7 Strategies If The Stretch IRA is Eliminated

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

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:

  1. Pushing back the age for Required Minimum Distributions (RMDs) from 70 1/2 to 72.
  2. Allowing workers over age 70 1/2 to continue to contribute to a Traditional IRA.
  3. 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).
  4. Allowing up to $10,000 in withdrawals from 529 College Savings Plans to pay off student loans. 
  5. Requiring 401(k) statements to show participants how much monthly income their balance could provide.
  6. 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.

Read more: Stop Retiring Early, People!

I am also a fan of showing the expected income from a 401(k). The SECURE Act will make it easier for 401(k) plans to offer participants the ability to purchase an immediate annuity and create monthly income from their retirement account. Lump sums tend to look very impressive, but when we consider making that money last, it can be a bit disappointing. 

For example, a 65-year old male with $100,000 could receive $529 a month for life. $100,000 sounds like a lot of money, but $529 a month does not. I would point out that $529 for 12 months is $6,348 a year which is a lot more than the 4% withdrawal rate we usually recommend for new retirees. (But the 4% would increase for inflation, whereas the annuity will remain $529 forever.)

Read more: How to Create Your Own Pension

The provision eliminating the Stretch IRA will be problematic for people with large IRAs. I am hoping that they will continue to allow a surviving spouse to treat an inherited IRA as their own, as is currently the law. If they do eliminate the Stretch IRA, there are several strategies which we might want to consider to reduce taxes on death. 

  • Rather than leaving taxable accounts to charity, it would be preferable to make the charity a beneficiary of your IRA. They will pay no taxes on receiving your IRA, unlike your family members. Also, you can change the charities easily through an IRA beneficiary form and not have to rewrite your will or hire an attorney.
  • You might want to leave smaller portions of your IRA to more people. Four people inheriting a $1 million IRA will pay less in taxes than one person, unless all four are already in the top tax bracket. Consider if making both children and grandchildren as a beneficiaries might help lower the tax bill on your beneficiaries. (Check with me about the Generation Skipping Tax, first. Your estate may be below the GST threshold.)
  • You could convert your IRA to a Roth, pay the taxes now and then there are no RMDs and your beneficiaries will inherit the Roth tax-free. You can spread the conversion over a number of years to stay in a lower tax bracket. Today’s low tax rates are supposed to sunset after 2025.

I will plan a full article on these strategies if the Stretch IRA is in fact repealed; we don’t know yet if existing Stretch IRAs will be grandfathered in place. This is the only negative I see in the legislation, and it will impose a higher tax burden on many beneficiaries of my clients’ retirement plans. There have been proposals to eliminate the Stretch IRA since at least 2012, but it just might happen this time.

While someone with $1 million or $2 million in a 401(k) is fairly well off, the reality is that this would be imposing a much higher tax burden on the beneficiaries of an IRA than for a genuinely wealthy family who has $10 million in “taxable” assets which will receive a step-up in cost basis upon death. The Ultra-Wealthy don’t have significant assets in IRAs, so this won’t really have an impact on them or their families, but for middle class folks, their retirement accounts are often their largest assets. Stay tuned!

7 Ways for Women to Not Outlive Their Money

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

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, 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

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

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.

Financial Planning In Your Sixties

Investors in their sixties are in a decade of decisions. Up to this decade, you could do very well by putting your saving on autopilot, and doing little more for your portfolio than occasionally rebalancing it. Now, you’re faced with some important decisions, whether you are planning to retire soon or to wait many years down the road.

See: Six Steps at Age 60

1. Social Security. The decision of when to start receiving your Social Security benefits is independent from when you retire from your job. The Full Retirement Age (FRA) today is 66, but you can start early benefits from age 62 on. Or you can delay past FRA, all the way to age 70, and receive an 8% annual increase in benefits for waiting.

Where else can you get a guaranteed 8% increase in benefits? It’s a great deal to wait, even if it requires that you spend down some of your cash. Guaranteed benefits are the best way to offset longevity risk, so maximizing your Social Security can be a great idea if you are healthy and have a family history of long lives. For married couples, there is a survivor’s benefit, which means that the spouse with the higher benefit has essentially a joint benefit. There are a lot of things which people don’t consider about Social Security, and that’s why it’s best to talk to me first.

