The maximum contribution to a SEP is $55,000, and with such high limits, the SEP is essential for anyone who is looking to save more than the $5,500 limit to a Traditional or Roth IRA.
Learn more about the SEP-IRA.

7. Tax Extension. For the Traditional and Roth IRA, you have to make your contribution by April 15 of the following year. If you do a tax extension, that’s fine, but the contributions are still due by April 15. However, the SEP IRA is the only IRA where you can make a contribution all the way until October 15, when you file an extension.

Bonus #8: If you are over age 70 1/2, you generally cannot make Traditional IRA contributions any longer. However, if you continue to have earned income, you may still fund a Roth IRA after this age.

A few notes: For 2018, contribution limits for Roth and Traditional are $5,500 or $6,500 if over age 50. For 2019, this has been increased to $6,000 and $7,000. You become eligible for the catch-up contribution in the year you turn 50, so even if your birthday is December 31, you are considered 50 for the whole year. Most of these income limits have a phase-out, and I’ve listed the lowest level, so if your income is slightly above the limit, you may be eligible for a reduced contribution.

Retirement Planning is our focus, so we welcome your IRA questions! We want to make sure you don’t miss an opportunity to fund an IRA each and every year that you are eligible.

How to Pay Zero Taxes on Interest, Dividends, and Capital Gains

Posted On February 2, 2019 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies /

How would you like to pay zero taxes on your investment income, including interest, dividends, and capital gains? The only downside is that you have to live in a beautiful warm beach town, where the high is usually 82 degrees and the low in the winter is around 65.

If this sounds appealing to you, you should learn more about the unique tax laws of Puerto Rico. As a US territory, any US citizen can relocate to Puerto Rico, and if you make that your home, you will be subject to Puerto Rico taxes and may no longer have to pay US Federal Income Taxes. You can still collect your Social Security, use Medicare, and retain your US citizenship. (But not vote for President or be represented in Congress!)

Citizens of Puerto Rico generally do not have to pay US Federal Income Taxes, unless they are a Federal Employee, or have earned income from the mainland US. This means that if you move to PR, your PR-sourced income would be subject to PR tax laws. In 2012, PR passed Act 22, to encourage Individual Investors to relocate to PR. Here are a few highlights:

Once you establish as a “bona fide resident”, you will pay zero percent tax on interest and dividends going forward.
You will pay zero percent on capital gains that accrue after you establish residency.
For capital gains that occurred before you move to PR, that portion of the gain would be taxed at 10%, (reduced to 5% after you have been in PR for 10 years). So if you had enormous long-term capital gains and were facing US taxes of 20% plus the 3.8% medicare surtax, you could move to PR and sell those items later this year and pay only 10% rather than 23.8%.
The application for Act 22 benefits costs $750 and if approved, the certificate has a filing fee of $5,000. The program sunsets after 2036. This program is to attract high net worth individuals to Puerto Rico, those who have hundreds of thousands or millions in investment income and gains. If your goal is to retire on $1,500 a month from Social Security, you aren’t going to need these tax breaks.

To establish yourself as a “bona fide resident”, you would need to spend a majority of each calendar year in Puerto Rico, meaning at least 183 days. The IRS is cracking down on fraudulent PR residency, so be prepared to document this and retain proof of travel. Additionally, PR now also requires you to purchase a home in PR and to open a local bank account to prove residency. (Don’t worry, PR banks are covered by FDIC insurance just like mainland banks). Details here on the Act 22 Requirements.

Note that Social Security and distributions from a Traditional IRA or Pension are considered ordinary income and subject to Puerto Rico personal income taxes, which reach a 33% maximum at an even lower level than US Federal Income tax rates. So, Act 22 is a huge incentive if you have a lot of investment income or unrealized capital gains, but otherwise, PR is not offering much tax incentives if your retirement income is ordinary income.

