Retirement–the long-awaited time in our lives when we can finally relax, explore our passions, and enjoy the fruits of our labor. However, for many, the years between retirement and when we are required to withdraw from our retirement accounts can be filled with strategic financial planning decisions, especially if you're also not yet tapping into Social Security benefits.
If you find yourself in this unique window, there are plenty of opportunities to optimize your financial future. Let's dive in.
1. The Roth Conversion Ladder
One of the significant benefits of having time between retiring and before starting Social Security or taking Required Minimum Distributions (RMD) from retirement accounts is the potential to be in a lower tax bracket. It can be an opportune moment to consider Roth IRA conversions. Converting Traditional IRA funds to a Roth IRA might make sense if you believe you'll be in a higher tax bracket in the future. While you'll owe taxes on the amount converted now, the advantage is that Roth IRAs grow tax-free and have no RMDs, offering flexibility in retirement income planning.
For example, suppose you retire and plan to live off savings for a few years before starting Social Security or taking RMDs. The interest in the savings account doesn’t add up to much income, so you could potentially find yourself in the 10% federal tax bracket or lower. If you also have a $2,000,000 Individual Retirement Account (IRA), once you turn 73 or 75, you will be required to take withdrawals. The initial withdrawal could be about $75,000. And if your combined Social Security is $60,000, you may find yourself in the 22% tax bracket. While you are living off savings, it may be an opportune time to convert some IRA dollars to Roth. You can pay a “cheaper” tax for the conversion by paying in the 10% or 12% tax brackets. Once converted to a Roth, you must wait five years, but then withdrawals are tax-free (assuming you are over the age of 59½).
Even if you expect your income to remain the same in the future, completing a Roth IRA conversion may make sense. If the current Tax Cuts and Job Acts law is allowed to expire in 2026 as it is set to do, many people may find themselves in a higher tax bracket.
If you are part of a couple filing a joint tax return, it’s likely both you and your spouse won’t die at the same time. When one of you passes away, the remaining spouse will file as a single person and will likely be in a higher tax bracket. For these reasons, you might consider a Roth IRA conversion. Note since there is a five-year waiting period to use funds once a conversion occurs, check with your financial advisor or tax planner.
2. Delaying Social Security for Greater Benefits
Each year you delay starting Social Security benefits beyond your Full Retirement Age up to age 70, you get an approximately 8% increase in monthly benefits. It might make sense for at least one spouse, especially the higher earner, to delay taking benefits to maximize the lifetime payout. That is because once one spouse passes away, one Social Security check is eliminated, and the surviving spouse will keep the higher Social Security check.
If you delay your Social Security, you are leaving money on the table to wait for a higher Social Security paycheck. Your financial advisor can model the break-even age–the age you need to live to for a higher paycheck to actually pay off. They can help you decide whether delaying one Social Security check or both works best.
3. Health Savings Account (HSA) Strategy
If you're eligible, HSAs offer a triple tax advantage: tax-deductible contributions, tax-free growth, and tax-free withdrawals for qualified medical expenses. If you're fortunate not to need to use these funds for medical costs immediately, they can serve as a supplemental retirement savings vehicle.
Note that you cannot add to your HSA once you start Medicare. You can pay for Medicare Part B and D, and Medicare Advantage plan premiums, deductibles, copays, and coinsurance; however, you cannot pay for Medigap premiums with HSA funds.
4. Tax-Efficient Withdrawal Strategy
If you are young enough that you're not mandated to take RMDs, you have the flexibility to strategize which accounts to withdraw from and when. Drawing down taxable accounts first might allow your tax-deferred accounts to grow, resulting in potential overall tax savings.
Combining this with Roth Conversions can be an excellent way of maximizing net income over time. An overall strategy needs to be developed to ensure proper cash flow now and in the future. A lot will depend on the makeup of your assets: retirement accounts, Roth IRAs, pension, Social Security, and individual or joint investment accounts.
5. Estate and Legacy Planning
With potentially significant assets accumulated, it's crucial to ensure that your estate plans reflect your wishes. When reviewing your estate plan, it is also a good time to discuss charitable giving strategies or establishing trusts that align with your legacy objectives.
The current Federal Estate tax exemption is $12,920,000 in 2023 (double this for married couples). If Congress doesn’t act, in 2026 the exemption will revert to the prior exemption amount. This amount is expected to be about $7,000,000. If your estate is expected to be higher than this, you may want to discuss with your financial advisor or estate planning attorney to see what you can do to reduce future estate taxes.
The Role of a Financial Advisor
Even though these strategies may sound enticing, they're not one-size-fits-all. Each individual's financial situation, goals, risk tolerance, and timeline are unique. This is where a financial advisor shines.
A skilled advisor can:
- Personalize Strategies: Based on a deep understanding of your financial situation, they can recommend which of the above strategies aligns best with your goals.
- Stay Updated: The financial landscape, especially tax laws, is ever-changing. Advisors keep abreast of these changes and ensure your plans stay optimized.
- Provide Peace of Mind: Retirement planning can be overwhelming. Having an expert by your side can offer reassurance and clarity.
Remember, retirement isn't just about money; it's about crafting the life you've always envisioned. The years leading up to taking Social Security or RMDs present a golden opportunity to fine-tune your financial strategies.
As with many things in life, guidance from a seasoned professional can make all the difference. Working with a financial advisor can help prepare you so that your pre-retirement years are spent not just planning for the future but relishing in the present. After all, the journey to retirement is as significant as the destination itself.