Monday, August 3, 2015

Retirement Planning: 3 ways to outsmart Uncle Sam


Creating retirement security isn't easy -- even for 61-year-old financial planning expert David Littell, retirement income program director at The American College.

Littell is looking forward to a long life. His father is 103 and was recently kicked out of Medicare's hospice program because he recovered from an ailment and Medicare considered him too healthy to qualify for hospice care.

"I have a lot of anxiety about retirement planning because I know a lot. I know that I have no idea what my retirement is going to cost. Will I spend 10 years in a nursing home or will I die at 70? That is what creates anxiety for me," Littell says.

Littell's hedge: Manage money well and keep the IRS at bay. He shares three tax tricks that you don't have to be a multi-millionaire to appreciate.

Understand thoroughly the value of your Social Security. 

Social Security is probably your most valuable asset, even if you have significant savings and a pension. Littell illustrates the value of Social Security by calculating its present value. For instance, the average Social Security benefit is $1,200 a month, which makes the average present value -- monthly benefit multiplied by an estimated average life span -- roughly $288,000. Littell points out this is more than double what most people have saved. (He doesn't discount for inflation because of the built-in cost of living adjustment).

This makes waiting to collect Social Security a financially wise decision. Littell calculates that, "Working two years longer has more impact on retirement security than saving 3 percent more in the five years prior to retirement." In sum, he points out that Social Security benefits are worth 76 percent more at age 70 than they are at age 62, and this inflation-adjusted annuity pays for as long as you live. Plus your spouse will get the higher of the two annuities for as long as he or she lives. You can't get a deal like that anywhere else.

While you wait, spend savings.
If you want to retire before you are able to maximize your Social Security, Littell says it often makes good tax sense to spend your savings first -- particularly if you have a tax-advantaged account like an IRA or a 401(k). This isn't an intuitive decision, he admits. It makes a lot of people nervous to spend up their savings. But it works, he says, because only up to 85 percent of Social Security income is subject to federal taxes. If you spend your taxable savings before you begin collecting Social Security, you'll pay taxes at a lower rate than you would if you wait and pile taxable income on top of Social Security. Then by the time you take Social Security, you can withdraw less from your taxable accounts, so you will pay fewer taxes on the combination of income, and that will help preserve what remains of your nest egg. Overall, Uncle Sam will get less and you'll keep more, Littell says.

Take advantage of low-tax years to convert to a Roth.

 If you have a year when you didn't make much money -- because you left work for part of the year, you started a new business or you made considerable charitable contributions -- that's the time to convert some of your pre-tax retirement savings to a Roth IRA. Converting when your tax rates are low will result in a tax-free stream of money as you age. As Littell points out, "The Roth IRA  makes a great contingency account." If you need to withdraw money in an emergency situation, it won't drive up your taxes. There are no required minimum distributions during the life of the account owner, and if you don't need the money during your lifetime, it is a tax-efficient way to leave money to heirs.

The bottom line for smart retirement planners, Littell says: "Figure out how to get as much money as you can out of your tax-deferred plan at a lower than normal rate."