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On Your Way Out

Howard Rohleder

IMAGINE YOU PLAN to retire next year. What can you do beforehand to gain the most later on? Here are some ideas to consider before you log off at work for the last time.

If you’re retiring mid-year, increase your 401(k) or 403(b) contributions. Raise your savings enough to make a full year’s allowable contribution in the months you have left. This may be your last chance to put away tax-deferred money. I retired mid-year, so I doubled my 403(b) deferrals. That way, I accumulated a full year’s contributions in just six months.

If you contribute to a health care spending account, don’t overfill it in the year you retire. These plans are “use it or lose it.” Estimate your health costs up until retirement and don’t add any more to the health spending account than that. Know the time window for submitting claims, and act promptly so you don’t lose the money you set aside.

If you have a defined benefit pension, know how much you’ll receive. The biggest advantage of a pension is that you can’t outlive it. It’s guaranteed income for life. But the payment is most likely fixed, so inflation will trim its purchasing power over time. There’s also a chance that your employer could default on its obligations. Yes, there are government protections for pensions. But they don’t make you whole if you’re owed a hefty sum—more than $5,400 a month in 2021.

If this worries you, ask if you can take your pension as a lump sum payment. Just make sure you’re up to the responsibilities. For starters, you’d want to roll over the money directly into an IRA. That way, you’d continue to defer taxes—and avoid a monster tax bill. You’d also have to manage the money, plus follow a disciplined withdrawal strategy so it lasts your whole lifetime.

When you turn age 65, you qualify for Medicare, the federal health care program for older Americans. You can sign up three months before your 65th birthday. If you’re retiring before 65, make sure you know the cost of continuing your employer’s health care coverage under COBRA. You’re usually responsible for paying the entire premium, including the part your employer paid when you were working.

COBRA coverage typically ends 18 months after retirement. If you would still be under 65 then, research the costs to buy coverage from an Affordable Care Act plan. Hint: “Affordable” may not be your reaction. Consider a high-deductible plan linked to a health savings account (HSA). If you can afford it, fully fund the HSA and pay your medical bills out of pocket. That will leave the HSA to grow tax-free and provide funds for medical care later on, including long-term care if needed.

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While you’re still employed, set up a home equity line of credit as an emergency source of cash. Banks usually want to see W-2 income before approving a credit line, so you might be declined if you wait until you retire. Look for a bank offering a no-fee application. These credit lines typically allow withdrawals for up to 10 years, and charge variable interest tied to the prime rate.

Retirement may leave you in a lower tax bracket. To reduce the taxes paid in your final year of work, try to defer payments for unused vacation, commissions or bonuses until the following year. Also consider accelerating tax deductions into that final work year. For instance, you might move up the following year’s charitable deductions into your last work year, perhaps by donating appreciated shares or even establishing a donor-advised fund.

If you want to sell investments in your regular taxable account to reduce your exposure to stocks heading into retirement, look to harvest losses in that last year of work. What about winners? If possible, sell those in your first year of retirement, when your tax bracket will likely be lower.

After entering retirement, consider converting some money in your traditional IRAs to a Roth IRA. You’ll owe taxes on the conversion amount. But this could be a good time to bite the bullet. If you retire early—and don’t collect a pension or Social Security immediately—you may have a lower marginal tax rate early in retirement than you will later on.

Finally, as your first post-retirement project, take an inventory of all your retirement accounts and look to consolidate them. A few phone calls and a little paperwork will reduce headaches and recordkeeping chores for you and your heirs. (Some 401(k) or 403(b) accounts can be rolled into an IRA, but make sure you understand the different withdrawal rules for each type of account.) When you contact old employers, ask if you have any overlooked benefits. Who knows? You might discover a forgotten pension in your name.

