Category: longtermcare

The 7 Most Tax Efficient Retirement Income Strategies

Tax efficiency maximizes retirement income!

When I started my first job as a soccer referee at 12 years old, my Mom used to tell me; “it’s not what you earn, it’s what you keep!” 

I’m not sure if working at 12 years of age is legal any longer, but I’ve had a job ever since.  My Mom instilled in me the value of forced savings and paying yourself first.   (thanks, Mom!)

I’ve been practicing financial planning now for over 14 years, and I find this quote is highly relevant for taxes.

Tax inefficiency of retirement income is one of the biggest drags on returns.   In fact, taxes are likely the largest expense for retirees, even more so than healthcare costs!

While we can’t control the stock market, we can control our taxable income (to a certain extent).

This article will outline the 7 most tax efficient retirement income withdrawal strategies so you can maximize spending on your lifestyle, not the IRS. 

1. Roth IRAs + other Roth Accounts

As you know, this is one of my favorite tax efficient income strategies for retirement.  Sure, you will forgo the tax deduction for contributions, but in exchange for a lifetime of tax free (“qualified”) withdrawals.   I’ll take that tradeoff any day!

Here is the nuts and bolts of how these accounts work:

  • You make a contribution (whether it’s payroll deductions with work or IRA contributions).
  • You invest the money according to your goals and risk tolerance.
  • Enjoy tax free withdrawals, assuming they are “qualified”:
    • The account is at least 5 years old (for an IRA)
    • You are 59 ½ or older

Your contributions in these accounts are always tax and penalty free, but you might have taxes and penalties on earnings if your withdrawal is “nonqualified.” 

There are some exceptions like for first time home purchases, educations expenses, etc.  But if you are reading this, these will likely not be of interest to you anyhow!  Why would you cash in your most tax efficient retirement vehicle for anything other than retirement?

There are some limitations on these accounts.

Contributions:

  • For Roth IRAs – the max contribution for 2022 is $6,000/year (if you are over 50, you can contribute $7,000/year)
  • For a Roth 401k/403b – the max contribution for 2022 is $20,500 (if you are over 50, you can contribute $27,000/year)

These contribution limits are per person.  If you are married, your spouse has their own limits to take advantage of.

Income phaseouts:

If you are over a certain income threshold, you might be phased out completely from a Roth IRA contribution (don’t worry, there may be a loophole).

Roth 401ks/403bs etc. are NOT subject to income phaseouts.  You can make $1million/year and still max out a Roth 401k.  Check out your 401k plan rules to see if there is a Roth option in lieu of the traditional.

Enter the backdoor and mega backdoor Roth contributions

In 2012, the IRS lifted the income limits for “Roth conversions.”  A Roth conversion simply means you convert all or a portion of your Traditional IRA to your Roth IRA.  You will then be responsible for any taxes due at that time.  However, you may find this compelling based on your expectations on where taxes might go in the future.

Here’s the loophole…there is no income cap for non deductible IRA contributions.  Therefore, savvy tax planners can make non deductible IRA contributions, and immediately convert those dollars into their Roth IRA!  This is known as a backdoor Roth contribution!

Pro tip – be careful of the IRA aggregation rule or your conversion may not be tax free!

Now, companies are starting to allow for “Mega Roth 401k/403b conversions!” Depending on your plan rules, you can not only contribute the maximum to a Roth 401k, but you can make an additional non deductible contribution up to the 402g limit.  That non deductible contribution can then be converted to your Roth 401k to enjoy tax free growth!  

Sound too good to be true?  Well, lawmakers are looking to shut this down ASAP, so take advantage while you can and read your plan rules to see if it’s allowed.

tax planning for retirement

2. Health Savings Accounts (HSA)

Healthcare will likely be one of your largest expenses in retirement, so why not pay with tax free income? 

In order to participate in an HSA, you must have a high deductible healthcare plan.  Talk to your HR team about which plans allow for these accounts.  

In general, if you are going to the doctor frequently or have higher than average medical bills, a high deductible health care plan may not be right for you.  However, if you are pretty healthy and don’t go to the doctor often, you might consider it so you can take advantage of the tax free HSA.

HSA’s have a triple tax benefit:

  • Tax deductible contributions
  • Tax free growth
  • Tax free distributions (if used for qualified medical expenses)

This triple tax benefit is the reason it’s one of the most tax efficient retirement income strategies!

You can also use an HSA to help pay for long-term care costs or even pay long-term care insurance premiums tax free.  

Try not to tap into this account early

You might be tempted to reimburse yourself the year you have a major surgery or other medical bill.  If you can pay out of pocket, do that instead!  As your account grows, you can even invest it according to your risk tolerance and time horizon.  This helps amplify the benefit of tax free compounding!

Save your medical bill receipts

There is no time limit on when you reimburse yourself.  You could have surgery in 2022, and reimburse yourself anytime in retirement tax free!

Planning a major trip in retirement?  Take a look at some medical bills you paid 20 years ago and reimburse yourself from the HSA…now you have more money to enjoy that trip instead of paying Uncle Sam!

Don’t leave this as a legacy

Your beneficiaries (other than a spouse) will have to liquidate the HSA the year you pass away, which could create an unnecessary tax bill for your heirs.  Spend it while you can, name your spouse as beneficiary, and enjoy this triple tax advantaged account!

