How to Successfully Plan for Retirement Income and Taxes 

(Today’s guest post come to you from David Rosenstrock, who is a certified financial planner with an MBA and the Founder of Wharton Wealth Planning, LLC.)

On average, it takes 10 to 14 years to become a fully licensed and trained physician. During this period, very little—if any time—is dedicated to topics related to personal finance education. Many assume that since physicians earn above-average salaries, financial stress is not common, but this is not always the case. Many people, including physicians, make financial decisions based on lifestyle choices without full deliberation, due to all the other time and energy constraints they have. When dealing with consequences that will impact your long-term finances, however, this can often prove to be a critical mistake. A strong understanding of financial health and financial goals and having a wealth management plan in place can help keep future personal and career-related goals on course.

Whether you are a pre-retiree or retiree, there are several major areas you should think about to successfully plan for retirement.  Retirement planning can reduce anxiety and increase happiness, security, and peace of mind.  If you take the time to plan wisely, retirement can be a richer and more rewarding time of life.

The first area involves having an income plan.  This building block component involves listing all your guaranteed sources of retirement income —pension, investment portfolio, retirement savings and investment accounts, such as a traditional IRA, 401(k), Roth IRA or Roth 401(k), Social Security, annuity income (if you have one), and any other sources of income.

Working past the traditional retirement age, either part or full time, is a great way to stretch and supplement retirement income.  Delaying retirement can have a significant impact on retirement finances by giving your existing retirement savings more time to grow and shortening the period of retirement you will need to pay for.  The 4% rule is a guideline stating that you should take out only about 4% of your retirement savings annually. Each person’s situation is unique but having some guidelines can help you prepare.

Choosing the Right Investment Strategy is involved in this component of your plan.  There are many investment strategies available, from aggressive to conservative. Generally, those who are younger are advised to invest more aggressively, tapering to more secure investments as they grow older. Safety comes at the price of reduced growth potential and the risk of erosion of value due to inflation. Safety at the expense of growth can be a critical mistake for those trying to build an adequate retirement funding strategy. On the other hand, if you invest too heavily in growth investments, your risk is heightened.

A retiree’s investment portfolio should hold no more than 5% to 10% of any individual stock, so that the portfolio can be protected and properly diversified for risk management purposes. In the early 2000’s, companies like WorldCom and Enron went out of business creating significant retirement account losses for investors. (Editor’s note: I don’t recommend any individual stock ownership.  It is far too risky. Use stock mutual funds to lessen this risk.)

Forecasting your expenses is a key financial building block for retirement.  How much you expect to spend in retirement is one of the biggest factors driving how much you need for a secure retirement.  Most of your money in retirement is spent on 3 major categories: housing, transportation, and medical expenses.  According to a Bureau of Labor Statistics’ Survey, for adults aged 65 and older: Housing represents 34% of spending, transportation is 16%, and health care represents 13%. How long you live and how much you need to spend on out-of-pocket healthcare expenses and long-term care are big factors for figuring out how much you will need.

Health care costs pose one of the most serious risks to retirement security, so it’s important to understand how to plan for this major expense and navigate the system. Out-of-pocket expenses for people in retirement have risen over 50 percent since 2002. Long-term care costs can be even less predictable than out-of-pocket costs.  About half of people 65 and over won’t incur any long-term care expenses, and an additional quarter will pay less than $100,000. Fifteen percent, however, will pay $250,000 or more. (Editor’s note: I don’t recommend physicians buy long term care insurance.)

Tax Strategies in Retirement

Another area that retirees and potential retirees need to think about is their tax strategies. Most will have less income after they retire so it is critical to be smart about what you can keep andhow much you will have to pay out in taxes.  It is important to match different types of accounts (such as taxable or retirement accounts) with particular investment strategies.  Not regularly contributing to tax efficient accounts is a common mistake in financial planning. Making increased contributions to retirement accounts (and there are many options involved here depending on age and circumstances) can help put you on track to be prepared for retirement.

Probably the best way to accumulate funds for retirement is to take advantage of IRAs and employer retirement plans. The reason these plans are so important is that they combine the power of compounding with the benefit of tax deferred (and in some cases, tax free) growth. For most people, it makes sense to maximize contributions to these plans, whether it’s on a pre-tax or after-tax (Roth) basis. A key part of a tax planning strategy is to reduce the taxes from withdrawn funds from tax-deferred accounts, such as 401(k)s or IRAs.

A Roth IRA is an Individual Retirement Account to which you contribute after-tax dollars. With a Roth IRA account, you won’t pay taxes as your money potentially grows, and you can make tax-free withdrawals during retirement. The reason these plans are so important is that they combine the power of compounding with the benefit of tax-free growth. Generally speaking, you can fund a Roth IRA account in addition to a 401(k) or SEP IRA retirement plan. The contribution limits for a Roth IRA are separate from the contribution limits for a 401(k) or SEP IRA. These plans aren’t offered through employers but can be set up fairly easily.

