Investing in Retirement (Rewind) (EP.132)

0:28We all need to make smart decisions with our money. but maybe you haven't heard before. So I'd love for you to check it out. And don't forget, if you're enjoying the podcast, the best way to say thank you is to leave a quick review or forward an episode to a friend. Now, let's get into this popular episode from my Investing by Age series.

0:49This is the sixth and final episode of the Investing by Age series. Because people go through different financial stages at different ages, you'll likely find useful information in the episodes outside your age bracket. If you're in retirement or retiring soon, you will definitely find aspects of the episodes on investing in your 50s and investing in your 60s to be relevant. With that in mind, here are six things to focus on if you are currently retired. Number one, simplify your investments. After multiple decades of saving, different employers, and maybe even different financial advisors, your portfolio is probably a bit like a cluttered closet.

1:36For me, a perpetually clean and organized closet is rare. But if you've ever done a full-scale closet cleaning, you've probably felt immense satisfaction from the resulting sense of order and ease of use. I've seen lots of portfolios in my career, and most are like a messy closet. A variety of accounts and holdings collected over the years without an obvious philosophy or order to make sense of things. All portfolios start out clean and organized, but as investors make changes, the portfolio slowly gets cluttered by holdings that don't fit together and feel out of style. To me, the perfect portfolio is like a clean closet.

2:20Its statement is clean and organized, reflecting strategies and a philosophy that someone can stick with for decades on end. Look, a clean statement isn't the point of portfolio construction, but giving it consideration makes it more likely you avoid a portfolio full of stuff you don't really need. And this ideal portfolio I'm describing doesn't mean you can't make changes. In fact, just like a clean and organized closet, the perfect portfolio offers enough flexibility to make changes that align with the guiding philosophy. But having that single, concrete guiding philosophy is so important, and it's far easier to achieve when you have fewer moving parts.

3:05Now that you're retired, supporting your lifestyle is probably your primary investment goal. There are also probably some other goals beyond that, but you must take care of your own living expenses before funding anything else. In my opinion, the simplicity of your primary investment objective makes it much harder to justify a lot of moving parts. Having worked with retirees in their 60s, 70s, 80s, and 90s, I can also speak from experience that more moving parts is harder to manage in an effective manner as you age. And I see people benefit from simplicity at different speeds, but everyone eventually does.

3:48I'll admit it feels a bit awkward to point out that there is a plethora of research on the effects of aging and cognitive decline, but I'll set aside my fear of this point being uncomfortable and hope you take it at face value. Your capacity for critical thinking and decision-making will decline as you age, which makes managing a portfolio with lots of accounts, holdings, and maybe even different advisors more challenging. The best time to simplify is earlier in retirement. And while there's interesting investment strategies in retirement related to asset allocation changes, withdrawal strategies, or tax optimization within in the portfolio?

4:29To me, the most underrated investment action retirees can take for themselves is simplifying their portfolio. There are a few obvious ways to achieve this goal. The first is consolidating accounts, and that starts with combining accounts wherever possible. That can be doing things like combining IRAs or trust accounts that are spread out at different custodians or being overseen by different advisors. It's also common for people to have different groupings of accounts that were implemented for mental accounting purposes, but make strategic investment planning far more complicated and confusing later in life.

5:08An added bonus of reducing your number of accounts is that you make things easier on those who will eventually inherit your estate. The next step upon reducing the number of accounts or account groupings is to reduce the complexity of your holdings. It's rarely going to make sense to realize taxes just for the sake of reducing the number of holdings you have, but I think the more that you can reduce the number of holdings in a tax-neutral manner, the better. You also may consider closing out positions in complex holdings that you or your significant other couldn't easily explain to a kid. Because if you can't do this, then how can you expect to make good decisions about such positions later in life.

5:53The process of simplifying your portfolio doesn't need to happen all at once, but the sooner you start the process, the easier it will be. And by simplifying wherever possible, it makes it easier to be more strategic with everything from your asset allocation to your withdrawal strategy. Number two, run a tax projection. There's a phrase we frequently say retirees here at PlanCorp, we should run a tax projection. And the reason we recommend tax projections so often is that understanding the potential tax impact of different options helps you make better decisions. That's not to say that taxes are the ultimate consideration.

6:34There might be very good reasons to accept a higher tax bill if the move provides other benefits. But by running those numbers, we can guide you towards a conclusion with a full understanding of the pros and cons of any financial move. A tax projection, like a financial plan, shows what the future might look like based on a set of assumptions. So we start with the income and deduction information from your last tax return and adjust for anything we know about the current year, including changes in income, tax rates, potential deductions, and so on. Then we calculate what your taxes would be based on those conditions.