3. Life Insurance

Life Insurance is an often misunderstood, misrepresented, and misused financial tool for retirement.  However, it can be used as a tax efficient retirement income strategy, or a tax efficient intergenerational wealth strategy (dual purpose!).

I started out with a life insurance company and am so thankful I did.  First and foremost, I was taught to load up on life insurance while I was young and healthy (even before needing it), to lock in my insurability and health profile. 

Secondly, I was taught the benefits of permanent insurance and loaded up on this as well.  Again, before having any insurance needs at all! 

Over time, the cash values have grown, and I’ve been able to tap into this asset class at opportune times when other asset classes were temporarily at a discount! 

Ever hear of the concept “buy low, sell high?”  Well, how do you buy low if all of your assets are down at the same time?

As we’ve seen with the market in 2022, bonds are not immune to significant drops in performance.  Life insurance keeps on keeping on!

Long term, my plan is to keep the insurance as a tax free legacy for my three boys (and hopefully grandbabies!).  There is no other financial vehicle that provides an amplified tax free death benefit like life insurance. 

Which type of insurance should I own?

Raising children is expensive.  Inflation has made it even more difficult!  If you are strapped for cash and are worried about making rent or your mortgage on time, you should buy some inexpensive term insurance and protect your family.  

Pro tips:

  • Buy lots of coverage – a rule of thumb is 10x – 16x your gross income, but some insurance companies allow you to buy 25x your gross income!
  • Make it portable.  If you are healthy, buy a policy NOT tied to your workplace, as you never know how long you will stay there.
  • Make sure it’s convertible.  Even though you may not be a good candidate for permanent insurance today, that may change over time.  Perhaps when your kids are out of the house, or your mortgage is paid off, or your income has skyrocketed.  Being able to convert to a permanent policy without medical underwriting is extremely helpful.  

For those of you comfortably maxing your tax advantaged retirement plans and HSA’s (as discussed previously), overfunding a permanent life insurance policy can be a great supplemental savings tool.  

There are multiple flavors of permanent life insurance that we won’t go into detail on in this article.  But in general, you can invest in fixed products or variable products.  This feature will impact the performance of your cash value, and potentially your death benefit.  

You can also add a long-term care rider on some policies to kill two birds with one stone.  That way, if you are someone who never needs long-term care, your family will still receive the death benefit.  

What I have found is that the intention might be to use this cash value as a tax efficient retirement income strategy, more often it’s used for the death benefit.  All of you diligent savers will accumulate assets in your 401ks/IRAs, taxable brokerage, HSA’s etc., and you might realize that this amplified death benefit is best used to enhance your intergenerational wealth objectives.  Plus, it gives you a license to spend down your other assets in retirement “guilt free.”

Don’t worry about making that decision today, but just know this asset can be a flexible vehicle throughout your lifetime.

4. Taxable Brokerage Accounts

This bucket is one of my favorite tax efficient retirement income strategies for three reasons:  

  1. There is no income restriction on who can contribute
  2. There is no cap on contributions
  3. There is no early withdrawal penalty

The title of this account sometimes leads people to believe it’s not tax efficient.

And this can be true if you invest in certain securities within the taxable brokerage account.

However, if you are strategic with your security selection, you can have minimal tax liability during the accumulation phase.  

In retirement, you can then use losses to offset gains, sell certain blocks of securities with limited capital gains, and use tax free income as cash flow by investing in municipal bonds (if appropriate).

I find this tool is great to maintain flexibility for funding college, saving for retirement, or any other major expenditures along the way. 

Intergenerational Wealth Planning

Certain assets are better used during your lifetime instead of passing on to your heirs, as we discussed with the HSA.  However, taxable brokerage accounts are extremely tax efficient for intergenerational wealth planning

When you pass away, your beneficiaries will get a “step up in cost basis” which will limit their tax liability if/when they sell that asset themselves.  

All in all, this can be a great multi functioning tool for retirement income, legacy, or any other major opportunity that comes along!

minimize taxes in retirement

5. Non Qualified Annuities

I find consumers have a negative connotation associated with the term annuity.  And, rightfully so.  These products, like life insurance, are often oversold or inappropriately utilized.  

In it’s purest form, annuities are used to provide a guaranteed income stream in retirement.  Think Social Security or a Pension. 

Creating a “retirement income floor” is one of the most powerful things you can do for yourself.  Believe me, when the markets go south, you don’t want to be worried about how to fund your basic living expenses in retirement.  

However, if Social Security + Pension + Annuity income covers your basic necessities, you can avoid losing sleep at night when the markets do take a dive (which they will!).

The tax efficiency components are twofold:

  1.  Tax deferred growth, much like a traditional 401k or IRA
  2. Exclusion ratio for lifetime annuity income

For you high income earners, you will want to limit tax drags on  your savings.  However, once you are maxed out of your qualified retirement plans, you’re going to be wondering where to go next.  One of the  benefits for annuities is the tax deferred growth.  You won’t receive a 1099 until you start the income payments in retirement!  

In retirement, instead of the gains being withdrawn first (“LIFO”), you can take advantage of the exclusion ratio.  This allows for a portion of your retirement income to be a return of basis, and a portion to be taxable income.  Therefore, it’s a great way to spread the tax liability over your lifetime. 

In retirement, if you decide you don’t need this income stream, you can flip on the switch to fund other tax efficient vehicles like life insurance or long-term care insurance.  

