Q&A: How to balance using retirement savings wisely with enjoying what you’ve earned

Dear Liz: I am 82, and my husband is 85. We are retired military, so we have a middling pension and some Social Security. Our monthly income of about $5,000 covers our monthly expenses. We rent in an independent living senior community. We have excellent health benefits via Tricare for Life. We both worked hard and are very thrifty. We have no debts.

We have savings of about $320,000. Our kids say we should spend some of our savings on cruises and things, but we just can’t let go! Are we in danger of running out of money? I am getting tired of always cooking and would like to eat out now and then. We do not want to be a burden for our kids and grandkids.

Answer: Your kids have the right idea. While you can, you should be enjoying some of the pleasures you’ve earned. You’re also smart to be careful.

You face at least two major threats to your financial stability. One is a reduction in income when one of you dies. The survivor will receive one Social Security check instead of two, and the pension income could go away or be reduced, depending on the payment option chosen at retirement.

The other threat is the potential need for custodial care. A long stay in a nursing home or a prolonged period where you need help at home could eat through most if not all your savings. Custodial care that helps people perform daily activities such as bathing, dressing, eating or toileting is not covered by Medicare or other health insurance, including Medicare supplements or wraparounds like the plan you have. Instead, Medicare covers limited periods of skilled nursing care, which typically requires licensed nurses to provide, while supplemental and wraparound policies can help pay co-insurance for such care.

There is a government program that pays for custodial care, called Medicaid. To qualify, the person needing care typically must have no more than $2,000 in assets. The spouse is allowed to have up to $120,900, although the limit can be lower depending on the state.

A visit with a fee-only financial planner could help you determine how much you need to prepare for these events. With that information, you should have a better idea of how much more you can safely spend.

Q&A: Retirement can bring some complex tax questions

Dear Liz: I was in the twilight of my career when the Roth became available, and I contributed the maximum for those few years before retirement. After retirement, I dropped to the 15% tax bracket, so I did Roth conversions of my regular IRA to fill out that tax bracket until I was age 70½. My reasoning was that I would likely be in the 25% tax bracket when I started my required minimum distributions from my IRA, and that turned out to be true.

The scary part is that the tax-deferred money in the rollover IRA has continued to increase each year in total in spite of the required minimum distributions. My tax preparer says he has clients who would be happy with my problem, so I should tread softly with my tax complaints.

One thing I regret is funding a nondeductible IRA for a few years before the availability of the Roth IRA. The nondeductible contributions only represent about 1% of the total. That means I can’t access that money I have already paid taxes on unless I have depleted all of my tax-deferred monies. Do you have any suggestions?

Answer: Absolutely. Listen to your tax preparer. Most retirees would love to have these problems-that-aren’t-really-problems.

You were smart to “fill out” your tax bracket by converting portions of your IRAs. For those who aren’t familiar with the concept, it involves converting just enough from an IRA to make up the difference between someone’s taxable income and the top of his or her tax bracket.

The top of the 15% bracket is $75,900 in 2017, so a married couple with a $50,000 taxable income, for example, would convert $25,900 of their IRAs to Roths. They would pay a 15% tax on the amount converted (plus any state and local taxes), but the Roth would grow tax-free from then on and no minimum distributions would be required.

These conversions can be a great idea if people suspect they’ll be in a higher tax bracket in retirement.

Now on to your complaint about getting back the already taxed contributions to your regular IRA. Withdrawals from regular IRAs are taxed proportionately.

The amount of your after-tax contributions is compared to the total of all your IRAs, and a proportionate amount escapes tax. So if nondeductible contributions represent 1% of the total, you’ll pay tax on 99% of the withdrawal. You’re accessing a tiny bit of your after-tax contributions with each withdrawal.

If you don’t manage to withdraw all the money, that’s not the worst thing in the world. It means you didn’t outlive your funds. Your heirs will inherit your tax basis so they’ll access whatever you couldn’t.

