Balancing a retirement and college savings can be overwhelming. Here are 6 tips that will help ease the long-term planning. USA TODAY
Dear Pete,
I’m 44 years old, and I fear I’ve made a massive mistake. I think I have too much money in retirement plans and not enough money in non-retirement investments. What if I get to be in my late 50s and I want to retire, but I don’t have any non-retirement funds to tide me over until I reach age 59½? — Brent, Brooklyn
Dear Brent,
This reminds me a little bit of the job interview question in which the interrogator asks the candidate their biggest weakness. “I’m just too dependable,” the applicant opines. Fearing you’ve saved too much for retirement is a fear many wish they had. Alas, it’s your fear, and I must calm that fear with my typing.
Your problem is either a little different than you think it is, or you fully understand the problem and just didn’t explain it well. Before we get to that, we have several other issues we have to deal with. A good place to start is clearing up the terms retirement and non-retirement. Typically when a person uses these terms they mean qualified and non-qualified.Retirement accounts such as a 401(k), 403(b), traditional IRA, Roth IRA, and a few others, are all consider tax qualified accounts. They enjoy various tax benefits, but in exchange for those lovely benefits, they generally can’t be accessed without penalty until you achieve the age of 59½. That’s what makes them “retirement” accounts. Therefore, a non-retirement account is an account which is not age-sensitive.
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There are a few technical strategies which could solve your perceived problem right away. The Internal Revenue Service allows you to use qualified (retirement) accounts prior to age 59½ without penalty, via rule 72(t). There’s some nuance, so you’d want to talk to a tax adviser, but basically you need to take “substantially equal periodic payments” from a retirement account. Once you start taking those distributions, you must continue making withdrawals for the longer of five years or until you reach 59½. In other words, you may be able to solve your perceived problem with rule 72(t).
Another reasonable solution is a Roth ladder conversion strategy. It’s a complicated process, but it can work wonders for people who want to retire prior to 59½. Essentially, you would convert traditional IRA money into Roth IRAs, paying the taxes now as you convert, and then withdrawal the converted money tax free and penalty free, after you’ve held the converted Roth for at least five years. If this appeals to you, then I’d start your conversions sooner, rather than later. Take note of two key points. First, you will have to pay taxes on the converted money. This could be a big issue if you happen to be in a high tax bracket. And second, please talk to a tax adviser about this strategy prior to pulling the trigger.
I know you didn’t ask, but the biggest issue with early retirement, whether it be prior to age 59½ or prior to age 65, is health-care expenses. You may have enough money to support your current lifestyle in early retirement, but it’s the added expense of paying 100 percent of your health-care premiums which could ruin everything. My experience tells me that people who’ve had their health insurance premiums subsidized by their employer throughout their career, sometimes struggle to grasp the gravity of funding health-care premiums without the help of a third party.
As for the real problem here — it’s impossible to have too much money in retirement plans. Not having enough money in non-retirement accounts is a separate issue altogether. Your retirement could last for five decades or more — yes, 50 years or more. During this time, your potential long-term care and health-care costs could skyrocket into the six-figure range on an annual basis. Unless you're one of those people who say things like “I want my check to the funeral home to bounce,” then you’ll always want to have too much money available to you in retirement. This is especially true if you retire in your fifties.
Once you’ve run the numbers a tenth time, and are still convinced you've saved too much for retirement, consider redirecting more of your current income to non-qualified investments, as opposed to retirement accounts. A nice compromise is to contribute to Roth accounts, if you’re able to. This is because you can always access your Roth contributions — tax and penalty free — at any time you like. If you’re not able to contribute to a Roth, then make sure your non-qualifed investments are either tax sensitive or employ a tax-loss harvesting strategy. This will keep your annual tax bill down as you try to grow this account to support you in your fifties.
Ultimately, you are seeking flexibility, and I like that. More people should see value in financial flexibility. Who knows how you’ll feel about work, money, or life in general 10 to 15 years from now. But I know this, 44 is the perfect age to start thinking seriously about all these different scenarios. Too often people wait until the last minute to put together an exit strategy. Your planning, with the right tax advice, will give you the flexibility you so desire.
Have a question for Pete the Planner? Email him at AskPete@petetheplanner.com or visit petetheplanner.com.
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Tune in to Pete the Planner, who also is Fox59’s personal finance expert, at 8:15 a.m. Wednesdays.