Intergenerational Wealth Planning

In years past, annuities were a terrible way to leave a legacy for your children.  Beneficiaries were often forced to take a lump sum distribution or take payments over a short period of time.  Now, some annuity contracts allow for the children to turn their inherited annuities into a life income stream.  This can also help spread out the tax liability over a much longer period.

I still recommend using these accounts during YOUR retirement phase and leave other assets to your children.  Having your beneficiaries deal with the death claim department within annuity companies can be a nightmare!

6. Reverse Mortgage

One of the largest, if not the largest, asset on your balance sheet over time will be home equity.  However, many retirees don’t maximize their home equity as an income tool, which could be a mistake. 

In simple terms, a reverse mortgage allows the homeowner to stay in their home as long as they live.  These products essentially flip your home equity into an income stream.  The income stream now becomes a loan with your home as collateral. 

Because it’s a loan, the income is not taxable to the borrower! 

Instead, the loan will be repaid from the home sale proceeds when you move, sell your home, or pass away. 

Creating this essentially tax free income stream can allow you to preserve other liquid assets on your balance sheet, like the ones mentioned above. 

It can also be a part of the “retirement income floor” concept that we mentioned previously.

7. Real Estate Income

You often hear of real estate investors paying little to no taxes.  The basic reason is the ability to deduct ongoing expenses from the income.

  • mortgage payments
  • taxes
  • insurance
  • maintenance
  • property management fees
  • And the “BIG D”  – Depreciation!

This depreciation expense is the real wildcard as it can essentially wipe out any taxable income you would otherwise have to report.  Depending on the property type, this can amount to approximately 3.6% of the cost basis year after year!  There is some “true up” at the end when you go to sell the property, but it’s a huge advantage to minimize taxable income while your property still cash flows! 

And once you sell the property, you can even take advantage of a 1031 tax free exchange and buy another investment property that better suits your overall financial goals.

Investing in real estate is not for everyone.  And it’s certainly not a passive activity, even if you have a property manager.  Studying your market, analyzing trends, upgrading your property and dealing with bad tenants are ongoing challenges.  

However, if you do it right, this can be an extremely tax efficient retirement income strategy.

Final word

Minimizing taxes in retirement is one of the most impactful ways to maximize your cash flow!  

However, most people don’t think about taxes in retirement…until they are about to retire!

These strategies only work if you begin building the framework 10, 20 or even 30 years before you quit your day job.  Furthermore, not all of the strategies discussed will make sense given your goals and financial circumstances. 

It’s important to consult with a fiduciary financial advisor that can take a comprehensive look at your financial plans.  

If you are interested in scheduling a call, feel free to use the calendar link below for a 30 minute “Mutual Fit” meeting over Zoom.

Also, make sure to subscribe to our mailing list so you don’t miss out on any retirement planning insights!

Until next time, thanks for reading.

-Kevin

Retirement Readiness Checklist

You are in the final stretch of your career!

Congratulations on a successful career!  You’re in the proverbial 7th inning stretch, ready to finish strong and start the next chapter.   Along with all of the excitement is a bit of uncertainty about the unknown.   Use our updated “Retirement Readiness Checklist” to help you prepare for whatever is next!

Step 1: What is your vision for "retirement?"

The word retirement means different things to different people.   Maybe you want to travel the world for the next 10 years.  Perhaps you want to spend more time with loved ones.  Or, you might have a business venture you’ve always wanted to pursue. 

This is the most exciting part about retirement planning.  You define what success means during this next chapter, not your current or former boss. 

Write down your biggest hopes and dreams you wish to experience.  If you are married, you and your spouse should sit down together to craft your vision.  You will be surprised at how much you learn about one another!  My wife and I do this on an annual basis, and I’m always learning new things about what’s on her heart and mind. 

You should also decide whether you will work in any capacity during retirement.  You might find yourself wanting to work part-time for the same company, or perhaps pursuing opportunities with a different firm. 

This is also known as a phased retirement, where you “try it out” before fully retiring. 

This is perfectly acceptable as it might be tough to quit your job cold turkey.  It also provides some financial incentives including; delaying retirement account withdrawals, deferring Social Security, and continuation of group benefits.

 You might decide not to work at all, and that’s okay too! 

Perhaps you dedicate your time volunteering for a passion project that excites you!

Whatever it is, this is your time to create your ideal schedule, which brings us to step 2.

Step 2: Create an ideal day/week

ideal week during retirement

Many people don’t realize that depression is more common than you think in your retirement years. 

According to Web MD, over 6 million people over 65 are impacted by depression.  However, only 10% receive treatment.  One of the reasons is the feeling of embarrassment.  Why would one feel depressed if they achieved financial independence?

Upon retiring, most people want to check off things on their bucket list.  It might be a dream vacation, or moving into their forever home, buying a boat, etc.  This can cause a spike in excitement in the early years which we call the “Go-Go Years.”  However, as you enter the “Slow-Go” and “No-Go” years in retirement, that excitement fades and depression can begin to set in.

If routines or structure aren’t in place with how you are spending your time, and with whom, the feeling of losing purpose can have a negative impact on mental health.  

Also, it’s more likely you have experienced the loss of a loved one or close friends. 

How do you solve this issue? 