If you are a business owner, however, and want to relocate your eligible business to Puerto Rico, there are also great tax breaks under Act 20. These include: a 4% corporate tax rate, 100% exemption for five years on property taxes, and then a 90% exemption after 5 years. If your business is a pass-through entity, like an LLC, you may be eligible to pay only 4% taxes on your earnings. If you are in the US, you could be paying as much as 37% income tax on your LLC earnings. Some requirements for Act 20 include being based in PR, opening a local bank account, and hiring local employees.

For self-employed people in a service industry, PR is creating (new for 2019) very low tax rates based on your gross income, of just 6% on the first $100,000, and a maximum of 20% on the income over $500,000. Click here for a chart of the PR personal tax rates and the new Service Tax.
A comparison of Act 20 and Act 22 Benefits are available at Puerto Rico Business Link.

When most people talk about tax havens, they would have to renounce their US citizenship (and pay 23.8% in capital gains to leave), or they’re thinking of an illegal scheme of trying hide assets offshore. If you have really large investment tax liabilities or have a business that you could locate anywhere, take a look at Puerto Rico. Besides the tax benefits, you’ve got great weather, year round golfing, US stores like Home Depot, Starbucks, and Walgreens, and direct daily flights to most US hubs, including DFW, Houston, Miami, Atlanta, New York, and other cities.

Puerto Rico is still looking to rebuild after the hurricane and it’s probably not the best place to be a middle class worker, but for a wealthy retiree, it might be worth a look. Christopher Columbus arrived in Puerto Rico in 1493 and the cities have Spanish architecture from the seventeenth century. I’ve never been to Puerto Rico, but would love to visit sometime in 2019 or 2020. If you’d care to join me for a research trip, let me know!

(Please consult your tax expert for details and to discuss your eligibility. This article should not be construed as individual tax advice.)

Roth Conversions Under the New Tax Law

Posted On December 2, 2018 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies /

Everybody loves free stuff, and investing, we love the tax-free growth offered by a Roth IRA. 2018 may be a good year to convert part of your Traditional IRA to Roth IRA, using a Roth Conversion. In a Roth Conversion, you move money from your Traditional IRA to a Roth IRA by paying income taxes on this amount. After it’s in the Roth, it grows tax-free.

Why do this in 2018? The new tax cuts this year have a sunset and will expire after 2025. While I’d love for Washington to extend these tax cuts, with our annual deficits exploding and total debt growing at an unprecedented rate, it seems unavoidable that we will have to raise taxes in the future. I have no idea when this might happen, but as the law stands today, the new tax rates will go back up in 2026.

That gives us a window of 8 years to do Roth conversions at a lower tax rate. In 2018, you may have a number of funds which are down, such as Value, or International stocks, or Emerging Markets. Perhaps you want to keep those positions as part of your diversified portfolio in the hope that they will recover in the future.

Having a combination of both lower tax rates for 2018 and some positions being down, means that converting your shares of a mutual fund or ETF will cost less today than it might in the future. You do not have to convert your entire Traditional IRA, you can choose how much you want to move to your Roth.

Who is a good candidate for a Roth Conversion?

1. You have enough cash available to pay the taxes this year on the amount you want to convert. If you are in the 22% tax bracket and want to convert $15,000, that will cost you $3,300 in additional taxes. That’s painful, but it saves your from having to pay taxes later, when the account has perhaps grown to $30,000 or $45,000. Think of a conversion as the opportunity to pre-pay your taxes today rather than defer for later.

2. You will be in the same or higher tax bracket in retirement. Consider what income level you will have in retirement. If you are planning to work after age 70 1/2 or have a lot of passive income that will continue, it is entirely possible you will stay in the same tax bracket. If you are going to be in a lower tax bracket, you would probably be better off not doing the conversion and waiting to take withdrawals after you are retired.

3. You don’t want or need to take Required Minimum Distributions and/or you plan to leave your IRA to your kids who are in the same or higher tax bracket as you. In other words, if you don’t even need your IRA for retirement income, doing a Roth Conversion will allow this account will grow tax-free. There are no RMDs for a Roth IRA. A Roth passes tax-free to your heirs.

