Retirement Income 201: Building on the Basics

Once you've laid the groundwork with a basic retirement plan, the next step is getting more strategic. This means exploring smart, sustainable ways to create a sufficient stream of income that supports the lifestyle you envision in retirement.

To help, we've asked First Citizens Wealth Planning Strategist Doug Semple and Investor Services Paraplanner Craig Shively to talk with us again. Among their key takeaways: Once you have your initial plan in place, adding complexity increases the importance of meeting regularly with your advisors to ensure your planning remains relevant to your life, responsive to the financial landscape and on track to meet your goals.

Where do people currently stand?

Before we explore more advanced strategies, it's helpful to understand where most Americans stand today when it comes to retirement readiness. The reality may surprise you—and it underscores why thoughtful planning really matters.

This gap in readiness isn't just about savings—it's also about planning for the right expenses. And few costs carry as much weight in retirement as healthcare.

Make healthcare your top priority

While Medicare may be central to managing medical costs beginning at age 65, the long-term healthcare expenses that fall outside its scope represent the biggest threat to the security of your retirement income planning.

According to one estimate, about 70% of older Americans will need some type of long-term care. For those who need full-time care, the cost can range from $50,000 to $100,000 per year or more.

"Long-term care insurance is absolutely essential," Semple says. "An unaccounted-for long-term health event can instantly wipe out a lifetime of savings and is the number one risk in retirement planning. As soon as possible, your mindset has to go from 'Do I need long-term care insurance?' to 'What are my risk exposures?' Because you can't afford not to have it, and the earlier you purchase it, the more affordable it's going to be."

As the economy struggles with high inflation, out-of-pocket medical expenses become even more of a threat. "Inflation is a real danger to retirement income, and medical costs are among the most inflation-sensitive," he adds.

An HSA can help with retirement

"If you have a health savings account, or HSA, and take the proper steps, you can hedge against that by turning it into what is essentially a healthcare Roth IRA that grows for the future, has tax-free withdrawals and is portable," Semple notes.

HSA contributions are pretax and allow you to invest your money after you hit a minimum threshold for deposits. You can add to your account over multiple years as your investments grow tax-free. Better yet, your withdrawals are also untaxed as long as you use them for healthcare expenses. If managed correctly, HSAs are tax-free from beginning to end. They're also a great place for high-income earners to continue to save pretax if they've already maxed out their retirement plan contributions.

"The current setup of HSAs places no expiration date on claiming medical expenses," Shively says. "So instead of immediately getting reimbursed for present medical expenses, you could opt to pay from current savings and let the money in your HSA grow through its investments. Then, as long as you have your receipts, you can apply for reimbursement for those costs after you retire."

Get tax smart with your withdrawal strategy

Before putting advanced retirement income strategies into place, you'll need to make a key decision. Do you want to prioritize providing for future generations or structure withdrawals and required minimum distributions, or RMDs, in the most tax-efficient manner possible?

Consistent Roth IRA contributions will be central to your strategy if you choose the former. But if you choose the latter, you'll need much more careful structuring and timing of withdrawals across your portfolio.

"If you're balancing a traditional and Roth IRA for tax efficiency, it's a straightforward matter of withdrawing from the IRA to satisfy RMDs plus nonessential expenses, then pulling from the Roth when you're about to bump into a higher tax bracket," Semple says. "This balancing act gets more complex when you factor in long-term capital gains and dividends. Many people aren't going to have especially high rates on those, and that can be complicated to structure with the rest of your variable income streams without a qualified tax advisor."

If you tend to give to charity, you can also utilize a charitable IRA rollover to your advantage by earmarking up to $100,000 of your RMDs to a tax-exempt entity. While you don't get the charitable deduction, you won't pay income taxes on the RMD either.

Semple and Shively are adamant on this point. As retirement income strategies become more advanced, the more likely it is that you'll need professional tax help. To highlight this, they provide two examples of advanced strategies for funding early retirement that can create benefits, as long as they're managed with the guidance of a specialist.