Create an ideal day or week and decide:

  • Who do you want to spend your time with?
  • What are you spending time doing?
  • Where are you living and whom are you living close to?
  • Where are you traveling?
  • What are some new hobbies you wish to start?
  • What do you want to learn?
  • What activities can you eliminate from your schedule?  (preferably ones that are draining your energy)

This will help maximize your fulfillment in retirement and avoid that feeling of loneliness or isolation. 

Step 3: Make a Budget

Stay with me on this one! 

I know, nobody likes to make a budget.  However, I find this exercise creates a ton of excitement around an otherwise mundane topic. 

Make a list of anything that will cost money, but divide them into three separate categories:

    • Needs
    • Wants
    • Wishes

 Examples of NEEDS are:

  • Housing
  • Utilities
  • Food
  • Clothing
  • Transportation
  • Insurance
  • Healthcare needs

A Quick "Aside" on The Housing Decision

Once you have decided on where you will be living in retirement, you will need to discuss whether or not you want to pay off your mortgage. 

Having a mortgage in retirement isn’t necessarily a bad thing.  It’s all about personal risk tolerance and liquidity needs.

If you are comfortable with taking on some risk with your investment portfolio, you could earn a higher return relative to the interest rate on your mortgage.  All while keeping your investments liquid.

If you decide to pay off your home with a lump sum, how does that impact your liquidity needs?  Sure, you could take out a home equity line of credit or cash out refinance, but your home is not truly a liquid asset. 

As interest rates have been creeping higher, this debate has begun to lean slightly more in favor with paying off the mortgage.   However, you might be locked into a 3.5% (or even better) interest rate, so keeping your funds liquid and investing in other asset classes could pay off in the long run.

With all that being said, there is a legitimate argument that having no debt in retirement provides a psychological benefit.  I’m all about helping people with peace of mind, and if paying off the mortgage can help with that, let’s do it (forget the math)!

Aside from the mortgage issue, you are likely going to consider whether or not to stay in your current home, downsize, or even move to a new city.  The conventional wisdom has been to downsize in retirement. 

However, I have found that not having enough space in the home might limit your adult children and grandchildren’s ability to visit (if that’s important to you)!  In other circumstances, I’ve had clients downsize and absolutely love the reduced maintenance and upkeep…but usually after the period of de-cluttering, selling, or giving away “stuff.”

Additionally, moving to a new city might sounds appealing given a lower cost of living or more favorable tax advantages, but it’s a big decision that should not be taken lightly. 

If you do decide to either downsize or move to a new market, you will need to factor in how this will impact you financially in this first category of “needs.”

downsize in retirement?

Examples of WANTS are:

  • Travel
  • Home Improvement
  • Major Purchase (Boat, RV, Pool, Hot Tub etc.)
  • Education funding (children or grandchildren)
  • New Home
  • Wedding

“Wants” could be reduced or even eliminated, if needed, during a period of unfavorable financial circumstances or as you begin to slow down.

Examples of WISHES are:

  • Leaving a financial legacy
  • Major gifting/donations
  • Dream vacation home
“Wishes” are things you would love to accomplish as long as your needs and wants are covered throughout retirement. 
 
Enjoy this exercise and make it fun and interactive!
 
 

Estimate each cost

I find most people know what their “needs” cost on a monthly or annual basis.  However, certain expenditures in the “wants” or “wishes” categories might be more difficult to estimate. 

Do your best.  Remember, you can always revisit these on an annual or semi-annual basis, as we will discuss in Step 10. 

And finally, tally up each category for your projected retirement income goal!

Step 4: How much of your retirement income will come from fixed sources?

The first pillar of your retirement income is your guaranteed or fixed income.  These resources may include:

  • Social Security
  • Pension
  • Annuities
  • Employment Income

These sources are immune to market fluctuations, and you can rely on them for either a fixed period, or for life. 

Social Security represents over 40% of retirement income for those over 65.  Therefore, it’s important to make the right Social Security decisions.  Some of the factors you might consider when choosing when to begin taking Social Security are:

  • Age at retirement
    • The earlier you retire, the longer you will need to wait until your full retirement age (between 65-67)
  • Life expectancy
    • If you have longevity in your family and are in good health, you might decide to delay Social Security past full retirement age. Age 70 is the latest retirement age where your benefit will be the highest.
    • Another consideration if you are married is your spouse’s life expectancy. Even if you are not in great health, delaying benefits could help maximize the survivor benefit to your spouse.
  • Other assets/income sources
    • If you have other assets or income to draw upon early in retirement, you might consider delaying Social Security for the reasons mentioned above.
    • However, if you need the income sooner to avoid draining your investment accounts, you might consider taking the benefit earlier (or working longer)

There is no “one size fits all” answer to taking Social Security.  I wrote another article on Social Security considerations that you can read here, but I also recommend speaking to a qualified fiduciary financial planner to address this important issue.  Of course, we can help with this 😊!

Step 5: Determine your income gap

what is a safe withdrawal rate in retirement?

What is a safe withdrawal rate for retirement? 

Once you have calculated your total expenditures for your needs, wants and wishes, and have tallied up all your fixed income sources, it’s time for some basic math. 

The first part to the equation is how much of your “needs” are covered by guaranteed income?  If the answer is 100%, you are in great shape! 

If it’s less than 100%, you will need to make the decision on how to draw income from your other assets like 401ks, IRAs, brokerage accounts etc., to fill the income gap.