One exception: if you plan to leave your IRA to a charity, do NOT do a Roth Conversion. A charity would not pay any taxes on receiving your Traditional IRA, so you are wasting your money if you do a conversion and then leave the Roth to a charity.

The smartest way to do a Roth Conversion is to make sure you stay within your current tax bracket. If you are in the 24% bracket and have another $13,000 that you could earn without going into the next bracket, then make sure your conversion stays under this amount. That’s why we want to talk about conversions in 2018, so you can use the 8 year window of lower taxes to make smaller conversions.

2018 Marginal Tax Brackets (this is based on your taxable income, in other words, after your standard or itemized deductions.)

	Single	Married filing Jointly
10%	$0-$9,525	$0-$19,050
12%	$9,526-$38,700	$19,501-$77,400
22%	$38,701-$82,500	$77,401-$165,000
24%	$82,501-$157,500	$165,001-$315,000
32%	$157,501-$200,000	$315,001-$400,000
35%	$200,001-$500,000	$400,001-$600,000
37%	$500,001 or more	$600,001 or more

On top of these taxes, remember that there is an additional 3.8% Medicare Surtax on investment income over $200,000 single, or $250,000 married. While the conversion is treated as ordinary income, not investment income, a conversion could cause other investment income to become subject to the 3.8% tax if the conversion pushes your total income above the $200,000 or $250,000 thresholds.

You used to be able to undo a Roth Conversion if you changed your mind, or if the fund went down. This was called a Recharacterization. This is no longer allowed as of 2018 under the new tax law. Now, when you make a Roth Conversion, it is permanent. So make sure you do your homework first!

Thinking about a Conversion? Want to reduce your future taxes and give yourself a pool of tax-free funds? Let’s look at your anticipated tax liability under the new tax brackets and see what makes sense your your situation. Email or call for a free consultation.

How to Create Your Own Pension

Posted On May 5, 2018 By Scott Stratton, CFP(R), CFA In Retirement Planning /

With 401(k)s replacing pension plans at most employers, the risk of outliving your money has been shifted from the pension plan to the individual. We’ve been fortunate to see many advances in heath care in our lifetime so it is becoming quite common for a couple who retire in their sixties to spend thirty years in retirement. Today, longevity risk is a real concern for retirees.

With an investment-oriented retirement plan, we typically recommend a 4% withdrawal rate. We can then run a Monte Carlo simulation to estimate the possibility that you will deplete your portfolio and run out of money. And while that possibility is generally small, even a 20% chance of failure seems like an unacceptable gamble. Certainly if one out of five of my clients run out of money, I would not consider that a successful outcome.

Social Security has become more important than ever because many Baby Boomers don’t have a Pension. While Social Security does provide income for life, it is usually not enough to fund the lifestyle most people would like in retirement.

What can you do if you are worried about outliving your money? Consider a Single Premium Immediate Annuity, or SPIA. A SPIA is an insurance contract that will provide you with a monthly payment for life, in exchange for an upfront payment (the “single premium”). These are different from “deferred” annuities which are used for accumulation. Deferred annuities come in many flavors, including, fixed, indexed, and variable.

Deferred annuities have gotten a bad rap, in part due to inappropriate and unethical sales practices by some insurance professionals. For SPIAs, however, there is an increasing body of academic work that finds significant benefits.

Here’s a quote on a SPIA from one insurer:
For a 65-year old male, in exchange for $100,000, you would receive $529 a month for life. That’s $6,348 a year, or a 6.348% annual payout. (You can invest any amount in a SPIA, at the same payout rate.)

You can probably already guess the biggest reason people haven’t embraced SPIAs: if you purchase a SPIA and die after two months, you would have only gotten back $1,000 from your $100,000 investment. The rest, in a “Life only” contract is gone.

