4 Little known ways to potentially maximize income during retirement.
Put money away in HSA
- Postpone Social Security Benefits
- Begin taking tax deferred money earlier
- Invest in real estate
If you’re like me, or if you want to secure a long lasting and fun retirement, then you better have a pension. Ok, well if you don’t have a pension, then there are ways you can structure your money so that you can live like you have one. There are a number of ways to ensure you’ll be able to live comfortably in the years after you’ve “finished” working. I say “finished” like that because I know some folks who just can’t sit still and have to do something productive.
So let's dive in.
Although there are many winning retirement strategies that can be implemented, here we’ll discuss 4 that I believe to be most successful.
- Utilize the HSA at your work (if you have one)
Health Savings Accounts are literally one of the best kept secrets to setting yourself up for a long and fruitful retirement. These accounts go relatively unnoticed while in your working years which is really a bummer, considering the number of benefits they have.
Let’s first dive into the taxation benefits of these accounts.
Imagine being in Vegas but the odds are actually in your favor. In fact, they’re three to one. You roll the dice and… boom! You win! That’s what its like having a Health Savings Account during your retirement years. In an HSA, there are 3 benefits which can’t be overlooked tax wise. For starters, the allowable contribution limits for families is $6,900 in 2018 which can be deducted from your ordinary income (like an IRA). Secondly, the account is tied to an investment portfolio and has the potential to grow tax deferred for as long as the account stays active. Third, when monies are taken from the account to pay for qualifying medical expenses, the withdrawals are tax free. Talk about a winning table!
Health savings accounts are also great in that if you were to decide that later in life you wanted to take withdrawals for something other than a qualifying medical expense, you can do that too. If at anytime you take a distribution from the account before age 65, you’ll be slapped with a 10% penalty (boo..) and you’ll pay ordinary income taxes on whatever you took out. Say however you needed money after age 65, there is no penalty. The distributions will be taxed, but you won’t have to pay the 10% fee. One can almost categorize this situation as an IRA but the age requirement for distributions is 65, not 59 1/2.
Now that you have a large chunk of money sitting on the sidelines for medical expenses that are tax free, you can live off of your retirement income which if played properly, could net you more money in the long run. You won’t be having to take money from your retirement income to pay for Medicare premiums which means you can take less from your investments. This means the withdrawals from portfolio could be lessened, allowing your accounts to be prolonged.
Your employer may or may not have an HSA for you to enroll in at your work. Check to see if you have a qualifying High Deductible Health Plan so you can begin putting money away for medical expenses in your later years. By the way, there are more benefits to Health Savings Accounts, but today we’re just looking at maximizing retirement income.
- Postpone Social Security Benefits
Ok, so this one might not be too much of a secret. The longer you wait to begin taking benefits from Social Security, the more growth potential your benefits have.
If you were born before 1954, your full retirement age is 66. This means you’ll get the full amount that Social Security calculated for you. If you decide to take your benefits early (which you can beginning at age 62), you’ll receive 75% of your full benefits. Because you’re taking your benefits 48 months before your full retirement age, the Social Security Administration reduces your payments for the rest of your life. If you start taking benefits at age 65, you’ll receive 93.3% of your stated benefits. That 6.7% difference can be huge later in life, so just be aware of that.
However, for every year you postpone your benefits, an 8% increase gets added on for as long as you don’t file for your benefits. The 8% growth stops at age 70 so in theory, you can begin receiving 132% of your full benefits for the remainder of your life because you allowed the money to grow for 4 extra years.
This can be a great strategy for those who have money in an IRA that can live on those accounts until age 70. This would create a situation with a smaller tax bill as the RMDs from your IRAs would be smaller, resulting in a potential tax savings. Higher income, lower taxes. Who wouldn’t like that?
- Begin taking money out of retirement accounts earlier
Once you reach 59 ½ you’re eligible to begin taking withdrawals without penalties from your tax deferred accounts. IRAs, SEP IRAs, 401k, etc. are all considered tax deferred accounts. Because you put money in them pre-tax (and got to deduct the contributions from your income), the Great And Powerful Uncle Sam wants his share of your earnings. Surprise, surprise…. Anything that comes out of these accounts is treated as ordinary income except for the Roth IRA which is generally untaxed when money is withdrawn from it.
So here’s one strategy most investors don’t know about: taking money from your tax deferred accounts before taking social security. This may help reduce your tax bill when you reach 70 ½ .
The government wants its fair share of taxes, right? Once you turn 70 ½ you’re required to begin taking minimum withdrawals from those accounts. What a buzz kill! We in the financial world call them “Required Minimum Distributions” or RMDs for short. RMDs are calculated based on life expectancy. For example, the RMD for a $1,000,000 portfolio at age 70 ½ is roughly $37,000 per year. If you reduce that account to $500,000 by spending it down over your 60’s, your RMD at 70 ½ is roughly $18,000/yr. Depending on your situation, you could potentially reduce your RMDs which may bring your tax bracket down resulting in more money in your pocket at the end of the day. It's like putting on a freshly washed pair of pants, reaching into your pocket and finding a $100 bill!
As we talked about earlier, if you can live off of your tax deferred accounts until age 70 ½, you’ll be able to reduce your RMDs AND if you postpone your social security benefits for a few more years, it may mean up to 32% more income in retirement. That’s Big League.
- Real Estate
Real estate can also be a great asset to one’s portfolio. Land is finite and people need places to live, play and conduct business. Depending on your situation, real estate may be a long term, more steady way of receiving income in the form of rental property.
We can get into the weeds on what a sound real estate portfolio should look like, but for simplicity reasons we’re just going to talk generally here. A decent return/income stream from real estate is typically around 5% of the property value after all expenses. That means, hypothetically, if you have a fully owned $500,000 rental property, a good rental value would potentially allow you to passively earn roughly $25,000/year after the property taxes, bills and other expenses.
Because our area is already highly valued, there might be a chance your return could be higher as the value of the property grows. (Let’s not forget that real estate is subject to capital gains taxes upon the SALE of the property which allows for potential growth and rent bumps too). That all being said, unless you have a substantial amount in cash from the sale of a business or money you’ve been putting aside for a while, it might be difficult to find something that would be worth the initial investment.
Another thing that may be beneficial to real estate owners is the taxation upon owner’s death. Once a real estate owner dies, the basis of the property gets stepped up to the date of death, which could potentially be passed off to the beneficiaries with minimal taxes. This is a general statement and you should discuss this strategy with a tax professional.
Of course, these are strategies that are should be carefully thought out before implementing them into your financial plan. In order to maximize your income during retirement, you should really think about how much you’ll actually need and work backwards from there. A lot of times, I’ll find folks talking about their portfolio and how they’re hoping to get 5% from their investments. In my experience, I find it’s better to make a budget, figure out how much you’ll actually need to sustain the lifestyle you want and then find ways of reaching your goals.
Another thing to be aware of is that you might have to lower your expectations on your retirement income. Sometimes folks expect a lot out of their investments and in reality, you have to plan for the worst and hope for the best. If you need more of an in-depth analysis of your current situation and are wondering if you’ll be able to sustain your lifestyle during retirement, I’m happy to help if you’d like to ask a question.
So in summary:
4 Little Known Ways To Potentially Maximize Income During Retirement:
- Get into an HSA (If you qualify)
- Postpone Social Security Benefits
- Begin taking withdrawals from tax deferred accounts in your 60’s
- Get into real estate