All Nerd's Eye View Articles On Retirement Planning

Who Should File-And-Suspend For Social Security Benefits By The April 29 Deadline?

April 20, 2016 07:01 am 30 Comments CATEGORY: Retirement Planning

Last fall, the Bipartisan Budget Act of 2015 changed the rules to eliminate two popular Social Security claiming strategies for married couples: File-and-Suspend, and Restricted Application.

Fortunately, the new rules didn’t take effect immediately, but the first transition – the elimination of File-and-Suspend – will apply for anyone who first requests for a voluntary suspension of benefits on April 30 or later. As a result, anyone who wants to be “grandfathered” under the old (current, and more favorable) rules has less than two weeks to complete their Social Security application and suspension request by the April 29 deadline!

As a result, anyone who has at least met the full retirement age of 66, and is not yet age 70, should be considering whether to submit a file-and-suspend request by April 29. Notably, the tactic is a moot point for anyone who has already claimed benefits, or who doesn’t plan to delay benefits going forward. Nor is file-and-suspend relevant for widows (who don’t need file-and-suspend to coordinate between retirement and survivor benefits), nor for divorcees (who rely on the Restricted Application strategy instead, which remains available after April 29 for anyone who was born in 1953 or prior).

Nonetheless, for married couples (and some parents with children) who are in the age 66-70 window and have not yet claimed their benefits, but where one person could activate a spousal or dependent child benefit for someone else while delaying their own benefit, only a small time window remains to submit a File-and-Suspend request before the rules are changed forever! And arguably, anyone who is single and doesn’t care about spousal benefits, but simply wants to preserve the right to “undo” and reinstate their delay decision in the next few years, may want to consider submitting a request to File-and-Suspend by April 29 as well!

How DO You Measure Which Retirement Income Strategy Is Best?

April 13, 2016 07:01 am 19 Comments CATEGORY: Retirement Planning

Given the myriad of products and services available to today’s prospective retirees, there are a lot of choices to consider about which retirement income strategy to pursue, from portfolio-based withdrawal strategies to annuities with income guarantees and more.

Yet as it turns out, what seems like a relatively simple question – which retirement income strategy is the best – is actually remarkably difficult to determine. Because as it turns out, which is “best” depends heavily on how you measure what “best” really means in the first place.

For instance, when evaluating by what produces the most wealth, the best retirement strategy is generally to just not spend very much (and ideally invest for growth along the way, too)! If the goal is to maximize retirement spending, then the “best” strategy is to invest as aggressively as possible in order to maximize the portfolio growth that will substantiate that spending. Yet portfolios with maximal growth can also produce the greatest catastrophes, which means a risk-averse retiree may not want that approach, even if it would otherwise have increased retirement spending!

What all of this ultimately means is that in framing different retirement income strategies – and the trade-offs they might entail – it’s important to give serious consideration to the measuring stick that will be used to evaluate the potential retirement outcomes. Because the “best” retirement income strategy may be very different depending on whether you measure based on wealth, spending, probabilities of success, magnitudes of failure, or utility functions that weigh both the upside and downside risks!

Will Congress Someday Repeal The Tax-Free Roth IRA Promise?

February 25, 2016 12:04 pm 29 Comments CATEGORY: Retirement Planning

Periscope Office Hours Cover Image February 24 Will Congress Someday Renege on the Tax Free Roth

The Roth IRA has become immensely popular in the nearly 20 years since it was first created - driven no doubt by its favorable tax-free treatment for all growth spent in retirement. From Roth IRA contributions, to Roth conversions, or Roth 401(k) and other employer retirement plans, there are more and more ways to get money into a Roth.

In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we look at the issue of whether retirees may be banking on too much of a good deal, though, and whether Congress might someday repeal the tax-free Roth treatment and renege on the Roth promise. Should retirees hedge their bets against a future tax law change?

Fortunately, the reality is that while repealing tax-free Roth treatment is legally possible for Congress to do, it is politically unlikely. Not just because it would be immensely unpopular with active senior voters, but also because eliminating Roth treatment actually scores very poorly in Federal revenue projections, due to the 10-year budgeting process that is typically used to analyze major tax law changes.

Notwithstanding this, however, the odds are still good that some "crackdowns" and loophole closers do come for Roth accounts soon. Potential changes include introducing Required Minimum Distribution (RMD) obligations to Roth IRAs for those over age 70 1/2, the elimination of the stretch Roth IRA for young beneficiaries, a cap on maximum IRA account sizes beyond which no new contributions are allowed, and the elimination of the so-called backdoor Roth IRA (which arguably is already risky if done too aggressively).

