The Two Ironies of Retirement Planning

Transcript of Podcast Episode 134

Hello, this is Bill Rainaldi with another edition of Security Mutual’s “SML Planning Minute.” In today’s episode, the two great ironies of retirement planning.

Paradox 1

There are perhaps two great paradoxes about retirement that people don’t recognize until they get there. The first and most important is that in retirement, people live on income, not principal. In other words, once you retire, it’s not so much about the amount of money you have in your account, but rather, the amount of money that account generates.

One reason this is such a problem is that retirement plan sponsors provide little guidance on how to turn assets into income. So how do you know, for example, if you’re spending too much in retirement, putting you at risk of outliving your money? It’s not easy to figure that out, and many plan sponsors don’t provide much assistance.

This is one place where an immediate fixed annuity can help. It is the quickest and easiest way to convert a portion of an asset portfolio into an income stream. An annuity payout provides a steady monthly flow of money that will allow you to pay some or all of your expenses. The amount of income depends on both interest rates at the time you buy it and the options you select. For example, you can select an annuity with a “life only” option, which will provide the highest potential income. You would get a fixed amount every month for the rest of your life. It doesn’t matter whether you live for another two years or another thirty years, the payments last for the rest of your life, and you can’t outlive them.

But there is, of course, a downside if you end up dying relatively soon. You may end up getting back only a fraction of what you invested.

There are several ways to deal with this. One way would be to get a “joint” annuity that would last the duration of both your life and your spouse’s life. You can also get a “life with guaranteed term option,” where you can select a guaranteed period for the income, such as 20 years. This means that if you have a 20-year guaranteed term, the annuity is obligated to pay to your estate or beneficiaries for the remaining period even if you die sooner. Life insurance provides another way to provide income benefits to the survivor. The life insurance policy’s death benefit can be paid to the beneficiary in the form of a lifetime income.

Understand just how critical the decision is here. As Michael Lynch pointed out in an article for ThinkAdvisor magazine, “A 65-year-old retired woman has a longer investing horizon than a toddler has for college.”¹ The retiree needs to plan for the next twenty years. The toddler’s family only needs to plan for the next eighteen. The point is that even retirees may need to have a long term time horizon. And one mistake could cost you money for a very long time.

Social Security, which is in some ways similar to a lifetime annuity, can also play a role. Whatever your Social Security benefit is at Full Retirement Age, it will go up by 8 percent per year for every year you wait up until age 70. So if you’re going to get $1,000 per month at age 67, you would get $1,240 if you can afford to wait until age 70. That 8 percent increase comes with a government guarantee, and in this low interest rate environment, it can be quite attractive. In fact, it could be argued that waiting to collect Social Security should be strongly considered by many. And don’t forget that Social Security benefits are indexed for inflation.

Paradox 2

The second paradox of retirement planning is that for many people, their retirement fund is their favorite account while they are working, but their least favorite once they actually retire.

The reason for this should be easy to figure out. Putting money into a retirement account generally saves money immediately in taxes. If you put $10,000 into a 401(k) and you’re in a 30 percent tax bracket, you’ve essentially saved $3,000 in taxes on Day One.

But it’s easy to forget that you’re not actually eliminating the taxes; you’re only deferring them. So if you’re in a higher tax bracket when you retire than when you were working (and by the way, many people believe tax brackets will be higher in the future), you could actually be worse off in the long run by taking the tax deduction. And there is also a 10 percent penalty if you take money out before you reach age 59½.

It’s important to plan for all this while you’re still working. Otherwise, a withdrawal to pay for a new car, a vacation home or a trip around the world could unknowingly result in a substantial tax bill.

One final note. It may come as a surprise that Medicare plays a role in this discussion. When you get to 65 and sign up for Medicare, everyone signs up for Part A, which is the major medical portion. Most people also sign up for Part B, which is the doctors’ visits and medical testing portion, and some people sign up for Part D, which is the prescription drugs portion.

But Parts B and D cost money. How much? In 2021, Part B can be anywhere between $148.50 per month and $504.90 per month, depending on your income. There are also income surcharges related to Part D. So the more money you withdraw from your retirement account, the more your Medicare coverage could potentially cost.

¹Lynch, Michael. “The 5 Paradoxes of Planning.” ThinkAdvisor.com, January 7, 2021. Accessed July 8, 2021. https://www.thinkadvisor.com/2021/01/07/the-5-paradoxes-of-planning/

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