Q&A: Avoid running out of money before you run out of breath

Dear Liz: I have two questions regarding the required minimum distributions from retirement accounts at 70½ years old. If I started taking 15% per year at 68, would I still be required to follow the IRS tables and take 27.4% at 70½? Also, can I take the required minimum distributions and roll them into a Roth?

Answer: Please, please, please hire a tax pro before you do anything else. Required minimum distributions can get complicated, and the cost of getting it wrong is huge. If you don’t withdraw enough, you’ll pay a whopping 50% federal penalty on the amount you should have withdrawn but didn’t. If you withdraw too much, you’re paying unnecessary taxes and losing years of future tax-deferred growth.

Which is exactly where you were headed. The IRS table to which you refer does not say you need to withdraw 27.4% of your nest egg at 70½. The 27.4 number is the distribution period. You divide your account balances by that figure to get the amount you’re supposed to withdraw the first year. Think about it: otherwise, your retirement accounts would be emptied within four years.

Even withdrawing 15% a year would exhaust your funds relatively quickly. A sustainable withdrawal rate — one that leaves you a reasonable chance of not running out of money before you run out of breath — is closer to 4%.

There are situations where you might want to start distributions early, even if you don’t need the money. Diligent savers might discover that their distributions would push them into a higher tax bracket if they wait until age 70½ to begin. When that’s the case, it can make sense to withdraw just enough to “fill out” their current tax bracket and pay a lower rate now rather than a higher rate later.

Here’s a simplified illustration. Let’s say a couple in their 60s has a large retirement portfolio and waiting until their 70s to start withdrawals would push them from their current 15% bracket to the 25% bracket. Instead, they might begin taking distributions early. If their current taxable income is around $30,000, for example, they could withdraw as much as $45,900 before being kicked into the 25% bracket, which begins at $75,900 for married couples.

These calculations have lots of moving parts, including different tax rates for taxable investments and for Social Security. That’s another reason to have a tax pro help you run the numbers.

Your pro will tell you that you can’t avoid taxes by rolling required minimum distributions into a Roth. You can contribute new money to a Roth, but only if you have earned income and your modified adjusted gross income is under certain limits. Those limits start to phase out at $118,000 for single filers and $186,000 for married couples filing jointly.

Q&A: Starting Social Security benefits early will cost you

Dear Liz: I started getting Social Security at age 62. I would have only gotten $327 a month based on my work history, but they gave me $666 based on my husband’s work history. He gets $1,966 but your article said I should get half. Should I be receiving more?

Answer: Probably not.

Your spousal benefit would have been half of your husband’s “primary benefit amount” only if you’d waited until your own full retirement age to apply. Because you started several years early at 62, your check was reduced by 30%.

His primary benefit amount is what he would have received if he started benefits at his own full retirement age. Full retirement age is currently 66 and will rise to 67 for people born in 1960 and later.

Q&A: My 401(k) is making only 2-3%, so why not borrow from it and pay it back at 5%?

Dear Liz: You have warned in the past about the risks of a 401(k) loan. I have been investing now for 15 years, and the last 14 years, my average return has been between 2% and 3%. I am considered moderately aggressive in my choices of international (24%), large and small cap (52%), midcap (16%) and 8% in bonds.

It has been an absolute joke (until last quarter) so I took out a loan a few years ago and was planning on doing it again when the first is repaid in approximately two years. I look at it as a 5% return to make myself a little something in an unstable and nasty market. I see the loan as my best consistent return option.

Answer: There is something wrong with your portfolio if your average annual return has been that low — and if you think paying returns out of your own pocket is a better option than putting your money to work in the markets.

If you had invested in a plain vanilla balanced fund 15 years ago, with 60% of its portfolio in stocks and 40 percent in bonds, you would have received an average annual return of over 9% (and it would be up 10% in the last year alone). While you wouldn’t have achieved 9% every single year, and your returns would vary based on when you bought your shares over the years, you certainly should have done better with your portfolio than you have.

It’s possible your plan charges higher-than-average fees or your investment choices have higher-than-average expenses. A site called FeeX will evaluate your 401(k) portfolio for free and show you how its costs stack up against other plans. You may be able to move to less expensive options within your plan or press your company to look for lower-cost providers.

The loan you took out depressed your returns as well. That money was pulled out of your investments, so it wasn’t able to participate in the market’s growth. The 5% interest rate you’re paying may seem cheap, but it’s a bad deal when compared to the returns the money could have been earning.

Q&A: When waiting to take Social Security doesn’t make sense

Dear Liz: I receive $2,400 per month in Social Security. My wife, who turned 66 in early April, was told by the Social Security Administration that her retirement benefit will be about $800. Can I get spousal benefits for her of $1,200, less what her Social Security amount will be? My problem is that she wants to wait to get her maximum amount of Social Security. Could she start spousal benefits now or does she have to wait until age 70?

