Financial vehicles for retirement have evolved in recent years, and the market will only continue to change.
“The shift employers have made from traditional pensions to 401(k)s as the main workplace retirement plan is even more profound than many think,” said James Mahaney, CLU, ChFC, MSM, MSFS, Vice President of Strategic Initiatives for Prudential. “Retirees are living longer, and women especially will need retirement income to last for longer periods of time. However, the survivor benefits that provided lifetime income for spouses and were paid through traditional pensions via the qualified joint survivor annuity are going away.”
Meanwhile, Social Security continues to be a centerpiece of retirement income for many retirees. In fact, from 2008 to 2011, Social Security as a percentage of retirement income for individuals in the top income quartile increased from 20 to 26 percent.
So what steps can you take to help clients manage their retirement finances as they relate to Social Security and generating lifetime income for both members of a married couple?
1. Consider how taxes affect retirement income in an era of longer lifespans.
Most Americans prioritize minimizing taxes in retirement and generating income for as long as it is needed. What many don’t realize is the two goals are often correlated. The more money saved in taxes, the longer an investment portfolio can last and/or the higher the standard of living one can enjoy. Furthermore, couples need to consider that income will likely need to be generated for multiple decades. “For example,” Mahaney said “there is a 50 percent chance that one person in a couple age 65 today will live to the age of 90.” 1
2. Focus on the most appropriate clients.
According to Karen Hofmann, CLU, ChFC, Director, Advanced Markets Group and National Partnership Program for the Individual Life Insurance Division of Prudential, producers have many opportunities to create retirement strategies with high-income clients who are in good health and under 55. High-income-earners often include physicians and surgeons, dentists, business owners, senior executives, attorneys, engineers, and others.
3. Delay Social Security to enhance income.
“One important strategy,” Mahaney said, “is delaying Social Security for as long as possible, which can help enhance retirement income and manage taxation.”
What are the benefits? Mahaney delineated three of the most important:
- When Social Security is delayed, the base benefit amount increases. For example, between the ages of 62 and 70, the base benefit increases by 77 percent for those retiring today (for whom the Full Retirement Age is 67).
- Cost of living adjustments (COLAs) are computed using the base benefit. So the larger the base benefit (which, again, increases with each year that a client delays filing), the larger the COLAs will be each year in the future. The Social Security office estimates that adjustments will average 2.7 percent a year over the long term. Between the ages of 62 and 70, the COLA continues to increase “behind the scenes.” This means that your client’s initial benefit will be even higher if they delay due to two factors, the increase in the base benefit and the COLAs that have accumulated since their eligibility age.”
- The survivor benefit is tremendously valuable, especially for a couple retiring with 401(k) savings, and not a traditional pension. If your clients are married, no matter which spouse dies first, the higher-income-earner’s Social Security benefit will remain, while the other spouse’s benefit drops off. So if the higher-income earner can maximize his or her benefits by delaying Social Security as long as possible, both spouses could potentially reap the additional benefits.
These three things can make a big difference in protecting your clients’ purchasing power — especially those who live another 20 or 30 years after retiring. Someone who delays Social Security until age 70 and lives a long life in retirement will receive significantly more money over the course of his or her lifetime than if Social Security was claimed at age 62.
4. Capitalize on the tax benefits of delaying Social Security.
Social Security has important tax implications. For example, if your client opts to file early and make withdrawals from an Individual Retirement Account (IRA), not only will the IRA income be taxable, but the Social Security income often will be, as well. This happens because the IRA income pushes total income above a thresholdthat results in the taxation of Social Security income.
However, if your client files for Social Security later and instead relies on IRA or other forms of income in the interim (life insurance or Roth income, for example), not only will your client likely receive more Social Security over the course of the rest of his or her lifetime, but this income may be tax-favored as well. Specifically, once Social Security income begins, lower amounts of taxable IRA income will need to be generated, while some of the Social Security income may avoid taxation completely.
If additional income is needed once Social Security payments begin, Roth distributions, life insurance withdrawals or loans2, and death benefit proceeds payable over time could all potentially provide tax-free income that won’t trigger Social Security income taxation.
5. Consider all retirement income options.
Before going any further, step back and look at all of your client’s retirement income streams that can enable delaying Social Security when they reach retirement age.
Hofmann said there are many options. These include:
- Continuing to work longer (which, she noted, few will likely want to do)
- Using personal savings
- Withdrawing from pension income
- Tapping into annuities or mutual funds
- Accessing life insurance policy cash values via loans or withdrawals
6. Remember the advantages of life insurance.
Discuss with your high-income clients how life insurance can be used to supplement retirement either through death benefit proceeds, or by accessing the cash value.1
Why would someone want to access life insurance policy cash values as opposed to pulling money out of other saving vehicles or retirement accounts?
“It’s simply about the tax,” Hofmann said. “Life insurance is tax-advantaged when it comes to pulling out loans and withdrawals if you do it up to the IRS limitations. In fact, it’s tax-free if done correctly.”
Life insurance is not included in the provisional income calculations used for Social Security taxation.
To use life insurance as a tax-advantaged source of income in order to delay Social Security, your client can choose to opt for the minimum death benefit that meets their need and the maximum premium payment. This structure will provide the most potential for cash value accumulation over the life of the policy.
Life insurance offers multiple benefits:
- Death benefit protection for the spouse if your client passes away early – any death benefit remaining at death can be used by the surviving spouse to offset the loss of Social Security checks.
- The ability to accelerate up to 2 percent of the death benefit for chronic illness for policies that include an optional chronic illness rider.
1 “How much longer might you live? Think again.” CBS News October 16, 2014. http://www.cbsnews.com/news/two-common-mistakes-we-make-thinking-about-how-long-we-might-live/
2 Life Insurance cash values are accessed via loans and withdrawals. Loans are charged interest; they are usually not taxable. Withdrawals are generally taxable to the extent they exceed basis in the policy. Loans that remain unpaid when the policy lapses or is surrendered while the insured is alive will be taxed immediately to the extent of gain in the policy. Unpaid loans and withdrawals reduce cash values and death benefits, may reduce the duration of the guarantee against lapse, which may lapse the policy and may have tax consequences.
Prudential and its representatives do not give legal or tax advice. Clients should consult their own advisors.
Life insurance is issued by The Prudential Insurance Company of America, Newark, NJ, and its affiliates.
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