It’s okay if your guaranteed income does not cover 100% of your needs.  Most of my clients will draw income from investments to cover the income gap. 

However, this brings about the question, “what is a safe and reasonable rate of withdrawal in retirement?” 

A reasonable withdrawal rate is relative to your goals and risk tolerance, but anywhere from 3% – 7%/year could be reasonable.  The higher the rate of withdrawal, however, the more risk of your plan failing.  The lower the rate of withdrawal, the lower the risk of your plan failing. 

Step 6: Make the decision on how your investments will be managed

Once you have determined the income gap, you will need to decide on the process of how investments will be managed.  If you are a “do-it-yourselfer,” make sure you have a process in writing!  This includes:

  • What is your optimal asset allocation?
  • Which investments will you use to create your optimal asset allocation?
  • How often will you re-balance and monitor your accounts?
  • How much will you withdrawal each month, quarter, or year?
  • Which accounts will you withdrawal from first?
  • The tax impact of withdrawals
  • A process to determine which investments to liquidate and when

For the “do-it-yourselfers” out there.  If something ever happened to you:

  • Death
  • Disability
  • Incapacity

What is the contingency plan?  Who is stepping in to fill that role?  Is it a spouse?  Adult child?  Sibling?

Do they have the ability, AND the availability to step in as the new “investment manager?” 

One of the primary reasons I find clients hire my firm or another fiduciary financial advisor is because they are the investment guru, but their spouse/son/daughter/sibling is not!  Or, their children don’t have the time to take on this role given they are busy with their own family and career! 

Therefore, my “do-it-yourselfers” want to be involved in the process of hiring a fiduciary financial advisor to help manage the affairs if/when something does happen to the them.

For those of you who have no interest or capacity, make sure you hire a fiduciary!  A fiduciary is someone who looks out for your best interests, always!  And yes, we can help you with this!  Our firm specializes in retirement planning including investment management.

Step 7: What to do with your old 401k and employer benefits?

When you are implementing your investment strategy and income strategy, you will need to decide on how to best consolidate accounts.

Perhaps you have several 401ks or 403b plans.  Maybe you have multiple brokerage accounts with different institutions. 

You might consider consolidating accounts to simplify your balance sheet.  I find most retirees want to avoid complexity!

By doing so, it will make managing your investments easier during retirement, particularly when it comes to making withdrawals. 

It will also help clean things up for your beneficiaries or powers of attorney, and we will discuss this topic more in Step 8.

The argument against doing a 401k rollover might include:

– Plans to work past 72 and defer required minimum distributions

– Certain proprietary investments within an employer plan that are not offered elsewhere (fixed annuities etc.)

Otherwise, rolling over those plans into one consolidated IRA will open the door for more investment options and diversification.  Additionally, you have more control over liquidity and fees within the investments you select.

Other Benefits to Consider

  • Life Insurance
  • 401k Contributions + Catch Up
  • Health Insurance
  • Legal Benefits
  • HSA (Health Savings Account)

Reviewing the checklist of benefits  you will lose is an important exercise when gauging your retirement readiness

You should begin to think about how you will replace these benefits when you retire, and maximize these benefits while you are still employed.

For Life Insurance, consider whether you will want to own some life insurance in retirement.  If so, purchase an individual policy that is portable after you retire.   If you can’t buy an individual policy, see if you can extend coverage with the group for a period of time.

401k’s and 403b plans allow for catch up contributions after you turn 50.  Take advantage of these catch up contributions while you can!

Here are the limits for 2022 on certain qualified plans:

  • 401k/403b/457:  $20,500/year + $6,500/year catch up
  • SIMPLE IRA:  $14,000/year + $3,000/year catch up
  • IRA/Roth IRA:  $6,000/year + $1,000/year catch up
  • HSA:  $3,650/year (single), $7,300/year (family) + $1,000/year catch up (age 55+)

In that final stretch of planning for retirement, your children might be done with school and you finally have some extra cash flow.  Take advantage of this final decade as it can pay huge dividends in your later years when healthcare costs tend to rise!

For legal plans, you might consider having your estate documents reviewed and updated before you officially retire.  These legal plans often have an estate planning benefit that can save you thousands of dollars while you are still employed.

Finally, consider health insurance options.  If you are retiring and are eligible for Medicare, compare the Original Medicare with Medicare Advantage.  Shop for plans, use a broker to help find you the best deal based on your medical needs. 

If you are retiring before you are Medicare eligible, consider your options for health insurance.  Perhaps your spouse will continue to work, or you may work during the early phase of retirement. 

Otherwise, you may need to buy an individual policy on the exchange (healthcare.gov).  These policy premiums are based on your income, so there could be some planning opportunities to keep your income low until you reach age 65 and qualify for Medicare. 

Step 8: Update your Estate Plan, and keep it up to date!

meeting to review estate plan

How will your assets transfer to your loved ones?  Who will step in to make decisions if you are unable to?  How are your assets titled?  What is the tax impact of the assets transferred to your beneficiaries?  These are all questions that you need to consider for your Retirement Readiness Checklist!

The basic estate planning package that everyone needs includes:

  • A Will
  • Financial Power of Attorney
  • Medical Power of Attorney
  • Living Will/Advanced Medical Directive

Others might need to supplement these documents with a revocable living trust, an irrevocable trust, a special needs trust, or a marital bypass trust.  Speak to a qualified attorney who specializes in estate planning in your state! 