Of course, none of this entirely eliminates the value of contributing to a Roth IRA as long as your tax rates are low, but it makes the timing of when it's best to contribute to a Roth IRA (versus making a traditional IRA or 401(k) contribution and doing a Roth conversion later), more important than ever!

Retirement Date Risk – The Impact Of Sequence Of Returns Risk On Those Still Accumulating For Retirement

February 24, 2016 07:01 am 27 Comments CATEGORY: Retirement Planning

The conventional view of sequence-of-return risk is that it’s something retirees face as they take ongoing distributions from a retirement portfolio, and requires caution in the early years of retirement.

Yet the reality is that sequence of return risk is equally relevant for accumulators in the years leading up to retirement as well. The only difference is the problematic sequence is reversed – for retirees, the dangerous sequence is to get bad returns at the beginning (of retirement), while for accumulators it’s getting bad returns at the end (of the accumulation phase) that causes the problem.

In fact, the volatility of an accumulator’s portfolio can also be viewed as its “retirement date risk” – the danger that a planned date of retirement (or financial independence) may turn out to be later than originally expected, due to a poorly timed sequence of bad market returns. And as it turns out, the greater the volatility of the portfolio and reliance on growth, the greater the retirement date risk that goes along with it.

Accordingly, accumulators in the final years leading up to retirement may wish to proactively manage risk and reduce the volatility of the portfolio, specifically as a means to reduce the retirement date risk they face. Of course, getting a portfolio more conservative at the end of the accumulation phase may also force an accumulator to work slightly longer, or save more, to make up for the lower expected returns in those last few years. Still, for those who don’t want the risk of a much later retirement date, a decreasing equity glidepath leading up to retirement may be a very appealing retirement date risk management strategy!

Supplemental Saving In An HSA For Retiree Medical Expenses

January 20, 2016 07:01 am 27 Comments CATEGORY: Retirement Planning

The Health Savings Account (HSA) is unique in the landscape of tax-preferenced investment acounts, as it is the only type that enjoys both the benefit of tax-deductible contributions and tax-free distributions (for medical expenses). In fact, the unique treatment of the HSA has created a wrinkle in the traditional approach of funding retirement accounts: given the inevitability of medical expenses in retirement, arguably the best savings account for retirement (or at least for a portion of retirement expenses) is to use a health savings account for retirement over “just” an IRA alone.

In other words, for any retiree that is saving for both medical expenses in retirement and also all of their other retirement goals, using a combination of an IRA (for most retirement expenses) supplemented by an HSA as a "retirement health savings account" may be the most tax-preferenced way to save holistically for retirement. In fact, the health savings account tax treatment is so good that it can even be superior to funding a 401(k) plan with a small match (for those who haven't already started a health savings account for retirement)!

Notably, this doesn’t mean that retirees would exclusively fund a health savings account for retirement, as the accounts are both taxable and potentially subject to penalties if used for non-medical purposes. But for those who already have some retirement accounts, and/or have more than enough dollars overall to achieve their goals, the fact remains that contributing the maximum to an HSA every year has the potential for more beneficial tax treatment than any other type of tax-preferenced account! Which makes accumulating in an HSA so desirable that it may even be preferable to pay current medical expenses out of pocket, just to preserve (and keep contributing to) the HSA account balance to be used as a future health retirement account!

Should Equity Return Assumptions In Retirement Projections Be Reduced For Today’s High Shiller CAPE Valuation?

January 13, 2016 07:01 am 49 Comments CATEGORY: Retirement Planning

The sustainability of retirement cash flows from a portfolio depends in no small part on the returns generated by that portfolio – in particular, the real returns, given the pernicious impact of inflation over a multi-decade retirement.

In today’s high-valuation environment, many retirement projections are being done with reduced long-term return assumptions… with the caveat that while many advisors agree on the need to project lower returns, there is little agreement on how much lower it should be.

A look at the available market data suggests that realistically, it would be appropriate to reduce equity return assumptions by about 100bps (or 1 percentage point) over the next 30 years, to reflect the current valuation environment. Ironically, the reduction is not greater, because 30 years is such a long time that even if returns are bad for a period of time, there are enough subsequent years to recover as well.

In point of fact, though, it turns out that market valuation is even more predictive of 15-year returns, and that today’s high P/E ratios imply that between now and 2030, market returns could be reduced by as much as 400bps. On the other hand, because market valuations (and the associated returns) tend to move in cycles, this also implies that in the 2030s and 2040s, market returns could be as much as 400bps above the long-term average as well.