7:14The more we know about your current year's finances, the more accurate the projection will be. And that's why we often wait until later in the year to run a projection. But for clients with more complex finances, such as business owners, executives with lots of non-salary compensation, or someone retiring this year or next, we might run a few tax projections a year based on different scenarios. Basically, anytime there's a big change in your finances, we can run a what-if analysis to see, one, the combined federal and state tax cost of every additional dollar of income you generate, and two, the combined federal and state tax savings of every additional dollar of deductions you take.

7:58And the output of a tax projection is more than just dollar figures, though. It provides critical information in the planning process for three key reasons. The first is that tax projections eliminate surprises. We never want our clients to owe a big, unexpected tax bill, even if it's for something positive like strong investment performance. Tax projections provide clarity and reduce the potential surprise about next year's tax bill. And these estimates are especially important in times when the tax law is changing. So there was the Tax Cuts and Jobs Act of 2017, the Secure Act of 2019, and the CARES Act of 2020 that all are recent examples of legislation that changed the game for individuals.

8:44The second reason that tax projections are critical to the planning process is that they help you make strategic decisions. There are multiple ways to structure a financial plan or complete a financial transaction, each with its own pros and cons. And when you analyze tax projection data, you can be more strategic about the option that's best for you. In your working years, we're often doing it to determine how a business owner should structure the sale of a business or the most tax-efficient way to deal with equity compensation. In retirement, we're frequently evaluating how to optimize withdrawals from your portfolio to support your living expenses, whether to do a Roth conversion or not, and the best ways to make gifts to charities or family members.

9:30Regardless of the goal, a tax projection lets us look at different scenarios to find the approach that provides the greatest benefit to you overall. And finally, tax projections help minimize taxes today and, just as importantly, into the future. Because we all have to pay our tax bill, but you don't want to leave the IRS a tip. We also don't want to make decisions that reduce taxes today at the cost of a bigger tax bill in the future. So striking that balance is much harder without these tax projections. For example, maybe you give the same amount to charity every year. We could examine whether bunching several years' worth of donations into one year using a donor-advised fund would actually save money over the long run.

10:18Alternatively, we might look ahead and realize that there's a big potential tax bill on the horizon, say, when you have to start taking required minimum distributions or RMDs, as many people know them. In that case, we could run a tax projection to decide if it's better to hold off on bunching deductions now so we can use that technique later. In each of these scenarios, what makes tax projections so effective is that we use them in the context of all the other information we have about you. This is the big difference between using a financial advisor with deep tax knowledge compared to relying only on a CPA for a tax projection.

10:58We know the details of your financial plan. So we can think beyond this year's tax return and focus on lowering your lifetime tax bill. And by understanding your lifestyle today and your goals for the future, we can look ahead to the future milestones and anticipate the parts of finances that will change in conjunction with them. And by examining potential moves from multiple sides and considering as much data as possible, you can feel even better about the decisions you make. And we believe that's really a recipe for building wealth in the long term. The topic of tax projections is really a segue into the next item, which is number three, consider partial Roth conversions.

11:42If a large portion of your nest egg resides in IRA accounts, you'll have significant required minimum distributions subject to income taxes that eat away at your hard earned savings. With a Roth conversion, you move money out of your traditional IRA, pay the taxes on it up front, and have a new source of tax-free retirement income. A common misconception, however, is that a Roth IRA conversion is an all-or-nothing thing. But in fact, you can convert smaller amounts over several years, and when you get the timing and the size of those conversions right, you can stay within your current tax bracket while reducing the size of your traditional IRA and future RMDs.

12:27Now, this strategy is most beneficial when your current tax rate is lower than your expected tax rate will be when the RMDs kick in. And in this case, you can calculate the exact amount of IRA assets you can afford to convert each year while staying within your current relatively low tax bracket. For many of our clients who choose to retire in their 60s, we find the sweet spot for partial Roth conversions is in the years after retirement and up to the RMD age, which as of this recording is age 72, but Congress appears to be working towards legislation that would bump the RMD age up to 75. Just to give you a sense of how this works, consider a couple who retire age 65 with$3 million portfolio,$1 million of which is saved in a traditional IRA.

13:18Their joint income has dropped from$250 ,000 they were earning before retirement to about$50 ,000, most of which is income on their taxable investments. So they are dropping down to the 12 % tax bracket. This lower income bracket gives the couple a lot of headroom to convert savings from their traditional IRA without increasing their current tax bracket. So they might decide to convert$27 ,000 each year for seven years to reduce their IRA balance by$189 ,000. This in turn helps reduce the couple's RMDs and related taxable income they must realize after age 72. Now in this particular example, someone may determine that they will move beyond the 22 % tax bracket and into the 24 % tax bracket once they start receiving Social Security benefits.