Roth conversions

A Roth conversion moves assets from a qualified plan like a 401(k) or a traditional, SIMPLE or SEP IRA—where withdrawals are taxed as regular income—into a Roth IRA, where future withdrawals will be tax-free.

You'll have to pay income tax on the amount of money you withdraw from your traditional account to convert to a Roth, which is why we see clients converting right after they've retired when their income and tax bracket are substantially lower. But because there's no dollar limit on conversions, the process lets you circumvent the $7,500 annual IRA contribution cap on the Roth—or $6,500 if you're younger than 50—to deposit substantial amounts of money. The only stipulations are that the recipient Roth account must be active for 5 years and you must wait until age 59 1/2 to withdraw to avoid a 10% penalty tax.

This makes Roth conversions a potentially beneficial approach if you're nearing retirement and have fallen behind with funding your post-work life. Used properly, Roth conversions can allow you to quickly boost your potential for tax-free income in retirement.

Calibrating the specifics of a Roth conversion requires precision, however. Before adopting this strategy, speak to a professional to help determine if your finances can handle the conversion taxes.

"It can definitely benefit you—especially if you're in a lower tax bracket—but the bottom line is it's a complex procedure that you'll still owe taxes on with every conversion," Semple says. "Precision calculations have to be done that involve transferring a partial or full total of any other plan into a Roth, and if done incorrectly they can cause problems—so you'll definitely want a qualified tax advisor if you're considering it."

Substantially equal periodic payments

Substantially equal periodic payments, or SEPPs—also known as 72(t) distributions—are another way to avoid IRS penalties when withdrawing funds from any qualified retirement account except your current employer's 401(k) before you reach age 59 1/2.

SEPPs allow a set amount of pre-59 1/2 withdrawals from your retirement account each year. The size of each distribution must be based on calculations derived primarily from both your IRS-determined life expectancy and that of your designated beneficiary.

Depending on which one of the three available IRS-approved methods you choose for calculation—RMD, annuitization or amortization—you may also need to assess interest rates, account balances and other factors.

"If the 72(t) distribution is modified, an individual no longer qualifies for the exemption from the 10% penalty, and the penalty is reinstated retroactively to all distributions taken prior to age 59 1/2, which becomes due at once," Shively notes. "Without a tax professional, you risk turning a potential advantage into a serious problem."

Create reserves and review assets

Along with preparing for healthcare costs and coordinating your tax strategy, you'll want to consider other areas of retirement income planning. Some of these will be essential considerations, while others are potential opportunities. Shively and Semple have three initial recommendations to get started.

• Set aside cash reserves. These can be used to cover unexpected expenses outside of your budget that could otherwise force you to go into debt or withdraw enough from your retirement funds to push you into a higher tax bracket.
• Survey your real estate holdings. Think about where you'll live in the future. If you own your home outright and don't plan to leave it to a loved one, a reverse mortgage may help you if you need cash to supplement your retirement income. Alternatively, if there's no mortgage on the home, renting it can create a stream of income from rental payments.
• Consider annuities. Once seen as a way to garner a tiny income stream in retirement, annuities have undergone significant changes—such as linking to market performance but with a floor to limit negative returns in a down market—that have increased their popularity. Pay close attention to the policy's terms—particularly when it comes to payout settlement options—and to their underlying fees and expenses.

Seek advanced help for advanced strategies

If some of these strategies sound like they might benefit your planning, the final point to remember is that your retirement income approaches must fit your goals and circumstances—and the more ambitious or complicated either are, the more likely it is that you'll need expert assistance, including specialized help with taxes, estate planning and financial planning.

"Ideally, you should have a team of professionals in place to help you navigate the financial complexities of retirement," Shively says. "Your financial planner, accountant and estate attorney should all be working in tandem to help you accomplish your goals before and well into retirement."

"Once you've got a plan in place with solid foundations and you have a firm understanding of some of the more developed actions you can take in key retirement areas, you should consider meeting with your team of professionals," he adds. "Because none of this is so simple that one person can figure it all out."