Q&A: When considering retirement, money isn’t the only factor

Dear Liz: You answer many questions about whether people are ready to retire. But there’s one other thing to consider besides money, and this is more important.

Folks need to seriously ask themselves whether they can handle being retired. I know I can’t stand it.

I have more than enough assets, plus a pension, plus healthcare, plus no debts or bills. I’m young and healthy. But I find happiness in work.

Unfortunately, I had to leave my job owing to conditions outside of my control. I now live in a beautiful house at the beach, with all my money and all the things I like to do — and I’m miserable. I’m looking for a part-time job. I live in a small community and there aren’t many jobs, but I’m hopeful to find one.

Tell your readers that it’s not only the advice of a financial planner, but also some good soul-searching that they’ll need, especially if someone is a manager or a highly educated professional. You can’t just give that up and go from full time to no time. At least work part time before retiring to make sure it’s what you want.

Answer: That’s excellent advice. Not everyone derives meaning and purpose from work, but many do, and an abrupt adjustment can be painful. Good luck in your search for a job that gives you a reason to get up in the morning.

Q&A: Don’t jump into early retirement without considering these things

Dear Liz: I am almost 59½. Can I retire at 60½?

I have $570,000 in a 401(k) and $180,000 in an IRA. I owe $253,000 on a condo that would sell for $600,000. I plan to buy a home next year for $400,000 and pay off the mortgage with the proceeds of the condo. Then I would be left with no bills. I will start collecting Social Security at 62 for approximately $1,850 a month.

I had a wonderful job for 23 years but something changed at work and now just going to work is hard on me. Let me know if you think this is doable.

Answer: That depends. How much do you need and want to spend?

Financial planners typically consider a 3% to 5% withdrawal rate as “sustainable.” The rate depends on how long you’re expected to live and your asset allocation, among other factors, but you should err on the conservative side if you expect to retire early.

A 3% initial withdrawal rate would give you $1,875 a month. A higher withdrawal rate could dramatically increase your chances of running short of money later in retirement.

While you might not have a mortgage, you would certainly have other bills, including the cost of healthcare insurance. If your employer is subsidizing your coverage, as many do, you could end up paying a lot more.

And if Congress dismantles or alters the Affordable Care Act, your health insurance could get even more expensive or perhaps hard to find. Your healthcare costs may go down once you qualify for Medicare at age 65, but they certainly won’t go away.

Also consider that taking Social Security retirement early means a smaller check for the rest of your life. If you do run short of money, that check may be your only source of income, and you may curse yourself for locking in the smaller amount.

You certainly shouldn’t bail on your job before you’ve had a fee-only financial planner look at your situation and see if your plans are realistic.

Q&A: Saving for retirement can’t wait

Dear Liz: I have a family member who at 57 has no savings, a house whose value is 58% mortgaged and debt from a family member of $180,000.

This person is just starting a new job that will cover expenses with about $1,000 left over each month. The job offers a 401(k) but doesn’t allow contributions until employees have been with the company for eight months.

This person has paid into Social Security so that will be there (hopefully!) at retirement. What would be the best way for this person to start saving toward retirement?

Answer: Your relative shouldn’t wait to be eligible for the 401(k). People 50 and older can contribute up to $6,500 annually to a traditional IRA or a Roth IRA, which is $1,000 more than the usual limit.

If your relative didn’t have a previous job that offered a workplace plan in 2017, then this year’s contributions to a traditional IRA should be deductible.

Next year, when your relative is eligible for the 401(k), the deductibility of contributions will depend on that person’s income. In 2018, deductibility begins to phase out when modified adjusted gross income reaches $63,000 for singles. If IRA contributions aren’t deductible, after-tax Roth contributions typically are a better deal, but the ability to contribute to a Roth begins to phase out for singles at $120,000 in 2018.

Encourage your relative to save and to delay starting Social Security for as long as possible. When Social Security makes up the majority of one’s income in retirement — as it will for your relative — it’s important to maximize that check.

It’s not clear why your relative has been saddled with a family member’s debt, but any retirement plan needs to include options for paying off, settling or even erasing (through bankruptcy) such a substantial amount. Your relative should talk to a credit counselor and a bankruptcy attorney to better understand the options.

Q&A: Saving for retirement also means planning for the tax hit

Dear Liz: I’m 40. We own our house and have a young daughter. Through my current employer, I’m able to contribute to a regular 401(k) and also a Roth 401(k) retirement account. My company matches 3% if we contribute a total of 6% or more of our salaries. Are there any reasons I should contribute to both my 401(k) and Roth, or should I contribute only to my Roth? My salary and bonus is around $80,000 and I have about $150,000 in my 401(k) and about $30,000 in my Roth. Thanks very much for your time.

Answer: A Roth contribution is essentially a bet that your tax rate in retirement will be the same or higher than it is currently. You’re giving up a tax break now, because Roth contributions aren’t deductible, to get one later, because Roth withdrawals in retirement are tax free.

Most retirees see their tax rates drop in retirement, so they’re better off contributing to a regular 401(k) and getting the tax deduction sooner rather than later. The exceptions tend to be wealthier people and those who are good savers. The latter can find themselves with so much in their retirement accounts that their required minimum distributions — the withdrawals people must take from most retirement accounts after they’re 70½ — push them into higher tax brackets.

That’s why many financial planners suggest their clients put money in different tax “buckets” so they’re better able to control their tax bills in retirement. Those buckets might include regular retirement savings, Roth accounts and perhaps taxable accounts as well. Roths have the added advantage of not having required minimum distributions, so unneeded money can be passed along to your daughter.

Given that you’re slightly behind on retirement savings — Fidelity Investments recommends you have three times your salary saved by age 40 — you might want to put most of your contributions into the regular 401(k) because the tax break will make it easier to save. You can hedge your bets by putting some money into the Roth 401(k), but not the majority of your contributions.

Q&A: Why tapping retirement cash early shouldn’t be done lightly

Dear Liz: I’m reaching out on behalf of my father, who does not know how to write emails. He was wondering if he pulls his money out of his IRA, how much will he get charged? Also, how much would he be able to give to his granddaughters without being charged?

Answer: Withdrawals from IRAs and most other retirement accounts are taxable. The tax bill will depend on his tax bracket and whether his contributions were pre-tax (deductible) or after-tax (non-deductible). If he withdraws money before age 59 1/2, he also may face tax penalties. A premature withdrawal can easily trigger a tax bill of 25% to 50%. Once the money is withdrawn, it also loses all the future tax-deferred returns it could have earned.

If he gives the money to his granddaughters, it’s unlikely he would face an additional tax bill. He would be required to file a gift tax return if the amount exceeded $14,000 per recipient in a year, but he would only have to pay gift taxes if the total amount he gives away in his lifetime over that limit exceeds $5.49 million.

Clearly, taking money out of a retirement account is a big deal and something that shouldn’t be done lightly. At the very least, your dad should consult a tax pro who can estimate the bill he’s likely to face. He’d be smart to consult a fee-only financial planner as well so he understands the potential effect this withdrawal could have on his future standard of living.

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.