14:12In this situation, a case could be made for converting a larger portion of your IRA and move into a higher tax bracket today, but still remain at a lower bracket than where you expect to be at the point at which you're taking RMDs. There's a lot of moving parts to this, so if you want to learn more about this strategy, I will link to a more comprehensive blog post in the show notes at thelongterminvestor.com. But to summarize, the goal of a partial Roth conversion is to reduce the value of a traditional IRA before required minimum distributions begin, thus reducing the size of those RMDs and the income tax you pay on them.

14:53Because Roth IRAs are funded with after-tax dollars, you pay taxes upfront on your contributions in exchange for a source of tax-free retirement income. When done correctly, a partial Roth conversion allows you to make smaller tax payments over time to avoid paying a big tax bill later on. But if done incorrectly, you might leave some of those potential tax savings on the table or worse. A flawed conversion might even cost you money. So I'm also going to link to a blog post in the show notes on how to avoid five costly Roth conversion mistakes. Moving on to number four, make the most of Social Security.

15:37If you haven't already, you should create a login at Social Security's website, ssa.gov, and download your Social Security statement. Before we get too detailed, I think it's important to make a few things clear. First, your Social Security payments are calculated using your 35 highest earning years in the workforce. If you don't work for at least 35 years, zeros get factored into the calculation and reduce your payments. Second, the age at which you begin collecting your Social Security has an impact on the benefit you receive. Although you can start collecting a reduced Social Security benefit as early as age 62, most financial professionals would agree that's a mistake.

16:24The age you receive your full benefit is known as your full retirement age. If you were born between 1943 to 1954, your full retirement age is 66. Then the full retirement age increases gradually if you were born from 1955 to 1960 until it reaches 67. and for anyone born 1960 or later, full retirement benefits are payable at age 67. Now, if you wait to take Social Security, your monthly Social Security benefit increases by 8 % for each year that you delay collecting benefits beyond the full retirement age. And again, taking benefits prior to full retirement age results in a smaller monthly payment.

17:10If you compare the total payments between claiming Social Security at age 62 versus the full retirement age of 67, the break-even point happens when you're 70 years and 8 months old. The point at which you break even by delaying payments until age 70 versus age 67 is 80 years old. So basically, if you live past 80 years old, delaying Social Security until you're 70 years old will net you the highest benefit. Of course, there are other considerations that go into maximizing Social Security benefits beyond life expectancy and break-even rates. Inputs that we typically consider include your current or former spouse's age, health, and earnings history, your cash needs, employment status and prospects, and perhaps most importantly, your taxes and Medicare premiums.

18:04Speaking of Medicare premiums, the next item in investing in retirement is number five, understand your healthcare options. If you retire prior to age 65, you won't yet be eligible for Medicare, but you have a few options available for coverage. Just be prepared because this monthly expense may be a significant one in your earliest years of retirement. In 2020, the average national cost was around$1 ,150 for a family for one month, not including government subsidies. Those averages apply across age categories, and older consumers pay higher premiums. You could start looking at the Affordable Care Act marketplace.

18:52Every state has a health insurance marketplace that was established by the Affordable Care Act. Your retirement is a qualifying event for enrollment, so you can enroll when you leave your job. Plans are available at three levels, sometimes four depending on your area. You have bronze, silver, gold, and sometimes platinum. Cost-sharing reductions are available based on your taxable income. So if you've saved into taxable retirement accounts, Consider funding all or a portion of your income from these accounts in order to minimize taxable income, which could result in eligibility for subsidies. The next option is private health insurance.

19:31If you have no pre-existing conditions, private health insurance may be an option for you. The Affordable Care Act was designed to ensure coverage for individuals with such conditions. Premiums are much lower than the Affordable Care Act plans for several reasons, but like any other sweet deal, there are drawbacks, including limited coverage. Make sure you're aware of the maximum out-of-pocket costs and have enough in savings to cover at least that much from your retirement to your Medicare eligibility date. The next option to evaluate is COBRA. If you will only have a short time gap until you're 65, COBRA may be a great option for you, especially if you're in the middle of a year where you've already met a deductible or out-of-pocket cap and you'd like to retain your current plan.

20:21Generally speaking, this would be a good option to finish out your current plan year, but it can get pretty expensive thereafter as you have to pay the full price for your coverage because likely your employer was subsidizing it while you worked. You can also look at a working spouse's employer plan. If your spouse is still working, consider being added to their coverage. Your retirement is going to trigger a special enrollment period for you to add coverage, but it's important to also note that if this coverage is available to you, it could make you ineligible for any subsidy for a marketplace plan, although the IRS promises this will be remedied soon.