An Estate Plan, however, is not simply what documents you have drafted! 

  • Do you have three IRAs and two 401ks that can be consolidated into one?  Do you have physical stock certificates in a safe that can be moved to electronic custody? 
  • Do your beneficiaries know where all of your life insurance policies are, or which financial institutions you have accounts with?
  • What about passwords? 

An estate plan is also about making things simple for your loved ones!

  • Keep key decision-makers in the loop as to what their roles are (and are not)! 
  • If you name one adult child as Power of Attorney, have that discussion with them. 
  • If you have other children, make them aware also. 
  • It could be difficult, but you need to be the one to speak up on “why” you made certain decisions.  Otherwise, it could impact how you were remembered and/or the relationships between your children.
  • Finally, keep an “important document list” that outlines where your accounts are and at least one point of contact for each institution.  (I have a template you can use, and I’d be happy to share it if you send me a Linkedin connection request asking for it!)

Step 9: Medicare or Healthcare Decisions

Are you 65 or older and eligible for Medicare?  Well, make sure you take advantage of the special enrollment periods!  That way, you can avoid penalties and unnecessary medical underwriting.  

If you are eligible for Medicare, the primary decision is whether or not you will go with “Original Medicare” or Medicare Advantage.

Original Medicare is great because there is no “network” or managed care.  You can pick and choose whatever specialists you want to see without worrying about a referral.  The deductible is also extremely low (less than $300/year)!  You will need to buy supplemental policies to cover prescriptions as well as gaps in Medicare part A and part B.  Either way, it’s a great way to plan for how much your healthcare expenses might be.

Medicare Advantage has been growing in popularity, but sometimes people are misled into thinking it’s the less expensive route.  If you are going to the doctor frequently, or have special medications, you might find yourself paying more for Medicare Advantage despite premiums being lower.  Also, be sure to check out the network of providers as you may find your doctors don’t take certain insurance policies.  If you are a snowbird, make sure the network is robust in both areas that you live.  

There are some great independent Medicare advisors out there that I would recommend speaking with:

I interviewed the lead advisor for Chapter, Ari Parker, on one of my podcast episodes.  Give it a listen for his insight on the topic:

Episode 13:  Planning for Healthcare Costs in Retirement

If you are younger than 65 and not Medicare eligible, you are going to buy private coverage through the exchange.  There are a variety of plans to choose from.  The online marketplace is a great place to go to search for plans and screen for what features are most important to you.

Healthcare.gov

Step 10: Make a Long-term Care Plan

I discussed this topic with Jean Wilke-Ausman, the Director of Long-term Care Solutions at Stewardship Advisory Group; she gave a phenomenal headline to kick this topic off.

“Why a checkbook is not a plan for long-term care.”  

Just because you have the means financially to pay for long-term care expenses, does not mean you have a plan.  Furthermore, just because you have insurance doesn’t mean your plan is complete.

Medicare doesn’t cover custodial care, so you will ether pay out of pocket, buy insurance, or some combination of the two.

Some considerations if you decide to self-insure:

  • If you needed care, how would it impact your surviving spouse?
  • How would it impact your financial legacy goals?

Jean also added these issues to consider when self-insuring:

  • “Who is going to manage the liquidation of assets?”
  • “What about considering market fluctuations while managing withdrawals for care?”
  • “Who is going to manage the caregivers providing the custodial care?”
  • “What about changes in the real estate market”
  • “What about navigating taxes when liquidating certain assets?”

Perhaps your spouse has been managing your care for months or even years, and it’s now time to hire a caregiver.  “Having insurance provides that liquidity need,” added Jean.  “Having insurance can avoid you having untimely withdrawals from investments that have other purposes.”

Partner up with experts like a fiduciary financial advisor who understands long-term care planning, and someone like Jean who can be a quarterback to finding the right coverage. 

There is no one-size-fits all with long-term care planning, but being proactive will help prevent you from becoming a burden on your loved ones later in life. 

Step 11: Communication and Ongoing Review

family get together retirement

Life will change!  Your family will evolve!  You will welcome new family members, and unfortunately say goodbye to others.

Make sure you continue to revise your plan.  Keep your plan flexible.

Communication is important in all aspects of life, but particularly when it comes to dealing with issues in retirement.  Active communication with your spouse, children, grandchildren, friends, work colleagues, neighbors, and other acquaintances, will help you stay connected during your retirement years. 

It’s easy to unplug after retirement but staying involved with relationships can help you enhance your legacy well beyond how much you leave behind financially.

In the event of an unforeseen circumstance, it’s best for your loved ones to know who is in charge of what, and there is no question what your intentions are!

Nobody wants to leave a mess for their family to clean up, so keeping open lines of communication is paramount as we all go through the aging process.

Final word

I hope you found this information helpful. 

Just remember, you are likely feeling a ton of excitement mixed with uncertainty.  This is completely normal.

Our clients that have successfully retired started by planning early!  If you aren’t technically starting to plan early, it’s okay too.  My Mom loves to say, “better late than never!” 

And guess what, planning doesn’t end the day you retire.  Your plans will evolve and become more clear once you have more time and energy to think about the future.  Therefore, continue to adapt and adjust based on what life throws at you.

Control what you can control, and the rest will fall into place.

Make sure to subscribe below so you never miss our retirement insights!

If you would like to schedule a Zoom with me to ask specific questions, you can access my calendar below.

