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Coordinate Retirement Withdrawal Strategies to Generate Most Income

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Advisors have a “fantastic opportunity to raise the bar” on the advice retirement clients are receiving, William Meyer, founder and managing principal of Social Security Solutions, said Tuesday.

Meyer led a webinar for Retirement Experts Network on designing withdrawal strategies optimized to generate the most income for clients.

Managing money for clients who are already retired is different from managing clients who are still working because withdrawing money gets them “out of balance,” Meyer said.

“If you’re withdrawing money, you’re making asset location out of whack,” he said. “If we put holdings in the right account, when you withdraw you can reduce” clients’ tax liabilities.

Coordination of withdrawals is a lot more important for retired clients, he noted. “By withdrawing from the wrong place, you can increase someone’s Social Security taxes,” he said. “If you withdraw in the wrong sequence, increasing someone’s taxes from 50% to 85%, it really makes a huge difference.”

Furthermore, if a withdrawal or Roth conversion drives clients into a higher Medicare threshold, they could find themselves paying as much as 45% more in premiums, he said.

Conventional wisdom on retirement savings drawdowns is misleading, he warned. The accepted strategy is for clients to withdraw from their taxable accounts until those assets are gone, then turn to their tax-deferred accounts, followed by tax-exempt accounts.

“That is the standard rule of thumb,” he said, but this default sequence “can be beat in a very material way” by withdrawing enough from tax-deferred accounts to reach the top of the “15% tax bracket and take some taxable [income] until it’s exhausted, and then continue the sequence.”

Additional income can be put into a Roth every year, he said. “Compared to the conventional rule of thumb that almost all of you are using, we found an additional two and a half years” worth of income, he said.

Another strategy is to convert part of clients’ savings to a Roth RIA with a recharacterization, he said. “When you do a Roth conversion, you can essentially do a do-over,” he said. He suggested doing two Roth conversions, one with a stock position and one with a bond position, and convert the underperformer back.

“We have to get beyond the conventional rule of thumb that we are currently using,” he said.

Meyer’s firm created software, SSAnalyzer, that runs sequences on how clients should draw down their retirement assets.

For example, a 62-year-old client who expects to live to age 85, and who has a spending goal of $5,000 per month, and a $600,000 portfolio could receive an additional year of income by reversing the conventional wisdom and withdrawing from tax-deferred accounts first, followed by tax-exempt and taxable accounts, Meyer said.

Lower asset clients can benefit from this strategy because Social Security benefits will be taxed less when they start receiving benefits, and they reduce their required minimum distributions, according to Meyer.

The same client could get an additional $64,000 by using the conventional wisdom with a Roth conversion that brings the client to the top of the 15% tax bracket. “If you do that year over year,” Meyer explained, “we’re taking more out, but there’s a breakeven point in which this Roth strategy does better.”

“It’s pretty profound when you show this to clients,” he said. “I call it the rainy day versus the sunny day.”

In another example, Meyer broke down the strategy for a married couple that expect to live to their 90s, and have $1.5 million in their portfolio and a spending goal of $100,000 per year.

By retiring at 70 instead of taking early benefits, the couple would receive an additional $362,969. “Don’t underestimate the impact of Social Security by itself,” he said. “I think people are starting to build awareness of the importance of Social Security planning, but when you frame it showing the numbers and how long you have to live, that’s when you see behavior change.”

Meyer found the difference between the conventional wisdom and the Roth conversion strategy added $650,000 to the couple’s portfolio.

Despite the Social Security rule changes late last year, Meyer warned that the rules are still very complex. Clients who did not turn 62 at the end of last year are deemed to be filing for all their benefits, he said.

The new breakeven point where the benefits of delaying filing offset those of filing early and collecting for longer has skewed backward, he said. Under the old rules, a 61-year-old couple’s cumulative benefits when they filed for benefits early dropped below the benefits of either beneficiary delaying filing around age 82 and six months, Meyer said.

Now the breakeven point is 88 years and 11 months, meaning advisors have to carefully consider a specific client’s mortality before recommending they delay filing for Social Security benefits, Meyer said.  

Meyer added that advisors have a “tremendous opportunity” to help clients who have already filed for Social Security optimize their benefits. “If you look at the numbers,” he said, “it’s pretty obvious that a majority of clients have taken Social Security too early.”

He suggested a “re-do strategy” for certain clients. “If you can get to them within 12 months of filing, you can essentially fix their strategy,” he said.

Clients who filed early can request a voluntary suspension of their benefits when they reach at full retirement age, Meyer said. This is different from the familiar file and suspend strategy that was eliminated by Social Security reform earlier this year, he stressed.

“For every year you suspend, you get 8%,” he said. So a client who was receiving $1,875 from Social Security and suspends benefits for four years can increase benefits to $2,475.

— Read How to Build Tax-Efficient Withdrawal Strategies for Retirement on ThinkAdvisor.