20:59The next consideration would be to use your HSA. You don't want to forget about these triple tax advantaged accounts. And I've talked a lot about how HSAs are one of the best retirement accounts in prior episodes. So I'll be sure to link to those along with some blog posts in the show notes at the longterminvestor.com. If you've been accumulating funds in your HSA, this is a great source of funding for deductibles, copayments, and other expenses. You generally can't use the funds to pay premiums with the exception of long-term care. And also, as long as you're not 65, you can even continue to make contributions to your HSA, including any catch-up contribution.

21:43Once you turn 65, you'll have made it to Medicare. And while the basics of Parts A, which covers hospitals, Part B, doctors and outpatient, and D, prescriptions, apply to everyone, everyone still needs to consider a supplemental policy to fill the remaining gaps in coverage. If you need to keep your monthly costs low, you may consider a Medicare Advantage plan, but keep in mind that like private health insurance, it's great until it's not. Be absolutely certain that you know the out-of-pocket maximum and have savings to cover those costs for the inevitable times when unanticipated medical care is needed.

22:25Medicare supplemental plans are provided by insurance companies such as UnitedHealthcare, Blue Cross, etc., and they range in coverage, co-pays, and deductibles. There are many options in the marketplace, and having a broker to assist in selection of a plan can be pretty helpful, or your financial advisor can provide education and assistance with your decision. Medigap policies don't cover vision or dental, nor do they cover hearing aids, so again, your HSA can be an incredibly helpful supplement for these items. Finally, watch out for IRMA. Affectionately known as IRMA, the Income-Related Monthly Adjustment Amount is a sliding scale of additional premiums that applies for Medicare users above certain income thresholds, beginning around$114 ,000 for a single filer in 2020.

23:18The adjustment is based on your tax return filed two years prior, so if you've recently retired, you may qualify to appeal this cost. Retirees with higher income needs in retirement should be aware of these additional costs and, if possible, consider incorporating funds from a taxable account to reduce your taxable income, especially if you fall close or just barely into one of the IRMA tiers. IRMA has a lot of implications for a lot of retirement tax planning and withdrawal strategies, so I'm hoping to dedicate a full episode to this topic later in the year. Finally, number six, update your estate plan.

23:59There are five essential estate planning documents everyone ought to have in place. A will, living trust, durable power of attorney, advanced medical directives, and letter of instruction. I have a blog post that explains these different documents in greater detail that I'll link to in the show notes, but I want to focus on the updates you might consider in retirement. In general, we like to review a client's estate plan every other year, but there are certain life events that we feel like justifies a more immediate review, one of which is retirement. Updating your estate plan to account for law changes that have taken place since you last updated your documents is an obvious starting point.

24:44Another item worth double-checking is that all your accounts and beneficiaries are titled correctly because the most thoughtful estate planning means absolutely nothing if that doesn't get done correctly. And if it's been a long time since you've updated the executors, trustees, or durable power of attorneys in your estate planning documents, that might be worth spending time thinking about again. One of the biggest mistakes I see people make when selecting people for these roles is when parents include all of their children together, or they use age or profession as a guide for their selections, but this often results in selecting someone that is not best suited for the role.

25:25The best option for an executor, trustee, or durable power of attorney is someone that lives in close proximity to you and has enough time or flexibility to address the issues that may arise. And while most parents seem to think appointing co-agents or all their children is the fairest thing to do, I frequently see this choice lead to additional administration time to transfer your assets upon death because any time a decision needs to be made, differing opinions and emotions come into play. In my opinion, it's best to select one person who is organized, efficient, and has the ability to make time for handling your estate matters rather than letting every child have a say in the matter.

26:11Finally, the older you get, the more visibility you're going to have on whether your estate will be subject to estate taxes at death. There are some relatively low-cost strategies that can be surprisingly effective, such as grantor-retained annuity trusts or GRATs, that allow you to maintain control of your existing assets, but remove future growth from your estate. Our chief planning officer, Brian King, wrote a really nice piece on Gratz that I'll be sure to link to in the show notes if you want to learn more about those. So to recap the most important elements of investing in retirement, you should simplify your investments, run a tax projection, consider partial Roth conversions, make the most of social security, understand your healthcare options, and update your estate plan.

27:01And that brings us to the conclusion of the Investing by Age series. I hope you take a moment to listen to episodes on decades that don't apply to your current age bracket because many of the items apply to a broad range of ages. And if you're listening on Apple Podcasts, I'd also really appreciate if you could rate the show and leave an honest review since that helps others find the show more easily. And finally, if you've never checked out the show notes for this podcast, I put much more effort into making them useful than most other podcasts. So check those out at thelongterminvestor.com. As always, thanks for listening.

27:40And until next time, to long-term investing.

28:12This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.