Let me be blunt …
After 35+ years’ experience working primarily with successful and affluent families, I am forced to conclude that most Americans will NOT be able to retire … or retire comfortably. Most individuals simply have not made the decisions along the way that will allow them to retire well, unless they make some major – and often painful – changes in their spending habits. This concern caused me to do extensive research – to add a “Retirement Income Certified Professional” (RICP®) designation to my resume – and take that knowledge & experience to create a video series called the “Top 10 Planning Mistakes That Will Keep You from Retiring Well … (And What You Can Do About Them!)” We just put the finishing touches on the entire video series, and I wanted to reward our Imagine That™! subscribers with an advance preview of these videos!
The topic of this month’s newsletter concerns “retirement friction” and is also covered in mistake #6 of our new video series. Feel free to watch the video if you prefer to receive your information visually or watch the video and read this article if you really want a firm grasp on the issues concerning this important topic … “Imagine That™!”
What Types of “Retirement Friction” Are We Talking About?
As a Chartered Financial Consultant (ChFC®) and Retirement Income Certified Professional (RICP®), as well as having my own independent Registered Investment Advisory firm, I have come to find four major areas of friction affecting retirement income. This article will focus on these four areas of “friction.” These are things that can reduce how much you get to keep from every check you receive:
- Excessive taxes (that may be an “oxymoronic” statement! Aren’t all taxes excessive?)
- Estate planning mistakes
- Underestimating healthcare costs
- Unbudgeted long-term care expenses
Friction from Taxes
The first point is friction from taxes. While for the moment Federal taxes are lower, given the estimate $72 TRILLION of unfunded government employee pension liabilities, Federal tax rates can only go one way in the future … and that is UP, and likely quite significantly up. In addition, with the increasingly greedy State governments of California, New York and New Jersey especially, having income that is either non-taxed or lower-taxed is critically important. Most Americans are putting away money pre-tax in their now lower tax brackets, only to take the income out in potentially higher brackets when they retire.
What else should you consider then? One way is to create tax-free buckets for future income … and there are just two options. One is a Roth IRA, and the other is a hybrid life insurance contract, which is geared toward generating income as opposed to generating a death benefit.
The challenge for most affluent or successful Americans is their income is too high to qualify for a Roth IRA to fund annually. In 2019, if your modified adjusted gross income (MAGI) is greater than or equal to $203,000 (married filing jointly) or $137,000 (single), you are not permitted to contribute to a Roth IRA. But there is a way to get around the direct prohibition: money in a traditional IRA can be rolled over into a Roth IRA by paying taxes at the time of transfer. There are even some advanced techniques we can use to “soak up” the taxes generated by the transfer of assets from the pre-tax plan to the after-tax plan of the Roth IRA. Anyone can choose this option and annual income does not disqualify the individual. Not only does a Roth IRA have tax-free growth and withdrawals, it also has these other benefits:
- No required minimum distributions—unlike a traditional IRA, which requires minimum distributions when you reach age 70½, the Roth IRA has no such requirement
- Avoids Social Security tax—you may wind up with a break on Social Security tax as compared to a traditional IRA. The annual distribution a person receives from a traditional IRA increases their annual taxable income, which can cause up to 85% of their Social Security benefits to be taxable during each year of their retirement. It can also bump them into a higher tax bracket
- Eliminate or reduce the Health Care surtax—Roth IRA distributions do not increase the “modified adjusted gross income” on your tax return and therefore can eliminate or reduce the 3.8% Health Care surtax on incomes above a certain level. Traditional IRAs do receive this benefit, too
Secondly, the hybrid life insurance option is available without any kind of phase-out from income. Further, it has no limit as to what can be contributed if the plan design is such that it meets several IRS guideline tests. It is still a life insurance contract “looking in” from the outside with all the favorable tax benefits. “Under the hood,” however, reveals a very different high-performance engine! The benefits of a hybrid life insurance contract can be summarized as:
- “Investment-grade” insurance—this is basically a life insurance contract, but it also has a component where you can buy stocks or mutual funds. These special life insurance contracts are considered “investment-grade” … which have minimal amounts of death benefit – and maximize the earnings growth inside the contract