Q&A: Roth IRA offers key tax feature

Dear Liz: In an article that ran in my local newspaper, you stated that, “Roths allow you to withdraw the amount you’ve contributed at any time without triggering income taxes or penalties.” I suggest that you review Pub. 590-B, where you will be reminded that, with some exceptions, withdrawals from a Roth IRA within the first five years will result in a 10% penalty.

Answer: The five-year rule applies only to earnings, not contributions. The IRS publication you reference states on page 30, “You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s).” There’s a helpful diagram on page 32 that explains when a distribution is made within five years of the year in which the Roth is opened, the “portion of the distribution allocable to earnings may be subject to tax and it may be subject to the 10% additional tax.” (Emphases added.)

Retirement distribution rules can be complex and it’s easy to make a mistake. But the fact that people can withdraw their Roth contributions at any time without taxes or penalties is not some obscure facet of these retirement accounts. It’s a central feature.

Unlike regular IRAs, where withdrawals are taxed proportionate to their earnings, a withdrawal from a Roth IRA is deemed to be from nondeductible contributions first. People have to withdraw more than they contributed to face a tax bill or penalties. If they’re over 59½ and the account has been open five years, their withdrawal of earnings will be tax-free and penalty-free.

Q&A: How to find your way out of difficult financial circumstances

Dear Liz: I desperately need your help! My husband, who is 91, is in the early stages of dementia. I just turned 88 and for the first time am responsible for making all the financial decisions.

We are deeply in debt and I don’t know the best way to proceed. We owe more than $40,000 on credit cards, nearly $50,000 on a home equity loan, $20,000 on solar panels and $3,500 for a timeshare.

I am thinking of getting a low-interest mortgage on our home to pay off all these debts. We have no savings left. I just don’t know if this is a good idea or who to go to for answers.

Answer: If you have a younger family member or friend you trust, please consider involving this person in your search for answers. The possible solutions you need to consider are complex and would be daunting even for someone with a lot of experience in making financial decisions.

Getting a mortgage could be one solution, assuming you can get approved and afford the payments. Start by consulting a mortgage loan officer at your bank to see if this is an option.

Another possibility is a reverse mortgage, if you have sufficient home equity. The reverse mortgage could allow you to pay off some or all of your debts without having to make monthly payments. If you have substantial equity, you also may be able to supplement your income.

The reverse mortgage would have to be paid when you sold the home, died or moved out. A housing counselor, available from many National Foundation for Credit Counseling agencies, can discuss those with you. You can get referrals at www.nfcc.org.

Bankruptcy is yet another option to consider.

If your income is below the median for your area, you may be able to file for Chapter 7 bankruptcy liquidation to legally rid yourself of the credit card debt and timeshare. You also may be able to erase the solar panel loan, if it’s unsecured. If you have a lot of equity in your home, though, you could be forced to sell the house to pay your creditors, making Chapter 7 a bad option.

The other type of bankruptcy, Chapter 13, allows you to keep more property but requires a repayment plan that typically lasts for five years.

If you don’t have a lot of equity, on the other hand, and your income is protected from creditors, you may be “judgment proof.” That means if you stop paying your unsecured debts, your creditors could sue you but be unable to collect. An experienced bankruptcy attorney can assess your situation and let you know your options.

Referrals are available from the National Assn. of Consumer Bankruptcy Attorneys, www.nacba.org.

If you don’t have a trusted person to help you sort through your options, or even if you do, consider hiring a fee-only planner who charges by the hour. An experienced planner who agrees to be a fiduciary — which means he or she puts your best interests first — can help ease your mind that you’re making the right choice.

You can get referrals from the Garrett Planning Network, www.garrettplanningnetwork.com.

Q&A: There’s a big difference in various kinds of bonds

Dear Liz: My mutual funds and IRA are mostly in stocks with very little in bonds. I’m thinking I should have more in bonds, but just don’t know how much I should transfer from the stock funds and which bond fund to pick. Are they all the same?

Answer: Just as with stock funds, bond funds have different compositions, fees and investment philosophies. There’s a fairly big difference, for example, between a rock-solid U.S. Treasury bond and a “junk” or low-rated bond.