Howard Rohleder, a former chief executive of a community hospital, retired early after more than 30 years in hospital administration. In retirement, he enjoys serving on several nonprofit boards, exploring walking paths with his wife Susan, and visiting their six grandchildren. A little-known fact: In May 1994, Howard was featured—along with five others—on the cover of Kiplinger’s Personal Finance for an article titled “Secrets of My Investment Success.” Check out his previous articles.

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L H
L H
1 year ago

My wife and I are preparing to retire. We have cash savings, a taxable investment account, a traditional IRA, her Roth, and my Roth. We will have my pension and S.S. . My question is : If the time comes that we need money in what order should we use these monies/investments to withdraw from?

Jonathan Clements
Admin
Jonathan Clements
1 year ago
Reply to  L H

The traditional advice is to tap taxable accounts first, traditional retirement accounts second and Roths last, so you maximize tax-deferred and tax-free growth. But you may want to draw down traditional retirement accounts in your 60s if it helps you avoid a much higher tax bracket in your 70s and later, when required minimum distributions kick in.

https://humbledollar.com/money-guide/taxes-in-retirement/

Roboticus Aquarius
Roboticus Aquarius
1 year ago

Some 401k plans also allow you to purchase annuities. The payout rates and fees on my plan are very enticing relative to what I’ve been able to find on line, and I’m likely to utilize this to some extent.

DrLefty
DrLefty
1 year ago

Great ideas, especially doubling contributions and opening a HELOC. When I retire, it will probably be on July 1 of that year, so I can double up for those first six months and get that final tax break.

Jackie
Jackie
1 year ago

Thanks for the article – its definitely timely for me. I knew about Roth conversions, but hadn’t thought about the HELOC. It a great idea – I need to get going before my husband’s job ends.

Y S
Y S
1 year ago

Also, if you have your firm’s 401K will allow it, consider moving all rollover IRA assets into your 401K. will make it easier to do Roth IRA conversions.

John McHugh
John McHugh
1 year ago

One exception to maxing-out tax-deferred contributions in the last few years of employment is accumulating cash for a Social Security “bridge” fund that lets you delay claiming until age 70.

Related, on a separate track, I’ve also noted recommendations to spend-down tax-deferred accounts rather than cash during those bridge years, after you’ve stopped working and don’t have much taxable income.

However, I am also planning some big Roth conversions in those years, which will raise my taxable income and so be in “competition” with tax-deferred distributions for “space” below the next-highest tax bracket.

It’s complicated! But good problems to have. Having more cash available helps.

Last edited 1 year ago by John McHugh
Joe Kiefer
Joe Kiefer
1 year ago

Another thing on HSAs: If you leave your employer’s plan midyear and switch to coverage that is not a high-deductible health plan, and thus you are no longer eligible for an HSA, your maximum contribution for that year is pro-rated. That is, if you work six months under the HDHP, your HSA maximum is half the normal max. Work 3 months, and it’s one-quarter. Etc. So don’t unknowingly overfill it.

R Quinn
R Quinn
1 year ago

Nice summary, but two clarifications. Need to distinguish between an FSA flexible spending account and an HSA health savings account. FSA can be forfeited and is essentially for employees HSA cannot be forfeited and can be valuable in retirement.

Also, using COBRA upon retirement pre-65 is almost always not the best deal because of the extra premium charge and limited choices. Better to explore ACA exchange plans in the area you will retire as part of retirement planning.

Charlie Warner Jr
Charlie Warner Jr
1 year ago
Reply to  R Quinn

Yes, I have an HSA and I retired 6 years, I can’t make contributions however it continues to grow tax free. You can also designate a beneficiary.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
1 year ago

You mention the health care spending account being use it or lose it- I assume that is a Flexspend account though not an HSA?

MarkP
MarkP
1 year ago

If you’re going to do a Roth conversion after you retire, I think it would make more sense to reduce your 401k/403b contributions in your last half year of work so you can increase cash to pay for the conversion taxes.

R Quinn
R Quinn
1 year ago
Reply to  MarkP

Or, if possible use Roth 401k option or even after-tax option 401k which some have.

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