Effective retirement planning reaches beyond investments and the numbers related to various accounts a person owns. First, it’s about understanding the scope of one’s future financial needs and goals. And from that framework, it’s about putting all areas of the plan together so that they complement one another and function 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, taxes, estate planning, etc. But holistic financial planning includes and ties together every aspect relevant to the retirement strategy. It analyzes and seeks to optimize each part of a person’s plan by making those pieces work together congruently.
One way to think about holistic planning is that most people have several pieces that comprise their retirement puzzle, and they all need to fit together to form a complete picture. But I find when talking about holistic planning in seminars, it’s eye-opening for people because they really haven’t thought about it in that context. Here are the fundamental elements in most people’s retirement situations:
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- Social Security
- tax planning
- Investments (401(k) plans, Roth IRAs, nonqualified accounts, etc.)
- Income plan (mapping out a strategy for how to use your money)
- estate plan
All those parts need to function together. You can’t maximize your situation if you’re looking at each of those aspects in a vacuum.
Putting the pieces together: Starting with Social Security
You have to view Social Security in the context of three of the bullet points mentioned above: investments, income plan and tax planning. You also have to figure out how much longer you’re going to work and your spouse’s needs — especially if one spouse might have 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 income, but perhaps they take it too soon and get hit with extra taxes as one result. When you look at Social Security in relation to a person’s investment accounts, that helps determine their strategy of when to turn the Social Security faucet on.
Let’s take a hypothetical example. A couple thinks they’re going to start taking Social Security right when they retire, but once a holistic planner does an overview with them and considers all the other pieces of their retirement plan, it makes more sense for one spouse to delay Social Security payments until age 70. That’s based on how much more they’re planning 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 might allow them to stop withdrawing money from his 401(k), thus lowering their taxable income while also letting their investments grow for a longer period of time.
Every piece affects taxes
You have to look at the tax efficiency part in terms of making every aspect of a retirement plan work together. When saving for retirement, it’s a good idea to diversify how and when your savings will be taxed. Doing so can help you successfully navigate the unknowns of retirement: How much of your income will be taxable, and what your tax rate will be in retirement.
Tax planning becomes complex as one’s wealth grows, which is why a holistic financial planner works in tandem with your tax adviser and your estate attorney. The idea is for them to take a proactive approach to minimizing taxes in different areas of your retirement plan. Putting a couple in a higher tax bracket, for example, makes it more difficult for them to do Roth conversions tax-efficiently (Roth conversions are taxable in the year of the conversion). One reason for Roth conversions is the tax efficiency it gives you in retirement, as qualified distributions of Roth funds are tax-free (opens in new tab). A couple that is able to do Roth conversions over several years can significantly lower their overall tax burden in retirement, perhaps to the point where the vast majority of their Social Security isn’t taxed later in retirement. In addition, Roth money is tax-free for your heirs as well, which ensures you don’t leave a tax burden for the next generation.
You’ll want to make sure investments are structured to be as tax efficient as possible. I also run into a ton of people who have nonqualified accounts such as stock portfolios, and they’re not using tax-managed strategies. It’s spinning off a lot of dividend income, and people who have mutual funds really have no control over capital gains triggered in their accounts. All of that trickles down to their tax return, in addition to the income they are living on. That can drastically change their tax bracket and make doing tax-efficient Roth conversions more difficult.
Typically, when people think about income planning for retirement, they think about using their bank accounts and nonqualified money first, then their IRAs and/or 401(k)s, and last their Roths. That’s not a bad strategy, but a simple tweak to it can help: At the same time, you’re using your bank money and other funds, converting some of your IRA and 401(k) funds to a Roth is a sensible idea.
The bottom line
Remember, if all the pieces of a retirement plan work independently of each other, you’re not getting the best out of each one. Every part affects another part. Many people don’t look at retirement planning in that context, and it’s vitally important to do so in order to maximize your success in retirement.
If you currently feel like your retirement plan is just a bunch 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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