The process of deciding when and how to use Roth accounts and what the size of your Roth accounts should be relative to your pre-tax retirement accounts is a balancing act for most.  Factors that may influence this decision include your age, life expectancy, the amount of your assets, tax bracket (today and projected for future), income level, budget (income needs), as well as a host of other circumstances.  We don’t always know what the future holds (taxes can certainly increase as parts of the current Tax Cuts and Jobs Act (TCJA) tax code are set to expire by the end of 2025) and having both types of retirement accounts can serve to help you increase your savings over time and provide a lot of additional flexibility. Because everyone has a different situation and there are multiple strategies to choose from, there are many areas of opportunity where a Roth account may be beneficial.

You have until tax-day in mid-April 2024 to complete a 2023 Roth IRA Contribution. In general, if you file under married filing jointly tax status in 2023, your modified adjusted gross income must be under $228,000 for tax year 2023 in order to make a Roth IRA contribution.  As long as you don’t exceed the IRS’s income limits, you can still contribute the maximum annual amount to a Roth IRA.  For the 2023 tax year, that’s $6,500, or $7,500 if you’re age 50 or older.  If you earn more than the respective amount then you are not permitted to make Roth IRA contributions and the Backdoor Roth IRA structure will have to be employed.  Roth strategies can also help you reduce Medicare costs (premium surcharges) in the future known as the income-related monthly adjustment amount (IRMAA).

A Roth IRA can be a good savings option for those who expect to be in a higher tax bracket in the future, making tax-free withdrawals even more advantageous. You can contribute at any age to a Roth IRA if you have a qualifying earned income. Also noteworthy, if you pass your Roth IRA onto your heirs, their withdrawals will also be income tax-free.

Whether or not you can make contributions to a Roth IRA depends on your tax filing status and your modified adjusted gross income (MAGI). High income professionals do not qualify to make Roth contributions. Back-door Roth IRA’s allow you to make non-deductible traditional IRA contributions and subsequently convert them to a Roth IRA.

One effective strategy that many overlook is converting previously funded tax-deferred funds to a Roth IRA or Roth 401(k). While the conversion amount is taxable in the year it is converted, the upside is these Roth accounts let your retirement savings grow tax-free and are not taxable when withdrawn (as long as you’re 59½ or older and have owned a Roth for at least five years).  It will be necessary to work with your accountant on this to ensure that the conversions do not inadvertently move you up to the higher tax bracket (this calculation will be based on your adjusted gross income each year, so conversions should be assessed after your taxes are prepared for each calendar year).

One additional area of opportunity to explore relates to establishing an HSA account (and switching to a qualifying high deductible health plan). Health Savings Accounts are different than Flex Spending Accounts because they offer a triple-tax benefit. Contributions you make to your HSA are tax-deductible so they should lower your income tax bill each year. You can withdraw money from your HSA tax-free if you use the money to pay for qualified medical expenses. An HSA account is also not taxed on the investment earnings, including dividends. In other words, you save taxes three different times with an HSA. (In contrast, while you can make tax-free contributions to 401(k) plans, you pay ordinary income tax rates on withdrawals). 

When you retire, you can withdraw money from your HSA to pay for qualified medical expenses (including Long-Term Care expenses). These withdrawals are tax-free. That means you don’t have to make a taxable withdrawal from your IRA or 401(k). In 2023, a family can contribute up to $7,750 annually to a Health Savings Account and an individual can contribute up to $3,850 annually. In 2023, those 55 and older can contribute an additional $1,000 as a catch-up contribution for a total of $8,750 for a family and $4,150 for an individual). Thanks in part to persistent high inflation, you will be able to sock away a lot more money in an HSA next year. Annual HSA contribution limits for 2024 are increasing in one of the biggest jumps in recent years, the IRS announced May 16: The annual limit on HSA contributions for self-only coverage will be $4,150, a 7.8 percent increase from the limit in 2023. For family coverage, the HSA contribution limit jumps to $8,300, up 7.1 percent from 2023. Participants 55 and older can still contribute an extra $1,000 to their HSAs.

You can fund an HSA until the last day of the calendar year. To get the optimal benefits from a Health Savings Account, you should invest the money for the future. You want to refrain from using it in the same year as you contribute money to the account.  You cannot contribute to an HSA once you are enrolled in Medicare. You will need to stop contributing to your HSA account 1 month prior to your 65th birthday. 

Maximizing your Social Security income is another building block for retirement. Because everyone has a different situation and there are many claiming strategies available, you should determine what’s best for you based on your age, life expectancy, income needs and other retirement assets. A few small mistakes can jeopardize your golden years. To maximize Social Security benefits for you and your spouse, you need to know which of the separate claiming strategies for married couples is right for you. Maximizing Social Security benefits isn’t easy as there are hundreds of rules governing payments alone.

Planning your estate is another area everyone needs to think about for successful retirement planning. One of the primary goals of estate planning (in addition to minimizing estate taxes) is to give the surviving family members and beneficiaries less stress and some privacy.  Estate planning allows you to make decisions that your loved ones carry out while following legal directives in your estate plan. 

Retirement can be a time of freedom, enjoyment, and security without significant stress and distractions, but in order to achieve these things retirement needs to be planned for.  Those who follow a specific financial plan can expect to have better average returns and long-term success in retirement than those who do not.

(Editor’s note: If you need more information about planning for retirement, check out my bestselling book, The Doctors Guide to Smart Career Alternatives and Retirement.)

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