Thanks for reading and I look forward to hearing your feedback along with suggestions for future topics!  You can drop me a line at kevin@imaginefinancialsecurity.com

Should I use an HSA for Retirement Planning?

"Should I use an HSA?"

In simple terms, a Health Savings Account, or “HSA,” is an account owned by an individual that can be used to pay for health care expenses, either now, or in the future.  The accounts are eligible for those who have a High Deductible Health Plan and are funded with pre-tax dollars.  If the funds are used to pay for qualified expenses, the funds can also be withdrawn tax free for those purposes.  If leveraged appropriately, it will be the most tax efficient vehicle you will utilize for retirement planning.

Why participate in a Health Savings Account?

 

Fidelity conducted a study that estimates a 65 year old couple will need $300,000 earmarked to pay for healthcare expenses.  This does not include costs for long-term care services.  $300,000 of course represents true expenses, meaning the funds used to pay for those expenses will be net of taxes.  If the bulk of your retirement savings are held in a traditional 401k or IRA, you will need close to $450,000-$500,000 in your account balance earmarked for healthcare costs alone.  Therefore, many of my clients are leveraging the HSA as part of their overall retirement planning strategy, and I’ll summarize some of the benefits in more detail below. 

1.  You recognize a tax deduction today. 

If you are single, the maximum contribution is $3,600 for 2021 ($3,650 for 2022).
If you are married and participating in a family plan for insurance, the maximum contribution is $7,200 for 2021 ($7,300 for 2022).  If you are over 55, there is a $1,000 catch up contribution available as well.  Unlike other tax efficient saving strategies, your adjusted gross income level does not phase you out of a contribution.   Also, you don’t need to worry if you itemize your deductions or take the standard deduction come tax time, all contributions will reduce your taxable income.  You will typically have the ability to make your HSA contribution before tax time.  This is helpful as you could wait until March or April before making your contribution from the previous year after you estimate what your tax liability might be.   Of course, consult with your tax advisor on federal and state tax impacts of making an HSA contribution. 

2.  Tax efficient growth

Once the contributions are made, the growth from year to year is not taxable.  Unlike a taxable brokerage account (investing in stocks/bonds/mutual funds), you will not receive a 1099 for interest or capital gains purposes.  Furthermore, the distributions are also tax free as long as they are used for qualified healthcare expenses.  Unlike a normal retirement account, you don’t have to wait until 59 1/2 to take those qualified distributions. We will cover what a qualified healthcare expense is later, but think about the tax power of this vehicle.  All other retirement vehicles that you take a tax deduction up front grows tax deferred, not tax free.  Furthermore, tax free retirement vehicles like Roth IRAs, Roth 401ks, etc., don’t allow for a tax deduction up front!  Therefore, the HSA has the best of both worlds from a tax standpoint in that it’s tax deductible, and grows tax free (as long as it’s used for qualified healthcare expenses). 

3.  Flexibility

A health savings account can be used for current medical expenses, or future medical expenses.  This means you are not required to “empty out” your HSA at the end of the year, unlike it’s cousin, the Flexible Spending Account.  This means that the HSA can be used in a year where you have abnormally high medical bills (major surgery, having a child, unexpected ER visit etc.), or can be used in future years, or better yet in your retirement years.  Furthermore, there is no limit on the timing of reimbursement.  Let’s say you had major surgery in 2021, but had some cash on hand to pay for the expenses.  Therefore, instead of taking an HSA distribution, you decided to let it compound and invest it for the long term.  Let’s say 15 years later, you needed to raise some cash.  Well, let’s say that surgery set you back $5,000 out of pocket, you could reimburse yourself for that surgery that occurred more than a decade ago.  This feature also allows you to grow the funds over time with compounding interest before reimbursing yourself.  Make sure you have a process to archive receipts, which often times can be done with your HSA provider.  The final component of flexibility is portability.  If you leave an employer, the HSA always remains with you.  You can even roll it over to a different HSA provider if your new company offers a plan that you want to participate in. 

4.  Growth opportunities

Given the ability to make contributions over your working years without the requirement of withdrawing funds, the HSA also offers an opportunity to accumulate a sizeable balance that can be used in your retirement years.  Additionally, you can even invest those unused funds in a basket of securities such as mutual funds or ETFs for even more growth opportunities.  Typically, the HSA provider will require some reserve amount that cannot be invested, let’s say $1,000.  Once you exceed the $1,000 mark, you can choose from a menu of investment options that suit your time horizon and risk tolerance. 

The tax deduction up front, the tax free growth, flexibility, and growth opportunity are all reasons why this vehicle is the most powerful vehicle you can utilize for retirement savings.  We already know healthcare is going to be a major expense during retirement, so why not get the most bang for your buck when paying for those healthcare expenses and leverage the HSA?!

 

Who is eligible?

Anyone who is not enrolled in Medicare and is enrolled in a high deductible health plan is eligible to participate in an HSA.  Most of you probably won’t worry about this, but you cannot be listed as a dependent on someone else’s tax return.  Some may view the high deductible health plan requirement as a downside, but most high deductible plans still provide your preventative care like annual physicals, child/adult immunizations, screening services and other routine check ups with little to no out of pocket charge.  The minimum annual deductible required to qualify as a high deductible is $1,400 for individual coverage and $2,800 for family coverage.  Additionally, the maximum out of pocket expense plus deductible needs to be $7,000 for individual plans or $14,000 for family coverage.  These are the basic requirements for the health insurance plan in order to be eligible for an HSA.  As you can see, the deductible may be slightly higher, but the tax benefits of the HSA contribution alone can help offset that slightly higher out of pocket cost.  Furthermore, that tax free compounded growth on your investments makes the high deductible plan worth it in many instances allowing you to build up that retirement health care nest egg. 