Ultimately, then, the ideal way to adjust return assumptions in a retirement plan in today’s environment may not be to reduce long-term returns at all, but instead to do projections with a “regime-based” approach to return assumptions. This would entail projecting a period of much lower returns, followed by a subsequent period of higher returns, in a manner that more accurately reflects the impact of market valuation on returns – and better accounts for the sequence-of-return risk along the way as well!

Why Monte Carlo Analysis Still Matters And The Risk Of A Retiree Black Swan Is [Probably] Overrated

January 7, 2016 12:01 pm 17 Comments CATEGORY: Retirement Planning

Michael Kitces Black Swan Office Hours Periscope Thumbnail

Over the past 15 years, we’ve seen the rapid rise of Monte Carlo analysis as a tool for analyzing retirement. Yet at the same time, the use of conventional statistics to project potential market scenarios has been under attack, for failing to capture the so-called “Black Swan” phenomenon.

In this week’s #OfficeHours with @MichaelKitces – a new video series we’ve launched where I will take reader questions, both emailed and live, every Tuesday at 1PM EST via the Periscope social media platform – we look at the phenomenon of Black Swans, what a black swan event really is, and how the “risk” of a black swan is quite different for a long-term retiree who takes annual withdrawals versus a leveraged hedge fund who faces the risk of having their debt called in.

In fact, we ultimately find that while Monte Carlo analysis for retirees is commonly criticized for failing to capture extreme market events, it turns out that the biggest problem with Monte Carlo is not that it fails to model the downside risks but that it actually understates the possibility for upside surprises!

You can see me discuss all of this and more in our #OfficeHours video posted in today’s article, along with details on how to sign up to watch the next broadcast live, and participate for yourself!

How Continuing To Work, Even In Retirement, Can Increase Social Security Benefits

January 6, 2016 07:02 am 76 Comments CATEGORY: Retirement Planning

The conventional view of delaying Social Security is that doing so is an opportunity to earn delayed retirement credits, an 8%/year increase in benefits that can be highly appealing in today’s low-yield environment.

However, the reality is that delaying Social Security benefits doesn't just increase benefits by earning delayed retirement credits. Additional years of working while collecting Social Security benefits can also increase the worker’s Average Indexed Monthly Earnings used to calculate those Social Security benefits in the first place, just as ending work early can reduce AIME below what is projected as benefits on the Social Security statement.

And depending on how much additional income will be earned – and how low his/her historical earnings really are – the reality is that continuing to work while getting Social Security benefits can produce a material increase in future payments for some workers, simply because of how benefits are recalculated. In other words, for those past full retirement age (and no longer subject to the Earnings Test), it’s possible to be receiving Social Security benefits while working and have those years added to the Social Security work history to generate higher future benefits as well!

In the end, working while on Social Security won’t always produce a significant increase in Social Security benefits. For those whose prior working years produced more income – at least on an inflation-adjusted basis – it’s possible that continuing to work will generate no additional benefits at all. Nonetheless, for those who haven’t fully capped out Social Security benefits based on 35 years of maximal earnings already, it is possible to be working and getting Social Security benefits at the same time, and have that work increase the benefits (at least after reaching full retirement age). And the potential for a benefits increase can be material in some cases, and thus should definitely be considered in the timing and impact of when to stop working!

Using Systematic Partial Roth IRA Conversions And Recharacterizations To Fill The Lower Tax Bracket Buckets

December 2, 2015 07:01 am 34 Comments CATEGORY: Retirement Planning

From the moment the Roth IRA was created in the late 1990s, it has been a popular vehicle to generate future tax-free growth and income, whether by contributing to the account on an ongoing basis, or even doing a Roth conversion of an existing IRA or other pre-tax retirement account.

Yet the caveat is that the decision to contribute or convert to a Roth IRA incurs an immediate tax liability. And in the extreme, a large Roth conversion can generate so much taxable income that it actually drives up the IRA owner’s tax bracket to the point that the transaction becomes wealth destructive!

Fortunately, though, the decision to do a Roth conversion doesn’t have to be “all or none” – and in fact, not only is a “partial” Roth conversion permitted, but in practice it’s often the optimal strategy, allowing retirement account owners to convert just enough to fill the lower tax brackets, without causing “too much” income that would trigger the top tax brackets.

In fact, the Roth recharacterization rules make it feasible to precisely fill the bottom tax brackets, but not a dollar more, by converting more than enough to fill the lower tax brackets each year, and then doing a partial recharacterization to back into the optimal partial Roth conversion amount after the year is over!