- Tax-free growth and distributions—earnings grow without tax and distributions can also be received without income tax if a certain amount of survivor benefit remains intact
- Long-term care benefits—not only can these contracts provide supplemental income, but some of the newest contracts can even add a benefit to reimburse the insured for long-term care expenses as well … something not permitted in an ordinary Roth IRA
- Won’t hurt student aid eligibility—these contracts can even be used for accumulating money that is outside the FAFSA – Free Application for Federal Student Aid – application for those applying for college or university financial assistance. The money accumulated in the life insurance contract, as well as the funding for it, is not included for purposes of determining scholarship assistance eligibility
- Asset protection—in certain states, such as Texas, accumulation in these hybrid vehicles is protected against the claims of creditors. (California has limited amounts of creditor protection status, but Nevada and certain other states provide enhanced creditor protection)
Friction Due to Estate Planning – Or Lack Thereof …
You need to have a valid Will to specify who gets what and who will oversee dispersing your money and possessions (also known as an “Executor” for males and an “Executrix” for females). If you die without a Will, your estate is subject to your State’s probate laws. Not only could your assets get tied up in court, possibly creating financial hardship for your spouse or heirs, but absent a Will, a judge might ultimately award your assets to an unintended party, such as an estranged spouse or ex-spouse or that goofy cousin you never really liked.
Without a Will, there is likely no Advanced Healthcare Directive in place. Thus, someone may be maintained on life support against their wishes … and the wishes of their pocketbook. And, if there are multiple marriages and various children involved, not only can an ex-spouse end up with money you don’t wish for them to have, but also needless court expenses and delays due to litigation and family “drama.”
Friction from Healthcare Expenses
Friction from unplanned healthcare expenses can be very significant. The 2018 Retirement Confidence Survey found that only 19% of workers have taken the time to estimate how much money they will need for healthcare expenses in retirement. According to the Fidelity Retiree Health Care Cost Estimate (published in April 2018), an average retired couple age 65 in 2018 may need approximately $280,000 saved (after tax) to cover health care expenses in retirement. (By the way, this is all the more reason to consider a Health Savings Account or a Flexible Spending Account if it is available at your employment. This allows you to grow money pre-tax and have it available to meet some of these expenses should they occur.)
Friction from a Long-Term Care Event
Finally, there is friction from a long-term care situation. There are six “activities of daily living” — eating, dressing, bathing, toileting, transferring (getting in and out of bed, and on and off a chair) and continence. The duration and level of long-term care will vary from person to person and State-to-State. It can even change over time. Here are some statistics (all are “on average”) you should be aware of:
- Someone turning age 65 today has an almost 70% chance of needing some type of long-term care services and support in their remaining years – that is, they will not be able to independently perform the above “activities of daily living”
- Women need care longer (3.7 years) than men (2.2 years)
- One-third of today’s 65-year-olds may never need long-term care support, but 20% will need it for longer than 5 years
- In the San Diego area, the cost of long-term care ranges from $8,000 to $12,000 per month
Conclusion: Let us Help you Avoid “Retirement Friction” so you can Keep More of Your Hard-Earned Money
Did you ever see the movie The Wizard of Oz? Do you remember when Dorothy and the Scarecrow initially met the Tin Man? He was unable to move at all. Only when Dorothy grabbed the oil can and applied some oil to the Tin Man, was he able to walk, talk and function normally again. Think of Wealth Legacy Group®, Inc. as the oil can to make sure your retirement plan goes smoothly and comfortably.
Let’s talk about what you are concerned about … what you have in place already and where there might be gaps. We offer a 20-minute free consultation to discuss your unique situation. I will tell you candidly what I like about what you are currently doing, and where I think there are ways to improve your plan and make it better. Let’s also discuss the perils that could threaten your ability to retire when you want and in the comfortable manner you, or you and your spouse/partner, wish to enjoy.
Regardless of your preference, don’t put it off. Your financial future is at stake. Let’s get it built on the most solid of footing. Let’s get started planning for your ideal tomorrows today …
Written by R. J. Kelly – May 2019