By Michael E. DeMassa, CFA, CFP®, AEP®
A couple in their early 60s with 2.4 adult children* came to us with questions we hear frequently from people approaching retirement:
- When can we retire?
- When should we start Social Security?
- Do Roth conversions make sense for us?
If you’re wondering how a couple can have 2.4 children, they can’t – but that’s what happens when working with averages.
Financial planning often relies on averages and rules of thumb but every family has its own unique goals, assets, tax circumstances, and priorities.
After more than 25 years of working with clients, I’ve yet to meet two families in exactly the same situation. A recommendation that works well for one retiree may be completely wrong for another.
In this case study, we ended up breaking three pieces of conventional financial planning wisdom.
Rule #1: Delay Social Security until age 70
Many financial advisors advocate delaying Social Security benefits until age 70 in order to maximize the monthly benefit. For the aforementioned couple, however, starting benefits earlier made more sense.
Like many diligent savers, most of their retirement assets were held in pre-tax retirement accounts, primarily traditional IRAs that originated from employer-sponsored retirement plans. They had accumulated far less in taxable brokerage accounts.
By starting Social Security earlier, they reduced the amount that needed to be withdrawn from their investment portfolio during the early years of retirement. This lowered their portfolio withdrawal rate to below 4%.
Why does that matter?
The early years of retirement are often the most vulnerable. A significant market decline, combined with large withdrawals, can create what’s known as “sequence of returns risk,” where poor investment returns early in retirement can have a lasting impact on a portfolio’s sustainability.
Receiving Social Security sooner helped reduce pressure on the portfolio during this critical period.
Customized recommendation: Start benefits earlier to reduce portfolio withdrawals and improve retirement sustainability.
Rule #2: Pay Roth Conversion Taxes with Non-IRA Funds
You’ll often hear advisors recommend paying Roth conversion taxes from assets outside the IRA. In many cases, that advice makes perfect sense. However, this couple’s situation was unique.
Most of their wealth was concentrated in traditional IRAs, while their after-tax savings were relatively limited.
Using those limited taxable assets to pay Roth conversion taxes would have depleted an important source of flexible retirement spending. Taxable accounts often provide greater flexibility for managing income and taxes throughout retirement.
Because the couple was already over the age of 59½, there was no early withdrawal penalty associated with using IRA funds to satisfy the tax liability.
By paying the taxes from the IRA itself, they preserved their after-tax assets and maintained greater flexibility throughout retirement.
Customized recommendation: Preserve limited after-tax savings by having the IRA cover the tax liability.
Rule #3: Trust the Retirement Calculator Implicitly
Today’s financial planning software is incredibly powerful and, at Forza Wealth Management, we use some of the industry’s leading tools. However, no single calculator or software package has all the answers.
Retirement planning involves thousands of assumptions regarding investment returns, taxes, inflation, spending, longevity, Social Security, and healthcare costs. Small changes in these assumptions can produce dramatically different results.
That’s why we often evaluate retirement strategies using multiple approaches:
- Financial planning software
- Customized Excel models
- Experience working with hundreds of retirees
Think of it as triangulating a solution. Each tool has strengths and limitations. By comparing the results across multiple methods, we can better understand the tradeoffs and gain confidence that the recommended strategy is appropriate for the client’s specific circumstances.
In this case, both the planning software and the Excel model arrived at similar conclusions regarding Social Security timing, Roth conversions, and retirement income withdrawals. That gave us greater confidence that the recommendations were grounded in sound analysis rather than the assumptions of a single calculator.
Customized recommendation: Use multiple tools to test assumptions and validate the strategy.
Retirement planning isn’t one-size-fits-all
The purpose of this case study isn’t to suggest that everyone should claim Social Security early or pay Roth conversion taxes from an IRA. In fact, for many people, the opposite recommendations may be appropriate.
The lesson is that retirement planning works best when it is customized.
Rules of thumb can provide a useful starting point but important financial decisions should be based on your unique goals, tax situation, spending needs, account structure, and family circumstances.
Sometimes the best plan follows conventional wisdom. Sometimes it breaks the rules. The key is understanding why.
The best retirement strategy is rarely found in a rule of thumb or an online calculator. It’s built around your goals, resources and priorities. If you’re approaching retirement and wondering how Social Security, Roth conversions, taxes, and portfolio withdrawals fit together, we’d be happy to help you evaluate the tradeoffs.
*This example is hypothetical and provided for educational purposes only. The reference to “2.4 children” is intended to emphasize that no real family has exactly average circumstances. Just as no family has 2.4 children, no retirement plan should be based solely on averages.