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Retirement planning involves employing strategies that once initiated, place you on an unchangeable path. In other words, once a course of action is begun there may be no turning back.
The problem, of course, is that “life happens,” and time and changing circumstances have a habit of making prior choices problematic. Here is a list of six selections that fall into the unalterable category:
• Converting to a Roth IRA
• Picking a retirement date
• Purchasing an annuity or selecting an annuity as a retirement plan distribution option
• Choosing the form of an annuity distribution (e.g., life annuity vs. joint and survivor annuity)
• Picking a Social Security start date
• Paying a large down payment to a Continuing Care Retirement Community (CCRC)
Let’s take a closer look at each of these retirement planning decisions by briefly describing the choice that needs to be made, detecting if a window of escape exists or if the decision is irreversible, and deciding if there is any strategy available to mitigate the finality of the issue.
Converting to a Roth IRA to minimize lifetime taxes
Many of you will have the choice of whether to convert your traditional IRA that will be taxed when distributed to a Roth IRA that will be tax-free when distributed assuming specified conditions are met. Your goal will be to minimize the lifetime taxes owed on your retirement savings. The rule of thumb is that if tax rates will be higher in retirement the Roth option is preferable and vice versa. More specifically, a Roth conversion means you are paying the taxes today in hopes that your converted funds will provide a greater yield by not having to pay taxes when they are distributed. The break-even analysis centers on whether the tax-free withdrawals exceed the time-value adjusted price of paying taxes upfront. Unfortunately, once you convert your traditional IRA to a Roth IRA you are essentially stuck with your choice. It is important to note that Roth recharacterizations are no longer a viable option. In other words, before the Tax Cuts and Jobs Act it was possible to rewind a Roth conversion to achieve more favorable tax treatment. You are no longer able to make a Roth conversion at the start of the year, but reverse course later in the year if stock values declined and redo the conversion at a later time with the lower-valued (and consequently lower-taxed) stocks.
Mitigating the unalterable decision: There is a strategy with Roth conversions that may take the sting out of the irrevocable nature of the transaction. You can plan a series of annual Roth conversions to lessen the tax impact for each year. In other words, by using a strategy to keep your taxable income below the next higher bracket so that, for example, none of your conversions are taxed at the 32% marginal bracket, but instead are only taxed at the 24% bracket. The consequence of multiple conversions is to delay the inescapability associated with the Roth conversion. The upside is that a measured approach gives you time to adapt to changing circumstances (plus the advantages of the “fill the bracket” strategy). The downside is that the math might not work out if you wait too long to convert because the overall yield on investment will be limited by fewer years of potential market growth.
Picking a retirement date
Another example of a retirement planning decision that will be difficult (if not impossible) to walk back is choosing your retirement date. Once you make the choice to hand in your notice it is unlikely that you can reverse course and restart your career in the future. There is, however, the escape window that your current employer or another employer may decide down the road that hiring or rehiring you is a valuable notion.
Mitigating the unalterable decision: One way to test the waters of retirement is to ask your employer for a sabbatical. A second way to avoid permanently surrendering your entire salary might be to surrender only part of your salary by entering into some sort of phased retirement program. In many cases the lingering connection brought about by phased retirement could grease the skids for resuming full-time work if it is desired. Also remember to explore any options under the Family and Medical Leave Act (FMLA) that may be available for you.
Purchasing an annuity or selecting an annuity as a retirement plan distribution option
Annuitizing part of your retirement nest egg is not for everyone. However, if you are so inclined, then your decision to either buy an annuity or choose an annuity distribution from the plan is for the most part irreversible once annuity payments begin.
Mitigating the unalterable decision: One common strategy to delay the irrevocable decision is to ladder purchases of single premium immediate annuities. This is to say that you can buy smaller annuities over several years and delay losing liquidity on part of your funds. As an bonus you may mitigate interest rate risk by delaying annuity purchases to when historically low interest rates have rebounded (recall that annuities provide more guaranteed income when interest rates are higher).
Choosing the form of an annuity distribution
Yet another decision is picking the form of annuity. Two common choices are life-only annuities and joint and survivor annuities. All else being equal a life only annuity will provide a larger monthly payment, but it stops payments upon the annuitant’s death. However, a joint and survivor annuity will continue payments to the survivor (typically a spouse) assuming that the spouse outlives the annuitant. For example, putting $100,000 in a life annuity for a 65-year-old might yield a $706 monthly payment. Conversely, placing $100,000 in a 100% joint and survivor annuity might yield a monthly paycheck of $586 and will continue as long as one of the two spouses (both currently age 65) is alive. In any case, once made the selected payout option made is not changeable.
Mitigating the unalterable decision: One way to mitigate the lower monthly income is to have an annuity pop-up feature that allows the annuitant’s income to increase at the death of the non-annuitant spouse. However, there is a cost in monthly income when such a provision is available. A second way to avoid the drop in monthly income is to simply choose the life annuity (with spousal consent) and the have other assets available (e.g., life insurance) to match or exceed the income that the surviving spouse would have had if a joint and survivor annuity had been chosen (one variation of this strategy is sometimes referred to as “pension maximization”).
Picking a Social Security start date
Another choice that must be made is choosing a date to start Social Security benefits. Typically, people choose an age between 62 and 70. As a general rule the longer the delay to start benefits the more monthly income. Much has been written about this topic and it has always been this author’s observation that waiting until 70 is preferable in many cases. However, the point of this article is to promote choices from being locked in.
Mitigating the “unalterable decision”: One bit of good news concerns the flexibility to change your mind for up to a year after you file for benefits. In other words, if your situation changes you are able to withdraw your Social Security claim and refile for increased benefits at a later date. There are three conditions: first, the reversal of course must come within 12 months of filing for benefits; second, you must repay all that you have received (including payments made on your behalf to Medicare); and third, you are limited to one withdrawal of your application in a lifetime. You can use form SSA-521 to make your request. Once the year passes, however, the decision to take a lower monthly amount from Social Security (for a longer payout period) is locked in.
Paying a large down payment to a continuing care retirement community (CRCC)
Some may see value in moving to a CCRC in order to get both health care services as well as amenities like one-floor living accommodations, prepared meals in a common dining hall, light housekeeping, planned social activities, etc. The problem is this opportunity usually comes with a both a monthly fee and an upfront lump-sum payment. The good news is the lump-sum payment may be partially refundable for a specified time (e.g., you forfeit 5% a month of the down payment for every month you live at the CCRC). Under this example, the payment of a $200,000 lump sum would be lost after 20 months. One way to look at this is that your monthly rent for 20 months was increased by $10,000 a month because of your death after 20 months! In other words, a short-lived resident made an irrevocable payment that lost them a significant amount of their estate.
Mitigating the unalterable decision: One way to avoid the untimely loss of the lump sum is to closely monitor the refund feature when you choose a CCRC. A second way is to carefully choose whether the refund is for the couple or the individual, because couples who have one spouse die earlier than expected and one spouse live on will forfeit the lump-sum as opposed to a lump-sum that applies separately to each party. A third alternative might be choosing a CCRC with slightly higher monthly costs, but slightly lower lump-sum payments.
Retirement decisions that lock you into a course of action should be carefully planned. Delaying the decision may give you more options, however, you may pay a price for the delay.