See: Social Security, It Pays to Wait
See: Guaranteed Income Increases Retirement Satisfaction
See: Social Security Planning: Marriage, Divorce, and Survivors

2. Health Care. Medicare starts at age 6r5. If you retire before 65, you will have to figure out how you will be covered until age 65. And when you do reach age 65, you will sign up for part A, and probably Part B (unless you have proof of employer coverage), and will then need to consider whether a Medicare Supplement or Advantage plan makes sense for you. Again, lots of decisions here, and if you don’t sign up at your “window” at age 65, you may have to pay permanent penalties on Part B when you do enroll.

See: Types of Medicare Health Plans

3. Retirement Age. The most dangerous thing I can hear is “It’s okay, I don’t plan to retire.” There are so many people in their sixties who planned to work for another decade or more and things didn’t work out as planned. Maybe they were laid off, or had a health situation, or their spouse had a health issue, or their employer asked them to relocate. Things change. We can’t assume that we have the ability to maintain the status quo indefinitely by choice. My goal for every sixty-something client is that you work because you want to and not because you have to. So even if your planned retirement age isn’t until sometime after 75, make sure you and your family will be all set financially if you decide to retire earlier.

See: How Much Income Do You Need In Retirement?

4. Withdrawal Strategies. If you are retiring and starting withdrawals from your accounts, you will need to make decisions about how much to withdraw and from which account or assets. If the market goes down, can you withdraw the same amount? What is the most tax efficient way to withdraw from your accounts?

See: Taxes and Retirement

5. Asset Allocation. We typically plan for a 20-30 year retirement period, so even if retirement is close, we are still investing for the long-term. Even so, we want to reduce market risk in the five years before retirement to mitigate the potential impact of a bear market right before you plan to begin withdrawals. After retirement has begun, there is evidence that it may be beneficial to sell your bonds first and not rebalance your portfolio. This would mean that your equity holdings would become a larger weighting in your allocation over time.

See: What Is The Best Way To Take Retirement Withdrawals?

Of course, there are many other decisions which we evaluate in a financial plan, such as whether to take a pension or a lump sum upon retirement. When you are facing these decisions, what you don’t know can hurt you. That’s where I can help you navigate these decisions whether you have already retired, are retiring soon, or have many years before you plan to retire.

How to Create Your Own Pension

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 Much Income Do You Need In Retirement?

Many people significantly underestimate how much income they will need to maintain their lifestyle in retirement. We’re going to point out how people underestimate their needs, explain why a common “rule of thumb” is a poor substitute, and then share our preferred process.

If we begin with the wrong budget, then our withdrawal rates, target nest egg, and portfolio sustainability are all going to be inaccurate, which is very difficult to correct after you’ve retired.

In general, when I ask someone to estimate their monthly financial needs, they use a process of addition. They think of their housing expenses, utilities, taxes, food costs, etc., and try to add those up. Unfortunately, the number many arrive at can be significantly too low, and here’s how I know.

They tell me that they spent $5,000 a month, or $60,000 last year. But I ask how much they made and they tell me $150,000. How much did they save last year? $30,000. To me, that suggests they spent $120,000, not $60,000. If they only spent $60,000, they would have saved more than $30,000. You either spend or save money; if it wasn’t saved it was spent, even if that spending wasn’t discretionary.

Here’s why most people fail with the “addition method” of trying to create a retirement income budget:

  • They don’t include taxes. Taxes don’t go away in retirement; pensions, Social Security (up to 85%), and IRA withdrawals are all taxable as ordinary income.
  • Unplanned expenses such as home repairs, emergencies, or car maintenance can be substantial and fairly regular, if not consistent or predictable.
  • Your health care costs may be much higher in retirement than you anticipate, especially in the later years of retirement.
  • You may finally have time to pursue activities which you did not have time for while working, such as travel, golf, or spoiling your grandchildren. With an additional 40 hours a week available, you will likely be spending money in new ways.

Some financial calculators use a rule of thumb that most retirees will need 75% (or 70-80 percent) of their pre-retirement income. This is called the “replacement rate”. And while there have been a number studies that confirm this 75% estimate as an average, its applicability on an individual basis is poor.

We know for example, that lower income people will need a higher replacement rate than higher income people. That’s because the lower income levels may have had a lower savings rate, a smaller proportion of discretionary spending, and little tax savings in retirement. Higher income workers may have been saving more and find significant tax savings in retirement, and therefore have a lower replacement rate.

