Ask Liz Weston

Get smart with your money

Retirement

Q&A: Investing during retirement

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Dear Liz: I’ll be retiring shortly. After 30 years of public service, I’m fortunate to have a generous pension. I’ll be paying off all my debts upon retirement, including my mortgage. I have a deferred compensation account that I will leave untouched until I’m required to take disbursements at 70 1/2 (15 years from now). Until then I will have disposable income but no significant tax deductions. Short of investing on my own in a brokerage account (and perhaps incurring capital gains taxes), are there any other investment vehicles that perhaps would be tax friendlier?

Answer: A variable annuity could provide tax deferral, but any gains you take out would be subject to income tax rates, which are typically higher than capital gains rates. (Annuities held within IRAs are subject to required minimum distributions starting after age 70 1/2. Those held outside of retirement funds will be annuitized, or paid out, starting at the date specified in the annuity contract.) Also, annuities often have high fees, so you’d need to shop carefully and understand how the surrender charges work.

Many advisors would recommend investing on your own instead and holding those investments at least a year to qualify for lower capital gains rates. This approach is particularly good for any funds you may want to leave your heirs, since assets in a brokerage account would get a “step up” in tax basis that could eliminate capital gains taxes for those heirs. Annuities don’t receive that step-up in basis.

You also shouldn’t assume that waiting to take required minimum distributions is the most tax-effective strategy. The typical advice is to put off tapping retirement funds as long as possible, but some retirees find their required minimum distributions push them into higher tax brackets. You may be better off taking distributions earlier — just enough to “fill out” your current tax bracket, rather than pushing you into a higher one.

Q&A: Options for a pension payout

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Dear Liz: I am a single, 52-year-old female. I just received some information about my pension from a previous employer that gives me the option to take a lump sum of $18,701 that I can roll it into an eligible retirement plan. Or I could also take it now and be subject to penalty and taxes. Or I could defer taking payment until I’m 65, when I would start getting a monthly estimated check worth $218.68. The time is limited to make my decision. I don’t need income now, so I am interested in taking the rollover and severing ties with them. But I could wait until I am 65 and take the monthly payments. Which deal is better financially?

Answer: Theoretically you can do better with the lump sum — assuming you roll it over into an IRA or other retirement plan, invest at least half of it in stocks for long-term growth and keep your hands off the money until you’re ready to retire. If you would be tempted to do something stupid like cash out, then you’re better off with the annuity. The annuity check also is for life, while the fate of the lump sum depends on market returns.

Q&A: Social Security benefits for children

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Dear Liz: My older brothers-in-law signed up for Social Security benefits at 62 and then suspended their benefits so that their children, who were under 18, could receive 50% of their checks. Is this process still available at age 62 for those with children who are below the age of 18?

Answer: In order for family members to receive spousal or child benefits based on the primary earner’s work record, that primary earner has to be receiving his or her own benefit.

In the past, people who had reached full retirement age — which used to be 65, is now 66 and is rising to 67 — had the option of immediately suspending their applications so their family could receive benefits while their own continued to grow. The “file and suspend” option was not available to people who applied for benefits before their full retirement age. And now it’s no longer available period, thanks to Congress.

If you do apply for your benefit early, keep in mind that your checks — and your children’s checks — will be subject to the earnings test. That reduces Social Security benefits by $1 for every $2 you earn over $16,920 in 2017. (The earnings test goes away at full retirement age.) Your benefit also will be reduced to reflect the early start.

Also, there’s a limit to how much a family can receive based on the worker’s record. The family maximum can be from 150% to 180% of the parent’s full benefit amount.

If you’re still working and your children will be younger than 18 by the time you reach full retirement age, it may make sense to wait until then to apply. To know for sure, though, you should use one of the calculators that takes child benefits into account, such as MaximizeMySocialSecurity.com.

Q&A: How much risk is too much in retirement?

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Dear Liz: If you have all your required obligations covered during retirement, is having 70% of your portfolio in equities too risky?

Answer: Probably not, but a lot depends on your stomach.

Retirees typically need a hefty dollop of stocks to preserve their purchasing power over a long retirement, with many planners recommending a 40% to 60% allocation in early retirement. A heftier allocation isn’t unreasonable if all of your basic expenses are covered by guaranteed income, such as Social Security, pensions and annuities. Ideally, those pensions and annuities would have cost-of-living adjustments, especially if they’re meant to pay expenses that rise with inflation.

Historically, retirees have been told they need to reduce their equity exposure as they age, but there’s some evidence that the opposite is true. Research by financial planners Wade Pfau and Michael Kitces found that increasing your stock holdings in retirement, where the allocation starts out more conservative and gets more aggressive, may reduce the chances of running short of money. Their paper, “Reducing Retirement Risk with a Rising Equity Glide-Path,” was published in the Journal for Financial Planning and is available online for free.

That said, you don’t want your investments to give you ulcers. If you couldn’t withstand a big downturn — one that cuts your portfolio in half, say — then you may want to cushion your retirement funds with less risky alternatives.

Q&A: Social Security calculators may overestimate your benefits

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Dear Liz: All of the Social Security calculators that I have found assume that you will work until you start drawing Social Security benefits. However, I plan on retiring around 62 but not drawing my benefits until age 66 or later. Whenever I calculate my future benefits, the calculator assumes that I will continue to draw the same salary as I have today until I start benefits. I’m worried the calculators are overestimating my benefit.

Answer: As you probably know, Social Security uses your 35 highest-earning years to calculate your benefit. When you work longer than 35 years, you’re typically replacing your lower-earning years in your teens or 20s with higher earnings from your 50s and 60s.

Free Social Security calculators usually assume that pattern will continue. If you stop working or earn less, the calculators may overstate your benefits. To get a better estimate, you’ll need to shell out $40 to use MaximizeMySocialSecurity.com, which allows you to customize your future earnings assumptions.

Q&A: What to consider when investing in target date retirement funds

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Dear Liz: I have 100% of my 401(k) in a fund called “Target Retirement 2030.” This fund is made of several other funds, so does that qualify as “diversified”?

Answer: It does. Target date funds have become increasingly popular in 401(k) plans because they do the heavy lifting for investors. The funds select asset allocations and grow more conservative in their mix as the retirement date approaches.

Target date funds aren’t perfect, of course. Some are too expensive. The typical target date fund charges about 1%, but Vanguard and Fidelity charge as little as 0.15%.

Another issue is the “glide path” — how quickly the funds get more conservative. There’s no consensus about what the right glide path should be, and investment companies offer a lot of different mixes. Any given glide path may be too steep for some people and too shallow for others, depending on their circumstances. As an investor, you can compensate for that by choosing funds dated later or earlier than your targeted retirement date. If the 2030 fund gets too conservative too fast for your taste, for example, you could choose the 2040 fund instead.

Despite the downsides, you’re likely to be much better off in a target date fund than you are in some of the other options. Too often novice investors take too much or too little risk without realizing it. They may have all of their money in “safe” low-return options, which means they’re losing ground to inflation. Or they may have all their money in stocks, including their own company’s stock, and would be unprepared for a downturn wiping out a good chunk of their portfolio’s value.

Even those who know they should diversify often do it wrong by randomly distributing their contributions across their investment options. If you don’t know what you’re doing, or you simply prefer investing professionals to take charge, target date funds are a good way to go.