I’m a single woman with no children, turning 63 this year, but my family is long-lived, so I’m using 100 years as my life expectancy for retirement planning.
I have a combined portfolio of $200,000 in a 5% money market, and $1.4 million worth of stocks in a 401(k) (mostly dividend stocks) and a Roth. I just bought a $200,000 annuity just to be on the safe side. I still have a $125,000 mortgage and need a new car soon. My salary is $135,000 per year. I hope to continue working, but I don’t take it for granted and want to be prepared for layoffs that seem to be common.
I expect my expenses in retirement to be about $100,000 per year.Should I convert some of my savings to a Roth and take the tax hit now? And at what age can I retire without worries?
– Jan
I think you’re in good shape. There are some meaningful gaps in the information you provided, but I’ll explain the reasonable assumptions I used to fill them in before explaining where I think you stand. As for converting money to a Roth, yes, I think a Roth conversion strategy could be valuable to you, although I don’t think I would recommend doing it all at once. You may consider spreading the conversion over a number of years. (If you have similar questions about your retirement planning, consider contacting a financial advisor.)
I don’t want to get distracted from answering your question, so let me briefly explain some of the assumptions I had to make. I’m not suggesting that these assumptions are “correct,” or that you should use them as targets. Adjust these as necessary as you make your final decision”
Investments: You mentioned that you own $1.4 million in “equity”, which I hope also includes some bonds of various types, or that you at least plan to reduce your equity exposure in the near future. I assumed that you would hold a classic 60/40 portfolio after retirement.
Social security: Just because I knew what one year of your salary is, I used the average Social Security benefit of $1,907. You can view your own Social Security statement or income statement to get your specific benefit.
Annuity: I assumed you had a deferred income annuity and would receive a lifetime benefit in five years. A popular online annuity estimator gave me a monthly payment of $1,618 and I assumed inflation wouldn’t rise.
(Keep in mind that everyone’s retirement prospects are different. That’s where having a financial advisor guide you through the planning process can help.)
Given these assumptions, a Monte Carlo analysis suggests that a reasonable retirement goal would be somewhere in the late 60s. However, if you plan more carefully and accurately, you may be able to retire earlier.
For example, with a life expectancy of 100 years, you expect to retire longer than most people have to take into account. It’s smart to include this longer timeline as you did. But have you thought specifically about how your expenses might change down the road? In most basic retirement planning scenarios, we assume that expenses generally increase due to inflation. That’s what I did here, but that’s not always the reality.
Medical costs tend to rise faster, while other expenses such as travel, entertainment, food and housing can decline – especially as we get older. Suppose you decide that your expenses will increase over a period of time, but then decrease in real terms as you physically slow down. You can then adjust your planning accordingly. This could significantly improve your projection – and give you the confidence to retire early.
One way to achieve this is to create a substantial ‘income floor’ of guaranteed money. You can do this by delaying Social Security until age 70 to maximize your benefits. Combining your higher Social Security benefits and annuity payments gives you a guaranteed income for life, reducing the risk of running out of money. If these sources can cover your living expenses, you may feel more comfortable retiring early, especially if you have adequate health and long-term care insurance.
Again, I’m not saying this is your thing should Doing. I’m just giving you an example of something you do could Doing. Another powerful tool that can go a long way is the simple willingness to be flexible with your spending and spend a little less when the market takes a hit.
Most importantly, you have several options depending on your scheduling preferences. (A financial advisor can help you create a retirement income plan tailored to your needs.)
Roth conversions are certainly worth considering and I suspect would improve your retirement outcome. I wouldn’t do it all in one go, though. You are now probably in the lower end of the 24% marginal tax bracket. Based on your retirement expenses, you’ll likely fall into the 25% or 28% bracket if the Tax Cuts and Jobs Act ends in 2025 as currently planned.
By making Roth conversions, you can pay taxes on that money while at a lower rate. Then, any growth on that converted money can later be withdrawn tax-free. Pairing this with deferring Social Security benefits, as mentioned above, could be extremely tax efficient. Taxable income, such as withdrawals from tax-deferred accounts and your annuity payments, can increase the portion of your Social Security benefit that is taxable. So if you make conversions before you start receiving them, you can reduce the tax on your benefits later.
Since you haven’t indicated how much of your $1.4 million is currently in tax-deferred accounts, it’s difficult to know exactly how a lump sum conversion would impact your tax rate. If you now convert all your deferred tax assets, this can be spread over the marginal tax rates of 24%, 32%, 35% and 37%.
Instead of doing that, consider spreading it out so you don’t subject yourself to those higher rates. You could start by filling the 24% bracket every year (and then 28% after TCJA). (This type of tax planning is an area a financial advisor may be able to help you with.)
Broadly speaking and based on some assumptions, I think you’re in a good position, even given your expected longevity. I think you can put yourself in a better position by carefully considering how you want to plan your retirement income and spreading your Roth conversions over several tax years. It may be that a tailor-made pension approach can ensure optimal results.
If you have tax-deferred retirement accounts, you’ll need to consider required minimum distributions (RMDs). These mandatory withdrawals begin at age 73 (age 75 for people who turn 74 after December 31, 2032). SmartAsset’s RMD calculator can help you estimate how much your first RMD will cost. Please note that failure to meet your RMD may result in a tax penalty.
A financial advisor can help you plan RMDs, make Roth conversions, and create a holistic retirement plan. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Have an emergency fund on hand in case you encounter unexpected expenses. An emergency fund should be liquid – in an account that isn’t at risk of significant fluctuations like the stock market. The trade-off is that the value of liquid cash can be eroded by inflation. But with a high-interest account, you can earn compound interest. Compare savings accounts from these banks.
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