Instead of trying to use an addition method or a one-size-fits-all rule of thumb, I’d suggest using subtraction:

  1. Begin with your current income.
  2. Subtract any immediate savings you will experience in retirement, including: the amount you were actually saving and investing each year, payroll taxes (7.65% if a W-2 employee), and work expenses, if significant.
  3. Examine your sources of retirement income and if you calculate any income tax reduction, subtract those savings.
  4. Consider any increases in retirement spending, starting with health care costs and discretionary spending (travel, hobbies, etc.). Add these back to your spending needs.

Unless you are planning to have paid off your mortgage, substantially downsize your house, get rid of a car, or stop eating out, I think most people will initially continue their spending habits in retirement very much the same as they did while they were working. Like everyone else, retirees spend a significant portion of their income on things which they did not want (property tax, income tax, insurance) and on things which were not planned (replacing a roof, medical expenses, etc.).

Underestimating your retirement income needs could lead to some very painful outcomes, such as depleting your nest egg, being forced to downsize, or impoverishing your spouse after you pass away. You have to still plan for occasional expenses, such as replacing a car, home repairs, and emergencies, in a retirement budget.

If you’ve calculated your retirement income needs and your planned budget is significantly less than your pre-retirement income, please be careful. When the number you reached through addition isn’t the same number I reach through subtraction, it’s possible you are not budgeting for some costs which you currently have and are likely to still have in retirement.

When Can I Retire?

There are a couple of approaches to determine retirement readiness, and while there is no one right answer to this question, that doesn’t mean we cannot make an intelligent examination of the issues facing retirement and create a thorough framework for examining the question.

1) The 4% approach. Figure out how much you need in annual pre-tax income. Subtract Social Security, Pensions, and Annuity payments from this amount to determine your required withdrawal. Multiply this annual amount by 25 (the reciprocal of 4%), and that’s your finish line.

For example, if you need $3,000 a month, or $36,000 a year, on top of Social Security, you would need a nest egg of $900,000. (A 4% withdrawal from $900,000 = $36,000 a year, to reverse it.) That’s a back of an envelope method to answer when you can retire.

2) Monte Carlo analysis. We can do better than the 4% approach above and give you an answer which more closely meets your individual situation. Using our planning software, we can create a future cash flow profile that will consider your financial needs each year.

Spouses retiring in different years? Wondering if starting Social Security early increases your odds of success? Have spending goals, such as travel, buying a second home, or a wedding to pay for? We can consider all of those questions, not to mention adjust for today’s (lower) expected returns.

The Monte Carlo analysis is a computer simulation which runs 1000 trials of randomly generated return paths. Markets may have an “average” return, but volatility means that some years or decades can have vastly different results. A Monte Carlo analysis can show us how a more aggressive approach might lead to a wider dispersion of outcomes, good and bad. Or how a too-conservative approach might actually increase the possibility that you run out of money.

It tells us your percentage chance of success as well as giving us an idea of the range of possible results. It’s a data set which provides a richer picture than just a binary, yes or no answer to whether or not you have enough money to retire.

Even with the elegance of the Monte Carlo results, the underlying assumptions that go into the equation are vital to the outcome. The answer to not outliving your money may depend more on unknowns like the future rate of return, your longevity, the rate of inflation, or government policy than on your age at retirement. Change one or two of these assumptions and what might seem like a minor adjustment can really swamp a plan when multiplied over a 30 year horizon.

Luckily, we don’t have to have a crystal ball to be able to answer the question of retirement age, nor is it an exercise in futility. That’s because managing your money doesn’t stop at retirement . There is still a crucial role to play in investing wisely, rebalancing, managing withdrawals, and revisiting your plan on an ongoing basis.

While all the attention seems to be paid to risks which might derail your retirement, there is a greater possibility that you will actually be able to withdraw more than 4%. After all, 4% was the lowest successful withdrawal rate for almost every 30 year period in history. It’s the worst case scenario of the past century. In most past retirement periods, you could have withdrawn more – sometimes significantly more – than 4% from a diversified portfolio.

If you are asking “When can I retire?”, we need to meet. And if you aren’t asking that question, even if you are 25, you should still be wondering “How much do I need to be financially independent?” Otherwise, you risk being on the treadmill of work forever, and there may just come a day in the distant future, or maybe not so distant future, when you wake up one morning and realize you’d like to do something else.