There’s also a difference in fees between funds that are trying to beat the market (active management, which is more expensive) versus merely matching the market (passive management, which is less expensive and typically offers better results).

The ideal asset allocation, or mix of stocks, bonds and cash, also varies depending on your age and risk tolerance. There are a variety of asset allocation calculators on the web you can try, or you can consult a fee-only planner.

Another option is turn the task over to a target date retirement fund, which manages the mix for you, or a robo-advisor, which invests according to computer algorithms.

Whatever you do, keep a sharp eye on the fees you’re charged. The average bond fund had an expense ratio of 0.51% in 2016, according to the Investment Company Institute. There’s little reason to pay much more than that, and ideally you’d try to pay less.

Q&A: How to avoid outliving your retirement savings

Dear Liz: The wife and I are both 65. We both work, with a combined income of $125,000, of which we spend almost all. We have $550,000 in IRAs and $1 million in other investments, plus home equity of about $500,000. We’ll get $3,800 from Social Security if we start next year but plan to work until age 67. Should we wait until then to claim?

Answer: Both of you needn’t wait, but one of you should — the one who has the larger benefit.

As a married couple, you can get two checks — either two retirement benefits, or a retirement benefit and a spousal benefit that can equal up to half the primary retirement benefit. When one of you dies, the survivor will receive only one benefit, which will be the larger of the two checks you received as a couple.

It makes sense to maximize that benefit by waiting as long as possible to claim so that it can grow. After your full retirement age, which is currently 66, unclaimed retirement benefits grow by 8% each year you wait, until maxing out at age 70.

You have substantial investments that should sustain a comfortable retirement, but plenty of things could go wrong.

The fact you’re spending all your current income is worrisome. If you don’t ratchet back your consumption a bit at retirement, you may draw down your investments at a rate that isn’t sustainable. (Depending on your investment mix, an initial withdrawal rate of 3% or 4% usually is considered “safe,” or the most you should take to minimize the odds of running out of money.)

Even if you do rein in your regular spending, bad markets or unexpected expenses could cause you to exhaust your savings faster than you expect. The longer you live, the greater the odds you’ll run short of money. Maximizing one of your Social Security benefits can be a smart way to ensure you, or your survivor, have more income when you may need it most.

Before you retire, you should consult a fee-only financial planner about the best ways to tap your retirement accounts and claim Social Security.

Q&A: Authentication apps can help thwart hackers

Dear Liz: I’ve heard that authentication apps are a better way to go than two-factor authentication that texts codes to your cell phone. Can you explain more?

Answer: Two-factor authentication adds an additional layer of security to financial, email, social media, cloud storage and other accounts. The first factor is something you know, which is a typically a password, and the second is something you have, such as a code that’s texted to you or generated by a device or authentication app.

The second factor is important, since passwords can be guessed or stolen in database breaches. Texted codes can be intercepted by hackers, so security experts recommend using an authenticator. Three popular apps are Google Authenticator, LastPass Authenticator and Microsoft Authenticator.

To use an authenticator, you must first enable two-factor authentication on the account you want to protect. Unfortunately, not every account provider offers two-factor authentication, although they should. You can find whether yours does at twofactorauth.org.

If the account provider supports authentication, you’ll typically be asked to take a snapshot of a QR code using the authenticator app to establish a connection between your account and the app. When you later log in to those sites, you’ll be asked to type in the code randomly generated by the app.

Any security approach can be thwarted, but the idea behind two-factor authentication is making your accounts hard enough to crack that most hackers will move on to an easier target.

Q&A: Here’s how to find that annual free credit report

Dear Liz: Please tell me the website for the free credit check. At a department store checkout counter, a stranger’s name came up connected to my cellphone number. I think I should check my credit reports, but I don’t want to pay for what I understand I can get free.

Answer: It’s entirely possible a clerk simply made a mistake in entering another customer’s phone number. But you should be checking your credit reports regularly anyway, and this is as good an excuse to do so as any. The federally mandated free site can be found at www.annualcreditreport.com. Searching for “free credit reports” can turn up a number of other sites, so make sure you use the correct one.