But that’s how insurance works; it’s a pooling of risks, based on the Law of Large Numbers. The insurance company will issue 1,000 contracts to 65 year olds and some will pass away soon and some will live to be 100. They can guarantee you a payment for life, because the large number of contracts gives them an average life span over the whole group. You transfer your longevity risk to the insurance company, and when they pool that risk with 999 other people, it is smoothed out and more predictable.

There are some other payment options, other than “Life Only”. For married couples, a Joint Life policy may be more appropriate. For someone wanting to leave money to their children, you could select a guaranteed period such as 10 years. Then, if you passed away after 3 years, your heirs would continue to receive payouts for another 7 years.

Obviously, these additional features would decrease the monthly payout compared to a Life Only policy. For example, in a 100% Joint Policy, the payout would drop to $417 a month, but that amount would be guaranteed as long as either the husband or wife were alive.

There are some situations where a SPIA could make sense. If you have an expectation of a long life span, longevity risk might be a big concern. I have clients whose parents lived well into their nineties and who have other relatives who passed 100 years old. For those in excellent health, longevity is a valid concern.

There are a number of different life expectancy calculators online which will try to estimate your longevity based on a variety of factors, including weight, stress, medical history, and family history. The life expectancy calculator at Time estimates a 75% chance I live to age 91.

Who is a good candidate for a SPIA?

Concerned with longevity risk and has both family history and personal factors suggesting a long life span,
Need income and want a payment guaranteed for life,
Not focused on leaving these assets to their heirs,
Have sufficient liquid funds elsewhere to not need this principal.

What are the negatives of the SPIA? While we’ve already discussed the possibility of receiving only a few payments, there are other considerations:

Inflation. Unlike Social Security, or our 4% withdrawal strategy, there are no cost of living increases in a SPIA. If your payout is $1,000 a month, it stays at that amount forever. With 3% inflation, that $1,000 will only have $500 in purchasing power after 24 years.
Low Interest Rates. SPIAs are invested by the insurance company in conservative funds, frequently in Treasury Bonds. They match a 30-year liability with a 30-year bond. Today’s SPIA rates are very low. I can’t help but think that the rates will be higher in a year or two as the Fed raises interest rates. Buying a SPIA now is like locking in today’s 30-year Treasury yield.
Loss of control of those assets. You can’t change your mind once after you have purchased a SPIA. (There may be an initial 30-day free look period to return a SPIA.)

While there are definitely some negatives, I think there should be greater use of SPIAs by retirees. They bring back many of the positive qualities that previous generations enjoyed with their corporate pension plans. When you ask people if they wish they had a pension that was guaranteed for life, they say yes. But if you ask them if they want an annuity, they say no. We need to do a better job explaining what a SPIA is.

The key is to think of it as a tool for part of the portfolio rather than an all-encompassing solution to your retirement needs. Consider, for example, using a SPIA plus Social Security to cover your non-discretionary expenses. Then you can use your remaining investments for discretionary expenses where you have more flexibility with those withdrawals. At the same time, your basic expenses have been met by guaranteed sources which you cannot outlive.

Since SPIAs are bond-like, you could consider a SPIA as part of your bond allocation in a 60/40 or 50/50 portfolio. A SPIA returns both interest and principal in each payment, so you would be spending down your bonds. This approach, called the “rising equity glidepath“, has been gaining increased acceptance by the financial planning community, as it appears to increase the success rate versus annual rebalancing.

There’s a lot more we could write about SPIAs, including how taxes work and about state Guaranty Associations coverage of them. Our goal of finding the optimal solution for each client’s retirement needs begins with an objective analysis of all the possible tools available to us.

If you’re wondering if a SPIA would help you meet your retirement goals, let’s talk. I don’t look at a question like this assuming I already know the answer. Rather, I’m here to educate you on all your options, so we can evaluate the pros and cons together and help you make the right decision for your situation.

