Effective retirement planning goes beyond investments and numbers related to the various accounts a person has. First, it’s about understanding the extent of his future financial needs and goals. And from that framework, it’s about bringing all the areas of the plan together so that they complement each other and work as an integrated whole.
Sometimes the financial world can seem segmented to clients, with professionals designated as experts in just one area of the plan – investments, insurance, tax, estate planning, etc. But holistic financial planning includes and connects all relevant aspects of retirement strategy. It analyzes and seeks to optimize every part of a person’s plan by making those parts work together cohesively.
One way to think about holistic planning is that most people have multiple pieces that make up their retirement puzzle, and they all need to fit together to form a complete picture. But I find that when we talk about holistic planning in seminars, it opens people’s eyes because they really haven’t thought about it in that context. Here are the fundamentals in most people’s retirement situations:
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- Social Security
- Tax planning
- Health Insurance
- Investments (401(k) plans, Roth IRAs, non-qualified accounts, etc.)
- Income plan (developing a strategy for using your money)
- Estate plan
All of these parts must work together. You cannot maximize your situation if you examine each of these aspects in a vacuum.
Putting the Pieces Together: Start with Social Security
You need to consider Social Security in the context of three of the points mentioned above: investments, income plan and tax planning. You should also consider how long you will be working and your spouse’s needs, especially if one spouse has a shorter life expectancy. Then the question is how your Social Security is going to be taxed. Most people have no idea what determines whether your Social Security will be taxed or not.
Sometimes people think they need Social Security for their income, but maybe they’re taking it too soon and getting hit with extra taxes as a result. When you look at a person’s Social Security versus investment accounts, it helps determine their strategy for when to turn on the Social Security tap.
Let’s take a hypothetical example. A couple thinks they’ll start getting Social Security when they retire, but once a holistic planner walks them through and considers all the other elements of their retirement plan, they makes more sense for one spouse to delay Social Security payments. until the age of 70. This is based on how much they plan to work, their other income streams and also their investments. At the same time, the other spouse may want to start receiving Social Security immediately, which could allow them to stop withdrawing money from their 401(k), thereby reducing their taxable income while leaving their investments bear fruit longer.
Each coin affects taxes
You have to consider the tax efficiency aspect, that is, making sure that all the aspects of a pension plan work together. When saving for retirement, it’s a good idea to diversify how and when your savings will be taxed. This can help you successfully navigate the unknowns of retirement: how much of your income will be taxable and what your retirement tax rate will be.
Tax planning becomes complex as your wealth grows, which is why a holistic financial planner works in tandem with your tax advisor and estate attorney. The idea is that they take a proactive approach to minimizing taxes in different areas of your retirement plan. Placing a couple in a higher tax bracket, for example, makes it harder for them to make Roth conversions in a tax-efficient way (Roth conversions are taxable in the year of conversion). One of the reasons for Roth conversions is the tax efficiency they provide you in retirement, as qualified distributions from Roth funds are tax exempt. (opens in a new tab). A couple able to make Roth conversions over several years can significantly reduce their overall tax burden in retirement, perhaps to the point that the vast majority of their Social Security is not taxed later in retirement. Plus, Roth money is also tax-free for your heirs, ensuring you don’t leave a tax burden on the next generation.
You will want to ensure that investments are structured to be as tax efficient as possible. I also meet a ton of people who have unqualified accounts such as stock portfolios, and who don’t use tax management strategies. This generates a lot of dividend income, and people who have mutual funds really have no control over the capital gains generated in their accounts. All of this reflects on their tax return, in addition to the income they live on. This can drastically change their tax bracket and make it more difficult to achieve tax-efficient Roth conversions.
Typically, when people think of income planning for retirement, they think first of using their bank accounts and unqualified money, then their IRAs and/or 401(k), and finally their Roths. Not a bad strategy, but a simple tweak can help: at the same time you’re using your bank money and other funds, converting some of your IRA and 401(k) funds into a Roth is a sensible idea .
The bottom line
Remember that if all the elements of a retirement plan work independently of each other, you won’t get the most out of each one. Each part affects another part. Many people don’t view retirement planning in this context, and it’s extremely important to do so in order to maximize your retirement success.
If you currently feel like your retirement plan is just a collection of individual pieces, a quality holistic planner could potentially add great value to your overall retirement.
Dan Dunkin contributed to this article.
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This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC or FINRA.
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