Life expectancy is longer today. Interest rates are low and inflation is rising. Taxes will probably increase in the next few years. Will the stock market continue its steady rise? You can hope, but who knows? Volatility could be part of this long-term equation.
All of these factors create financial uncertainty for the future and make retirement planning more complex. With that in mind, here are five key elements of preparing for retirement:
1. Get an income plan
How much money do you need and where will it come from?
These are two very important questions. As you enter your prime earning years, it’s important to think ahead about how much income you’ll need in retirement. So invest accordingly.
When you are working, investing is quite simple. Your money just has to grow. When you retire, your money needs to provide income, pay taxes and grow to support your lifestyle. Investing becomes much more nuanced and even more difficult once you start earning income.
As you approach retirement, here are some steps to get you started on an income plan:
- List all your sources of guaranteed retirement income – Social Security, pension, annuity with a guaranteed minimum amount, etc.
- List retirement savings and investment accounts, such as a traditional IRA, 401(k), Roth IRA, or Roth 401(k).
- Ask yourself if your expected income will cover your expenses and the type of lifestyle you desire. Remember that a common rule of thumb is that upon retirement, most people need to replace about 60% to 80% of their pre-retirement pre-tax income in order to maintain their lifestyle.
2. Maximize your Social Security income
To maximize Social Security benefits for you and your spouse, you need to know which of the estimated 567 separate application strategies for married couples is best for you. Sometimes it makes sense to start taking Social Security while letting your nest egg grow. For others, it makes sense to dip into investments to let your Social Security benefits continue to grow until full retirement age (usually around age 67) or until the amount of benefits reaches its maximum (70 years) before claiming benefits.
Important Note: If you and your spouse were born on or before January 1, 1954 and have both reached full retirement age, you can apply for spousal benefits and let your own benefits continue to increase. At age 70, you can switch to the highest benefit. The strategy is an option called “restricted deposit”, and it is not available to people born on January 2, 1954 or later.
3. Explore your tax strategies
Taxes catch many retirees off guard, as conventional wisdom suggests that with less income than they earned during their working years, taxes would be significantly lower in retirement. Many retirees find this is not the case. A key part of your planning strategy is to reduce taxes on funds withdrawn from tax-deferred accounts, such as 401(k)s or IRAs.
The required minimum distributions for tax-deferred accounts start at age 72, so it’s crucial to have a plan in place well before that date.
An effective strategy is to convert tax-deferred funds into Roth IRAs or Roth 401(k). Although the conversion amount is taxable in the year it is converted, the advantage is that these Roth accounts allow your retirement savings to grow tax-free and are not taxable upon withdrawal (as long as you have 59.5 years old and you have owned a Roth for at least five years). Don’t let the initial tax bill keep you from transferring your retirement funds from taxed accounts, no matter when you withdraw them to non-taxable accounts. The goal is not to be myopic at the risk of being hit by tax ticking time bombs in retirement.
Roth IRA conversions are just one strategy to keep your Social Security tax free. If your provisional income is between $25,000 and $34,000 (for single filers) or between $32,000 and $44,000 for joint filers, then up to 50% of your Social Security is taxable. If your provisional income is higher than this, then up to 85% of your benefits may be taxable. These additional taxes may require you to take more money out of your nest egg to support your lifestyle.
4. Plan your medical expenses
Health care continues to be one of the biggest expenses in retirement. Many people assume that Medicare will cover all of your health care costs in retirement, but that’s not the case. One way to prepare is to enroll in a Health Savings Account (HSA), which some employers offer. When you contribute to an HSA, you can save pre-tax dollars (and possibly collect employer contributions), which have the potential to grow and can be withdrawn tax-free in retirement if used for eligible medical expenses. For 2021, the regular CGS contribution limit is $3,600 for single coverage ($3,650 in 2022) and $7,200 for family coverage ($7,300 for 2022). Individuals enrolled in Medicare cannot make new contributions to an HSA.
Another way to fill the gap not covered by health insurance is long term care insurance. Although long term care insurance premiums are not affordable for everyone, an alternative is to purchase a life insurance policy that offers the option of adding a long term care insurance rider.
5. Plan your estate
Estate planning isn’t just about how you want your assets distributed after your death. It’s about being prepared for contingencies if you become unable to make your own financial or medical decisions. It is about creating a smooth transition for your loved ones in settling your affairs.
Key elements of an estate plan include a will; assignment of power of attorney, which gives the person you appoint the power to manage your financial affairs if you are unable to do so; a health care proxy, who authorizes someone you trust to make medical decisions on your behalf; and a living will, a statement of whether you want life-saving medical intervention if you become terminally ill and unable to communicate. Relieve your children of difficult decisions by having them follow the legal guidelines of the estate plan. Work with a lawyer to make sure you get the right estate planning documents for your situation.
For something as important as your financial future, it’s important to work with a financial professional. Everything in the plan must be coordinated – taxes, social security, income planning and investments. Your advisor should understand your overall financial picture, how things like taxes and income generation relate, and how they can help you achieve your retirement goals.
Dan Dunkin contributed to this article.
These materials are provided for general information and educational purposes. Echelon does not provide investment, tax or legal advice. The information presented here is not specific to an individual’s situation. To the extent that this material relates to tax matters, it is not intended or written for use and may not be used by any taxpayer to avoid penalties imposed by law. Each taxpayer should seek advice from an independent tax professional based on their situation.
Co-Founder, Echelon Financial
Chris Wilbratte has worked in the financial services industry for 30 years and is co-founder of Echelon Financial in Austin, Texas. He received his BBA in finance and marketing from the University of Texas.
The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.