What are qualifying medical expenses?

The list of qualifying medical expenses is very extensive.  Chances are, anything that is non cosmetic is likely a qualified medical expense, including costs associated with dental and vision.  If the HSA distribution is deemed non-qualified, the funds are taxable and subject to a 20% penalty if you are under the age of 65.  Here is a link to a resource that provides a list of all qualified medical expenses:  CLICK HERE

Outside of the traditional list, I wanted to point out a few that might not come to mind initially.

1.  Long-term care services, and qualified Long-term Care Insurance premiums

This is monumental, given the likelihood of retirees needing long-term care.  The most recent statistic is 70% of those 65 and older will need some type of long-term care services during their lifetime.  On average, women receive care slightly longer at 3.7 years vs. men at 2.2 years.  Given the costs associated with long-term care, it is prudent to incorporate a plan well before you retire, whether it’s buying insurance, “self insuring,” or a combination of the two.  For those who decide to buy insurance, you can withdrawal funds from your HSA tax free to pay the premiums, as long as it’s a qualified long-term care policy.  Traditional, stand alone, long-term care policies without any cash value features are generally qualified policies, and HSA funds can be tapped to pay these premiums.  Hybrid policies, however, are a bit more complex.  These hybrid policies combine life insurance with a long-term care benefit, so if you never need long-term care services, typically your beneficiary will receive some sort of death benefit when you pass away.  These policies have historically been considered NOT qualified, and HSA funds could not be used to pay these premiums tax free.  However, companies are now identifying what is called a “separately identifiable long-term care premium,” which would be allowable as a qualified premium, and therefore HSA funds could be used in this situation.  Consult with your insurance agent and tax advisors to ensure you don’t make any mistakes here. 

If you decide not to buy insurance, or you plan on buying a small policy and “self insuring” for any additional long-term care costs, an HSA is a home run tool for this pool of dollars.  Long-term care services are in fact qualified expenses, and HSA funds can be tapped to pay these costs.  It’s estimated that a private room nursing home is upwards of $105k/year in the US (depending on where you live).  If you needed to tap $105k/year to pay into a nursing home and only had tax deferred accounts on your balance sheet, such as a 401k, you would need to make distributions in the amount of $125k-$150k/year depending on your tax bracket.  On the contrary, a $105k expense is a $105k distribution from an HSA given the tax free nature of these withdrawals.

I wrote an entire article on long-term care planning.  If you are interested in reading more, you can use the link HERE.

2.  Medicare premiums

This would apply to Medicare part B, C and D.  However, Medigap policies are not considered qualified expenses.  This is important because if you build up a substantial HSA balance, you could guarantee that you will have qualified medical expenses simply by way of being enrolled in Medicare.  Additionally, there might be years where your Medicare premiums go up based on your income (think selling a business or real estate property, Required Minimum Distributions etc.), and you can use the HSA to offset that increase in premium.

What happens to your HSA when you die?

If your spouse is named as beneficiary when you pass away, your spouse will take over and continue the tax benefits as an HSA.  Basically, there are no changes.  However, when the HSA is passed to a non spouse (adult child or other beneficiary), the account is no longer an HSA and the full balance is taxable income for that beneficiary.  Nobody has a crystal ball, but if you are building significant savings in an HSA, you might want to have a process to make regular reimbursements during retirement so you don’t create a tax windfall for your heirs.  Given the flexibility in the timing of reimbursements, you can very easily go back over the years and pay yourself for medical bills incurred in the past.  One other final disclaimer on that note.  You cannot reimburse yourself from an HSA for expenses that were incurred before that HSA was established!  If you set up an HSA in 2015, you can only reimburse yourself for expenses as long as that HSA was established (2015 and beyond). 

Final Word

Medical costs are pretty much a given, so why not take advantage of the IRS tax code and maximize your ability to pay for them now and in the future.  If you are young and healthy, I would strongly encourage the use of a high deductible health plan combined with an HSA.  If you have concerns about the higher deductible given your medical history or unique situation, simply do the math on the tax savings of making an HSA contribution vs having a slightly higher out of pocket expense for the deductible.  Most HSA providers even give you calculators to help you with that math.  However, the real power is in the ability to build up a substantial nest egg with tax free compounding and investment opportunity within the HSA.  This will allow for you to recognize some tax relief while you are working and contributing, but have another layer of tax free distributions to supplement your retirement income.  This is especially true if you no longer qualify for Roth IRA contributions or don’t have a Roth 401k/403b option available at your employer.  Even if are are closer to retirement, don’t let that discourage you.  You can still max out the HSA contribution every year, invest the funds in a well diversified portfolio, and have a decent account balance to pay healthcare costs in your retirement years. 

Be sure to consult with your tax advisors and financial planner before making any changes to your situation.  If you would like to schedule a call with me to review your situation and figure out what strategy fits in your overall plan, you can book a “Mutual Fit” meeting by clicking the button below.