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.