How The Tax Act Impacts Retirement Planning

Posted On February 3, 2018 By Scott Stratton, CFP(R), CFA In Retirement Planning /

With all of the new changes in the Tax Cuts and Jobs Act (TCJA), we’re looking very thoroughly at how this will impact retirement planning. Some of the impacts are direct and immediate, but we are also considering what might be secondary consequences of the new rules in the years ahead.

Although taxes will be slightly lower and more simple for many middle class retirees, the tax changes may mean that some old strategies are no longer effective or that new methods can help reduce taxes or improve retirement readiness. Here are seven things to consider if you are now retired or looking to possibly retire in the next decade.

1. Plan ahead for RMDs. The new lower tax rates will sunset after 2026 and the higher 2017 rates will return. Once you are past age 70 1/2, retirees must take Required Minimum Distributions and must have started Social Security. There are many retirees in their seventies who actually have more income, and therefore way more taxes, than they require to meet their needs. I think we should be doing much more planning in our fifties and sixties to try to reduce retirement taxes, because once you are 70 1/2, you have no control.

See 5 Tax Saving Strategies for RMDs

If you want to reduce your future RMDs, consider doing partial Roth Conversions before age 70 1/2 – converting a small part of your IRA each year, within the limits of your current tax bracket. This is valuable if you now are in a lower tax bracket, 10% to 24%, which is scheduled to rise after 2026.

If you are retiring soon, consider delaying Social Security and starting first with withdrawals from your retirement accounts. Withdrawing cash for several years can help reduce future RMDs, and delaying Social Security benefits past Full Retirement Age provides an 8% annual increase in benefits. That’s a rate of return that is higher than our projected returns on a Balanced (50/50) portfolio. If you delay from age 66 to 70, you’ll see a 32% increase in your Social Security benefit, which reduces longevity risk. Social Security is guaranteed for life, but withdrawals from your portfolio are not!

When higher rates tax return, your (delayed) Social Security benefits are taxable at a maximum of 85% of your benefit, whereas, 100% of your IRA distributions are taxable as ordinary income.

2. Roth 401(k). If you are in a moderate tax bracket today because of the TCJA, you might prefer to contribute to a Roth 401(k) rather than a Traditional 401(k). You don’t get a tax deduction today, but the Roth will grow tax-free and there are no RMDs on a Roth. Therefore, having $24,000 in a Roth is worth more than having $24,000 in a Traditional IRA. In retirement, if you’re in the 25% tax bracket, a $24,000 Traditional account will net you only $18,000 after tax.

Rather than looking to convert your IRA to a Roth after it has grown, the most cost effective time to fund a Roth is likely at the beginning. If you currently have substantial assets in a traditional 401(k) or IRA, consider the Roth option for your new contributions.

3. Second Homes less appealing. The new tax law has placed a cap of $10,000 on the deductibility of state and local taxes. If you own a second home, or are considering purchasing one, this cap may make it more expensive.

Many retirees have paid off their primary residence and then use a home equity loan to purchase a second property. Starting in 2018, you are no longer able to deduct home equity loans. This makes it less attractive to use a home equity loan (or line of credit), and it also makes paying off your mortgage less appealing. If you have a mortgage, it can still be deductible, but if you pay it off, you cannot then borrow from your equity in a tax beneficial way.

If you were previously paying more than $10,000 in state and local taxes, you will either be capped to $10,000, or more likely, be unable to deduct ANY of those taxes, because you are under the standard deduction of $24,000 for a married couple. Going forward, I think more retirees will find it financially appealing to downsize and minimize their housing expenses since they are effectively getting zero tax benefit for their property taxes and mortgage interest.

4. Charitable Strategies. Another casualty of the increased $12,000 / $24,000 standard deduction: Charitable Giving. Most retirees will no longer receive any tax deduction for their donations. Two planning solutions: establish a Donor Advised Fund, or if over age 70 1/2, make use of the Qualified Charitable Distributions from your IRA. We have begun several QCDs this month for our clients!

