As you approach your “third act,” does it need to be adjusted? