Transitioning to retirement can be challenging for many reasons. There are tax law changes to navigate, spending strategies to consider, and worries about outliving your money. On top of that, market volatility adds another layer of concern.
Now, more than ever, clients need an experienced guide who specializes in retirement planning and distribution strategies to minimize taxes and maximize wealth. That’s where you come in.
Here are four key ways to ensure investments are set up properly for retirement.
1. Going beyond the obvious: Helping clients in the distribution phase
Transitions to retirement can be really difficult. Advisors need to demonstrate value by helping clients move through difficult life phases. Although investors may have been successful thus far in the “accumulation” phase, the “distribution” phase is where it gets difficult. Many investors need to change their approach as they transition to retirement, and professional help is needed with portfolios, taxes, wealth transfer and estate planning.
Everyone is in one of two categories, accumulation or distribution. And the rules change during the distribution phase. In many respects, the accumulation phase is simple, but not always easy. There are two rules for clients to follow: Live within means and don’t do anything stupid. For many of your clients, they have survived the pitfalls of the accumulation phase, and now they need to pivot to the distribution phase.
However, for the mass affluent, and definitely for the high-net-worth client, the distribution phase is definitely more complex. Investors need a financial plan focusing on distributions and a strategy to manage spending and taxes (caused by RMDs and high taxable income) in retirement. Advisors should develop plans that consider income strategies, inflation, hedging, alternatives and annuities.
The reality is that taxes are simpler in the accumulation phase than the distribution phase. Clients can expect to say goodbye to child tax credits, tax-free employer-paid medical insurance, and tax-deferred contributions to 401(k) or similar offsets. In the distribution stage, they will be saying hello to Social Security, RMDs, paying for Medicare, long-term care expenses, longer life spans, inflation, and much more.
Some investment options to consider include:
- QLACs: You must start taking RMDs from your IRA, 401(k), or other qualified retirement plan at age 73. Qualified Longevity Annuity Contracts (QLACs), which is a type of deferred income annuity, can help avoid some RMDs since money in a QLAC is excluded from RMD calculations. The SECURE Act 2.0 allows transfers up to $200,000 from a retirement plan to a QLAC, deferring distributions from the QLAC until age 85.
- Annuities: These products offer retirees a reliable, guaranteed lifetime income, reducing uncertainty and financial stress during retirement. The recent rise in interest rates has made income annuities more appealing. According to Barron’s, income annuities now yield the most since 2009, with immediate-income annuities averaging a 7.5% payout, up from 5.7% in May 2020, as per the CANNEX Payout Annuity Yield Index.
Pro tip: A distribution strategy is just as important as an accumulation one. The right strategy can potentially save clients hundreds of thousands of dollars or millions in unnecessary taxes while also providing lifetime income, and sometimes both.
2. Going beyond income and beating inflation with growth and tax planning
Protect your purchasing power! Inflation significantly impacts income planning, especially in recent times. If you need $5,000 per month today, you’ll need $10,000 per month in 20 years, assuming a 3% inflation rate, which is close to the historical average. This doesn’t even consider the currently high inflation rates that may persist.
To combat inflation, focus on growing income annually and consider higher growth investments, even if they occasionally push your client out of their comfort zone. Additionally, find ways to eliminate unnecessary portfolio costs, such as fees or taxes. Tools like Nitrogen can aid in fee and expense analysis.
And while you are at it, consider placing those growth investments specifically into the Roth account. A Roth account helps keep income down, increasing AGI-dependent deductions and reducing Medicare IRMAA surcharges. Key benefits include no RMDs, allowing tax-free growth for this and the next generation. Make early conversions a smart defense against higher retirement tax rates.
Eliminating unnecessary taxes can also boost a client’s spendable income, especially where large tax bills could erode their wealth over several decades, reducing their purchasing power.
Pro tip: It’s crucial to appreciate the unique needs of each client based on their family situations and goals. Create a flexible plan that models inflation and spending over several decades. Also, regularly review and adjust the plan to guide investment choices and ensure your client doesn’t outlive their assets. Most importantly, model out the lifetime taxes and devise a strategy to decrease those taxes for your client.
3. Financial education makes a difference
Many individuals struggle with understanding investment options and making informed decisions about their retirement savings. Figuring out where to invest and how to adjust risk with age can be challenging. While financial professionals can help, they are often inaccessible to most Americans.
Improving financial education in schools and workplaces could help individuals make better financial choices and optimize their retirement savings. The Social Security Administration reports that firms offering financial education to their employees see significant benefits, including a 12-percentage point increase in 401(k) participation, as well as higher contributions and account balances.
Pro tip: Consider hosting seminars and educational events to help prospects and clients gain a better understanding of their financial situation. Be sure to offer education even within your own firm for your team.
4. Find ways to lower lifetime taxes and devise a plan
It is quite simply why tax planning is a “must do.” Without good advice and smart tax planning, your client’s money will go to Uncle Sam instead of their heirs. Nobody wants that. Taxes are one of the largest expenses in retirement with $600 billion extra paid a year in unnecessary taxes. On the other hand, a capable advisor can add 1.2%-3% a year in portfolio returns, and much more than that.
Currently, tax rates are at historical lows and the only place to go from here is up. The Tax Cut Jobs Act (TCJA) of 2017 not only cut taxes, but doubled the lifetime exemption ($13.6 million for singles, $27.2 million for a couple). This is beneficial for most as it eliminates the need for aggressive estate planning. If Congress does nothing, TCJA is due to sunset in 2025. Tax rates will revert to those of 2017 and income and estate tax rates will increase for most. Washington is awash in debt and annual deficits, and with interest increasing on the national debt, the natural course is for taxes to increase at least somewhere and for some people.
Also consider your client’s lifetime tax liability, projected annually, and assess the potential future tax rates compared to current rates, especially if they are transitioning from Married Filing Jointly to Single filing status as a result of the “widow’s penalty.” Remember that waiting until later could lead to a tax nightmare with unexpectedly high bills. Act now while clients still have the opportunity to take proactive steps!
Pro tip: Many advisors wait until year-end for tax planning, like tax-loss trading, capital gain harvesting, or Roth conversions. However, this approach can unnecessarily limit opportunities and potentially cost clients millions. Instead, view tax planning as a year-round effort, seizing opportunities as they arise, whether during market downturns or specific loss scenarios. Don’t delay valuable tax-saving strategies until December.
There are so many examples of how tax-intelligent advice can benefit a client. From basic blocking and tackling (such as tax-loss trading and capital gain harvesting) to favoring a Roth account over a traditional retirement account, we are seeing more and more evidence that tax planning matters.
Now is the time to dig in to assist those many clients that can benefit from your expertise in this area.