5. In-State Municipal Bonds. For high income retirees in states with an income tax, it is not difficult to exceed the $10,000 cap on the SALT taxes. In the past, many of these high earners invested in National municipal bonds to get better diversification, even if it meant that they paid some state income tax on their municipal bonds. “At least you are getting a Federal Tax Deduction for paying the State Income Tax”, they were told. Going forward, they won’t receive that benefit. As a result, I expect that more high earning retirees will want to restrict their municipal bond purchases to those in their home state, where they will not owe any State or Federal tax on this income (especially New York, California, Illinois, etc.). Here in Texas, with no state income tax, we will continue to buy municipal bonds from any and all states.

6. Estate Tax. The TCJA doubled the Estate Tax Exemption from $5.5 million to $11 million per person, or $22 million for a married couple. Now there are only a very small number of people who really need to worry about Estate Taxes. Most retirees will not need a Trust today. (If you might still be subject to the Estate Tax, we can definitely help you.)

7. Health Insurance Costs Will Rise. The repeal of the Individual Mandate of the Affordable Care Act will allow many healthy young people to skip having health insurance. I think that’s a mistake – no one plans to get sick or injured. But what it means for society is a loss of healthier individuals from the insurance risk pool. Adults between age 55 and 65 should expect to see large increases in their individual insurance premiums. More people will be unable to retire until age 65, when they become eligible for Medicare, because they cannot afford the rising individual health insurance premiums. Just this week, a client informed me that they are delaying their retirement for one year because their health insurance bill is increasing from $575 a month to nearly $800.

Wondering how the new tax law will impact your retirement plan? Let’s get together and take a look. Even if your retirement is years away, there are steps we can take today so you can feel confident and prepared that your finances will all be in place when you need them.

Can You Contribute to an HSA After 65?

Posted On November 12, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning /

If you are working past age 65 and covered by an employer-sponsored health plan that is HSA compatible (a high deductible health plan or HDHP), you could in theory continue to fund a Health Savings Account with employee or employer contributions. However, an HSA contribution is only allowable if you do not have any other type of insurance. Once you enroll in Medicare Part A (or any other Part), you cannot continue to make new HSA contributions. Many health plans require coordination with Medicare at age 65, so be sure to check with your insurer. Once you have enrolled in Medicare, no further HSA contributions are possible.

If you don’t sign up for Medicare at age 65, be sure to maintain records that you were covered by an employer sponsored health plan. Otherwise you will pay permanently higher premiums for Part B when you do eventually enroll.

[For a primer on HSAs, start here: Health Savings Accounts, 220,000 Reasons Why You Need One.]

The Benefits of an HSA

Fortunately, if you have an existing HSA, there are lots of uses for your account after 65. Just like before you started Medicare, you can use funds in an HSA to pay your out-of-pocket expenses such as doctor or hospital co-pays and prescription drug costs. You can also use your HSA to pay for dental, vision, or other medical expenses not covered by Medicare.

Additionally, Medicare participants can use an HSA to pay for their premiums for Part B, Part D, or for a private Medicare Advantage plan. Are your Medicare premiums are automatically deducted from your Social Security check? If so, you can reimburse yourself from your HSA. Be sure to keep detailed records as proof. Retirees may also use their HSA to pay a portion of their premiums towards a Long-Term Care policy.

You can use an HSA to reimburse yourself for medical bills for past years, again providing you can document and prove these were qualified expenses. When you pass away, if you have listed your spouse as beneficiary, your spouse can inherit your HSA and treat it as their own. Then they can also access the money tax-free for qualified medical expenses. However, if your HSA beneficiary is not a spouse (or one is not named), then the account will be distributed and that distribution will be taxable.

For Medicare participants interested in an HSA-like option, there is the Medicare MSA. This is a Medicare Advantage Plan which provides a cash account for expenses, with a high deductible. Details from Medicare here.

Have retirement planning questions? We are here to help! Contact Scott for a free consultation.