09 Sep 3 Critical Shifts For Clients In Retirement
Whether we are your business advisors or your tax preparers, if you are one of the 10,000 Baby Boomers turning 65 every day, your need for retirement planning has never been greater. Retirees need to make three critical shifts in thinking to obtain the most enjoyment out of their golden years, and as CPAs, we can help with several additional financial planning areas.
Those shifts in thinking are:
- Shifting away from earning toward spending savings without feeling like a moral failing;
- Shifting the tax goal away from minimizing taxes on a year-by-year basis toward sometimes intentionally incurring taxation to minimize the total retirement tax bill; and
- Shifting from the belief that durable and medical powers of attorney should be given to one’s spouse toward naming younger family members or trusted local professionals who could potentially manage both spouses’ day-to-day financial and/or health care affairs.
Shifting from saving to spending
When clients say that they are looking for help answering the question of how much they can safely spend in retirement, what they’re also looking for is coaching around how to even start spending when most of their adult life has likely been focused on earning and saving. For more frugal clients, a CPA’s role may actually be to encourage spending.
For instance, many wealthy retirees got that way because they’ve mastered the art of thrift; they are proud of how little they spend and often skimp to live solely from guaranteed income sources such as Social Security, annuities, and/or pension payments. During their working years, having to tap savings was often a sign that things had gone wrong, and this mindset doesn’t go away in retirement.
For other retirees, transitioning from a regular paycheck that essentially determined how much they could spend each month to a savings drawdown may put them at risk of outliving savings. Clients who are used to spending according to what’s available may view their penalty-free access to larger sums of money as a windfall and be more inclined to elevate their lifestyle through overspending, especially in the early years of retirement. In these cases, CPAs may opt to center retirement plans around spending/withdrawal limits.
Shifting the tax planning approach
Besides rethinking their ideas about spending, another critical mental shift for retirees involves taxes. The change to their taxation in retirement often catches newer retirees by surprise. Not only are different retirement income sources taxed differently, but tax withholding rates also vary depending on the asset. This will likely necessitate a conversation around withholding choices as well as possibly implementing estimated tax payments to avoid underpayment penalties.
Most retirement account administrators default to the standard 20% withholding rate, while Social Security doesn’t require any withholding, which is a departure from the way payroll tax withholdings are calculated. It’s not uncommon for newer retirees to have an unexpected balance due on their taxes during their first post-retirement tax season after decades of refunds or a minimal balance due. Couple this with the varying ways that states tax retirement income, and clients may need a tax projection to aid in cash flow planning each year.
For clients with larger balances in tax-deferred retirement vehicles such as traditional IRAs, a shift in thinking around intentionally incurring taxation may also be necessary. Depending on their other sources of income, it may be a good idea to make taxable withdrawals that go beyond current spending needs to “fill up” lower tax brackets, which will reduce future required minimum distributions that could be taxed at a higher rate in the clients’ 70s. This strategy doesn’t require those funds to be spent — they can be converted to a Roth IRA or shifted to taxable municipal bonds or other stable options to supplement inflexible spending needs in future years. (For more on this topic, including a numerical illustration, see “Building a Tax-Efficient Retirement Income Plan for Clients,” JofA, May 12, 2022.)
Shifting Powers Of Attorney
The third critical shift in thinking for retirees involves estate planning, especially beliefs about who should be given powers of attorney. Many clients will head into retirement with outdated estate plans that were put in place when their children were minors, so they already may be aware of the need to address this area. We like to help our clients think beyond just updating (or creating) a will or trust by raising the question of whether currently named parties are still the appropriate choice for all estate planning documents.
For example, it’s common to give one’s spouse the durable and medical powers of attorney during working years, but as both spouses age, it’s best to reassign those responsibilities to a nearby family member or trusted friend who is younger than 50. When it comes to a medical power of attorney, a spouse can serve this role initially, but it may be wise to add a secondary party to account for times when both spouses may need health care assistance.
While a qualified estate planning attorney should be the professional who handles estate planning changes, a CPA may be in a better position to discuss who would be the best choice for powers of attorney due to years of familiarity with our client.