Answer: Waiting would be pointless. Even though she would boost her retirement benefit by 8% each year, or a total of 32% by age 70, she still would receive less than if she just signed up for spousal benefits now.

Because she has reached her full retirement age of 66, her spousal benefit would equal 50% of what you’re receiving. (Technically, she will receive her own benefit plus an additional amount that brings her up to 50% of your benefit.)

Delayed retirement credits, which increase retirement benefits between full retirement age and age 70, don’t compound but increase benefits by two-thirds of 1% each month. There are no delayed retirement credits for spousal benefits, but spousal benefits are reduced when people start them before their own full retirement age.

Q&A: Start saving early for retirement in case that last day of work sneaks up on you

Dear Liz: What advice would you give to a Silicon Valley professional who hasn’t done a good job planning for retirement? I’m 53 and maxing out my 401(k), saving $24,000 a year with my employer matching my contributions dollar for dollar up to 6% of salary. In addition, I’m saving $50,000 to $60,000 of my $240,000 annual salary. I’m debt free.

I wish I had started saving like this early in my career. Looks like I’ll probably have to work until I’m at least 65 or 70. Any advice on retirement planning would be greatly appreciated.

Answer: Your current savings rate is impressive, but you probably should plan to work at least until your full retirement age for Social Security, which is age 67.

Retiring earlier would require you to cut back even more on your spending or increase the odds your funds won’t last you through a long retirement.

Early retirement may be involuntary, of course.

Many people retire sooner than they expect thanks to a layoff, a health crisis or the need to take care of a family member. That is yet another reason why people should get started saving for retirement as early as possible — they may not have as many years to save as they think, and making up for lost time gets increasingly difficult the longer they wait.

Most people aren’t in the fortunate position to be able to save 30% or more of their incomes in their 50s, which means catching up is close to impossible.

You may still have options if your career and your savings sprint are cut short.

If you own a home, you can tap the equity either by downsizing (selling and moving to a smaller place) or using a reverse mortgage. You can reduce your expenses, possibly by moving to an area with a lower cost of living. You can supplement your retirement income by working part-time.

You also should consider maximizing your Social Security check by delaying benefits until age 70, even if you wind up retiring earlier. Social Security benefits grow by 8% a year between full retirement age and age 70, which is a guaranteed rate of return you can’t find anywhere else.

Delaying Social Security is a way to insure against longevity — if you live longer than you think and run out of other money, that larger check can help protect you from poverty at the end of your life.

Q&A: Keeping retirement money in various accounts helps with tax bills

Dear Liz: I am having difficulty determining if I should invest money in my 457 deferred compensation account or in a taxable account, as I am in the 15% tax bracket.

Also, does it matter whether I invest in a Roth IRA instead of my traditional IRA? My biggest pot of money is in a taxable account, then my IRA, then a Roth. I am single, no dependents and over 50.

Answer: In retirement, having money in different tax “buckets” can help you better control your tax bill.

Taxable accounts, for example, can allow you to take advantage of low capital gains tax rates plus you can withdraw the money when you want: There are no penalties for withdrawals before age 59½ and no minimum distribution requirements.

Tax-deferred accounts allow you to save on taxes while you’re working but require you to pay income taxes on withdrawals — and those withdrawals typically must start after you turn 70½.

Roth IRAs, meanwhile, don’t have minimum distribution requirements, and any money you pull out is tax free, but contributions aren’t tax deductible.

Because most people drop to a lower tax bracket in retirement, it often makes sense to grab the tax benefit now by taking full advantage of retirement accounts that allow deductible contributions.

That means the 457 (generally offered by governmental and nonprofit entities) and possibly your regular IRA. (Your ability to deduct your IRA contribution depends on your income, since you’re covered by the 457 plan at work.)

If your IRA contribution isn’t deductible, then contribute instead to a Roth. If you still have money to contribute after that, use the taxable account.

If you expect to be in the same or higher tax bracket in retirement, though, consider funding the Roth first. Prioritizing a Roth contribution also can make sense if you have plenty of money in other retirement accounts and simply want a tax-free stash you can use when you want or pass along to heirs.

Q&A: Social Security lets you un-retire to avoid a benefit hit, but only once

Dear Liz: My wife recently retired at age 62 and will collect Social Security. But she has decided to return to work full time. I know she will collect less if she makes more than Social Security allows per month. If she eventually goes back to not working at all, can she go back to collecting the original amount?

Answer: Yes, but she’d be smart to reconsider her decision to start collecting Social Security early because she’s permanently reducing her benefit for little (if any) good reason.

