The phrase helping people quit dredges up all manner of images, most of them having to do with substance-abuse therapy. For many advisors that's apt, because the process of easing a client into retirement can feel like an intervention at times.
But it's one that's worth the effort. In fact, for those seeking a niche, it's easy to argue there is no more lucrative area than helping people transition from employment to retirement. U.S. Census data show about 2.5 million Americans turning 62 this year, and SRI Business Intelligence Research says people retiring in the next 10 years control a quarter of all the assets in this country.
The downside of this potential bonanza is that advisors will be forced to increase their skill sets to become financial-advisors-for-life to these retirees. At a minimum, this requires clever and dynamic investment analysis.
There are also myriad taxation and insurance issues that advisors must confront and master before they can competently advise retiring types.
Taxes: Stiffing Uncle Sam
Dividends vs. Coupons
If the lowest interest rates in a half-century aren't enough to turn retirees away from bonds and toward stocks, maybe lower taxes will. Under the 2003 tax act, individuals in the top tax bracket would have to earn 3.25 percent on a CD to get the same after-tax return of a qualified stock dividend of 2.5 percent. The expected greater volatility of a common stock portfolio can be mitigated somewhat by the current onslaught of open- and closed-end mutual funds designed to take advantage of the dividend tax loophole.
Postpone Social Security
Fight the client's impulse to immediately turn on the federal check-a-month spigot. Once that money starts coming in, it can't be stopped or modified. And, because money withdrawn from pension and IRA accounts can make Social Security benefits taxable, this inflexible payment plan can put clients in tax brackets not seen since the early 80s. A couple with $25,000 in annual Social Security payments and $50,000 annual income from other sources would raise their federal tax bill by about $500 for each additional $1,000 they withdraw from a tax-sheltered annuity or retirement plan. Legally, the tax can't be avoided, but in the few years between retirement and starting Social Security payments, it is possible to reposition clients' assets to more flexible options. Selling securities that have large capital gains, withdrawing extra money from IRAs and annuities and transferring balances to Roth IRAs can give retirees breathing room when they do finally receive their government checks.
“Peak and Valley” Withdrawal Plan
In retirement, clients lose the luxury of a steady salary, but they gain the flexibility of being able to take some or all of their income when it is most advantageous to do so. Taking more money out of taxable accounts one year and less in the next can prevent clients from being taxed on their Social Security payments, at least in the lower-income years. The “low” periods may also allow them to qualify for other tax credits and deductions that wouldn't be available if their incomes were kept level from year to year.
Roth and Roll
Clients should fund Roth IRAs whenever possible. Converting regular retirement accounts to Roths is a good idea, too, as long as the change won't put them up in the top brackets and they don't have to withdraw IRA money to pay the taxes. But there is a unique window of opportunity for retirees to convert IRAs to Roths, contribute to the same account and still pay little or no taxes on the conversion. The answer lies in the 2003 tax act's “Saver's Credit.” Let's take, for example, a couple that retired from their full-time careers, but wouldn't mind a little part-time work. If the husband earns $2,000 this year, they can each contribute $2,000 to their respective Roth IRAs. If they have little other taxable income, they qualify for the saver's credit — up to a $1,000 reduction in federal income taxes for a $2,000 deposit into a qualified retirement plan or Roth IRA. They could then convert around $14,000 in IRA money to a Roth IRA, and use the saver's credit to offset any conversion taxation.
But advisors and clients have to use this tool while they can — the saver's credit is only available through 2006. There is more information and a saver's credit calculator available at hrblock.com.
Insurance: The Safety Net
While we all hope that a large tax bill is the biggest problem that will face retired clients, the reality is that bad things can (and will) happen to them — and old age makes them more vulnerable than ever. Advisors may not be able to prevent the unpleasantness of life from disrupting their retirement years, but these tools can minimize the financial and emotional impact.
The Cost of Mortality
Most clients nearing retirement will have wills, but they likely haven't updated them recently. Running an estate plan can pinpoint the damage potential of any applicable “death taxes.” Clients also should have an attorney write durable powers of attorney for both financial and health care decisions.
Back to the Bank
People in a retiring frame of mind typically have all or most of their primary residence paid for. But advisors should advise them to open a line of credit account on the equity they have in their home. For a nominal cost, they can ensure quick access to money in an emergency that would otherwise have to come from selling the house, or liquidating securities and investment accounts.
People in their early 60s are prime candidates to consider long-term care insurance — bound to be the fastest-growing financial services solution over the next decade. In addition to providing for clients' health care, the premiums paid to these policies may cut the client's tax bill. Up to $2,510 of qualified LTC premiums (per insured, age 61 to 70) can count towards deductible medical expenses. Check out Publication 502 at irs.gov for more information.
Kevin McKinley is a CFP and vice president of investments at a regional brokerage and author of Make Your Kid a Millionaire — 11 Easy Ways Anyone Can Secure a Child's Financial Future.