Q&A: How to sort out the taxes when you sell your house

Dear Liz: I am trying to understand the capital gains tax exemption as it applies to the sale of a house. If I have no mortgage and I sell my house before I have lived in it for two of the previous five years that are now required for the exemption, is it based on the total selling price of the house or on the amount over what I paid for it? And what is the tax rate based on?

Answer: The home sale exemption can shelter from taxes up to $250,000 per owner ($500,000 for a couple) of capital gains from a home sale. If you don’t live in the home for at least two of the previous five years, you typically can’t use the exemption unless the sale was because of a change in employment, health problems that require you to move or an unforeseen circumstance that forced the sale.

The rules on these exceptions can get pretty tricky, so you’d need to discuss your situation with a tax pro. If you qualify, the amount of the exemption usually would be proportionate to the percentage of the two years that you actually lived in the home. If you sold after one year, for example, you might exempt up to $125,000 per owner.

Whether you have a mortgage does not affect the capital gains calculation. What matters is the difference between the price you get when you sell the house and the price you paid when you bought it.

From the sale price, you get to subtract any selling costs such as real estate commissions. From the purchase price, you can add in certain costs, such as home improvement expenses. What results after these adjustments is your capital gain for tax purposes.

If you have capital gains in excess of the exemption, you would pay long-term capital gains rates on that profit. Long-term capital gains are typically taxed at a 15% federal rate, although the highest-income taxpayers (those in the 39.6% bracket) may pay 20% and the lowest-income taxpayers (those in the 10% and 15% brackets, including taxable capital gains) pay a 0% rate.

States typically have additional taxes.

Q&A: Volunteering can fill a void for unhappy retirees

Dear Liz: I was very disappointed in your response to the reader who was unable to cope with unplanned retirement. The reader has sufficient assets but was unable to manage the loss of purpose. This is common, and maintaining purpose is one of the most important components of a healthy retirement.

You did not mention volunteer work as an option, and that is a shame. There are hundreds of organizations that need volunteers of all skill levels, and they come in every shape and size you can imagine.

There are social services, cultural, civic, social justice, child development, healthcare and senior organizations that exist only because of their volunteers. You can volunteer long term or short term, or even on occasion.

I have just spent the last five months running a series of events connecting retirees to organizations who need volunteers. My own retirement will be completely focused on doing all of the volunteer work I did not have time for while working.

Retirement is an excellent time to make your contribution to the community that helped you along the way.

Answer: Several people wrote in to suggest volunteering was the answer to the reader’s unhappiness with an involuntary retirement. Volunteering may indeed fill her time, but her point was that she found fulfillment in paid work. She rightly warned others that they need to think through what they might lose by retiring too early.

People may get more than paychecks for their labor. They can get recognition, respect, a feeling of achievement and a sense of mission. What they do may be a significant part of who they are — perhaps far more than they realize.

If they give that up without sufficient thought and planning, they may feel as if they’ve gone from a “somebody” to a “nobody” overnight. That can be a terribly hard adjustment that volunteering may not alleviate. Here’s another perspective:

Dear Liz: Your recent writing about considering when to retire and the dangers of a too-early retirement rings a big bell.

I am a psychotherapist who has worked with a number of people who were either considering retirement or who took early retirement. For those who took early retirement, the emotional problems associated with the large amount of both time and space in their lives after retirement, which they never fully considered, have been very surprising and upsetting for them.

To those working every day at jobs they don’t love, retirement seems like a great thing. But the reality of an open, unstructured life can present an array of problems — financial, relational and emotional — for the newly retired.

People should think about this decision carefully because it is hard to re-create a steady job. Or, even better, have a long hard conversation about it with someone close to you or a specialist like me.

Answer: Excellent advice. In addition to traditional therapists, there is a growing field of professionals who combine financial advice with psychological counseling. People can get referrals from the Financial Therapy Assn. at www.financialtherapyassociation.org.