The earnings test, which applies when people start Social Security early, takes away $1 of benefits for every $2 she earns over a certain limit, which is $16,920 in 2017. The earnings test will end when she reaches her full retirement age, which for people born in 1955 is 66 years and two months. Her check at that point would be what she originally received at 62, plus any cost of living increases.

But that original check is reduced by nearly 25% from what she would get at full retirement age, and the reduction lasts for the rest of her life. That’s a huge hit, and it should make her question the advisability of starting benefits early when so much could be taken away from her.

Fortunately, she has a little time to change her mind. Social Security allows applicants to withdraw their applications, allowing their benefit to continue growing, if they do so within 12 months of becoming entitled to benefits. People who withdraw their applications have to pay back any benefits that received in order to restart the clock.

This is a one-time do-over: Applications can be withdrawn only once in a lifetime and can’t be withdrawn after a year has passed. She can read more about this at the Social Security site, https://www.ssa.gov/planners/retire/withdrawal.html.

Social Security benefits make up half or more of most people’s retirement income. Making smart decisions is essential if you want to avoid a lifetime of regret.

At a minimum, people should use a free claiming-strategies calculator, such as the one on the AARP site, to determine when and how to begin benefits. For $40, they can use more sophisticated planners such as MaximizeMySocialSecurity.com and SocialSecuritySolutions.com.

Another good option is to consult a fee-only financial planner familiar with Social Security claiming strategies to make sure they’re not making an irrevocable mistake.

Q&A: Deferred compensation plans

Dear Liz: I’m 54 and plan on retiring at 55 with a government pension. I have about $450,000 in a 457(b) deferred compensation plan. I owe about $220,000 on my home. I would like to pay off my 15-year, 2.5% interest mortgage. This would free up $1,900 a month and leave us debt-free. Everyone I’ve spoken to says this is a bad idea since I’d lose my mortgage interest deduction and I’d be “investing” in a low-interest vehicle (my mortgage). My only other obligation is my daughter’s college education, and I’m paying that in cash. Am I crazy to pay off this mortgage?

Answer: You’re not crazy, but you probably haven’t thought this all the way through.

The money in your deferred compensation plan hasn’t been taxed. Withdrawing enough to pay off your mortgage in one lump sum would shove you into a higher tax bracket and require you to take out considerably more than $220,000 to pay the tax bill. You could easily end up paying a marginal federal tax rate of 33% plus any applicable state tax — all to pay off a 2.5% loan.

There are a few scenarios where using tax-deferred money to pay off a mortgage can make sense. Some people have so much saved in retirement plans that the required minimum distributions at age 70½ would push them into high tax brackets and cause more of their Social Security to be taxed. They also may have paid down their mortgage to the point where they’re no longer getting a tax break.

In those instances, it may be worth withdrawing some money earlier than required to ease the later tax bill. The math involved can be complex, though, and the decisions are irreversible, so anyone contemplating such a move should have it reviewed by a fee-only financial advisor who is familiar with these calculations.

In fact, it’s a good idea to get an objective second opinion from a fiduciary any time you’re considering tapping a retirement fund. (Fiduciaries are advisors who pledge to put your interests ahead of your own.)

During your meeting, you also should review the other aspects of your retirement plan. How will you pay for health insurance in the decade before you qualify for Medicare? If you’re a federal employee, you should be eligible for retiree health insurance but your premiums may rise once you quit work. If you’re planning to buy individual coverage through a healthcare exchange, what will you do if that’s yanked away or becomes unaffordable? How will you pay for long-term care if you need it, since that’s not covered by health insurance or Medicare?

You can get referrals to fee-only financial planners from the National Assn. of Personal Financial Advisors at napfa.org. You can find fee-only planners who charge by the hour at Garrett Planning Network, garrettplanningnetwork.com.

Q&A: Money in the bank isn’t safe from inflation

Dear Liz: I am 68 and not in very good health due to heart disease. I’m not sure what do with my savings of over $1 million, which sits in online bank accounts, earning 1.25% to 1.35% in 18-month certificates of deposit. (No account contains more than $250,000 to remain under the FDIC insurance limits.) The money will eventually go to my daughter, though I could use it for my retirement. I don’t have the appetite for market swings. What should I do with my money?

Answer: Your money currently is safe from just about everything except inflation. If you want to keep your nest egg away from market swings, you’ll have to accept that its buying power will shrink. There is no investment that can keep your principal safe while still offering inflation-beating growth.

If you do want a shot at some growth, you could keep most of your savings in cash but also invest a portion in stocks — preferably using low-cost index mutual funds or ultra-low-cost exchange-traded funds.

Before you know how to invest, though, you’ll need to think about your goals for this money. A fee-only financial planner could help you discuss the possibilities and come up with a plan. You can find fee-only planners who charge by the hour through the Garrett Planning Network, www.garrettplanningnetwork.com.