Seniors understandably want to maximize how much they’ll get from their investments, retirement accounts and Social Security benefits, especially after they stop working.
The natural inclination may be to focus on investment selection and rate of return, but the real secret to a healthy retirement income has as much to do with timing and tax planning as those other factors.
Indeed, the gap between good and bad timing can be quite significant, says Mark Tepper, managing partner at Strategic Wealth Partners in Seven Hills, Ohio.
“It’s not just an extra $100 a month for the rest of your life. It could be the difference between your income lasting until you’re 90 or running out of money when you’re 85,” he says.
Tapping retirement accounts
For many, the biggest decisions involve when to tap investment accounts and when to collect Social Security benefits.
Seniors are required to take minimum distributions from individual retirement accounts, or IRAs, and 401(k) plans, beginning the April 1 after the year in which they become 70½ years old. The first minimum distribution is 3.65 percent of the account balance; after that, the percentage increases each year.
Roth IRAs are an exception. These accounts have no required minimum distributions.
Seniors usually are well-advised to tap nonqualified accounts first, IRA and 401(k) accounts next, and Roth IRAs last, Tepper says. This strategy delays the tax implications and allows the tax-advantaged investments to continue to grow for a longer period of time.
That said, some situations call for a different approach. Carlo Panaccione, president of Navigation Group, a wealth management firm in Redwood Shores, Calif., says some of his clients have shifted funds out of an IRA to take advantage of a time when they were in a lower tax bracket than might be the case in the future.
“If you have everything in an IRA and you’re in a low tax bracket, you should shift (some) over because if you get into an emergency and need a lump sum, you don’t want to spike yourself into a higher tax bracket,” he says.
Taking Social Security
Seniors can claim Social Security benefits starting at age 62, but those benefits are reduced until the senior reaches the so-called full retirement age, based on his or her year of birth.
Seniors who are unemployed or retired, either by choice or default, may want to collect Social Security as soon as they’re eligible. Tepper says that’s a good strategy if the senior’s investments can earn an after-tax return of at least 3 percent per year. Again, the idea is to keep more money invested for future growth.
Seniors who are working may want to delay Social Security because their benefit may be reduced, depending on their current age and income, until they reach full retirement age. (The Social Security Administration website offers more information about the effects of income and age on Social Security benefits.)
“If you are still working, try to postpone Social Security until full retirement age,” Tepper says. “If you’re not working, take it as early as you can, so you can give your investment portfolio a chance to rebound.”
The break-even point at which the total Social Security benefit is about the same, whether it’s taken in a smaller amount at age 62 or a larger amount at age 65, is about 10 to 12 years, Panaccione says.
3 mistakes to avoid
A few classic mistakes can throw a wrench into the timing machinery. Here are three to watch out for.
Taking out too much money too early. “Overspending early in retirement is definitely a huge mistake,” Tepper says.
One rule of thumb is to not spend more than 4 percent of an investment portfolio in the first year. Spending a smaller proportion can allow a portfolio to continue to grow and keep up with the rate of inflation.
Investing too aggressively or too conservatively. Another rule of thumb is to keep three to five years’ of expenses — or more conservatively three to seven years’ — in safe investments, and be slightly more aggressive with money that won’t be needed for a longer time.
“You don’t want to go too crazy, but if you can handle the ups and downs, you shouldn’t lose sleep over (money) you don’t need for seven years,” Panaccione says.
Overlooking the tax implications of IRA withdrawals. Tapping — or tapping out — an IRA too soon can radically alter a senior’s tax situation. A typical miscalculation is using the money to pay off a mortgage.
“Say it’s a $100,000 mortgage and a $100,000 IRA,” Panaccione says. “You yank out the $100,000 to pay off the mortgage, and then you’ve taken a $100,000 income-producing asset, which gives you tax deferral, out of circulation, and you’ve gotten rid of your tax break, so maybe now, you can’t itemize.”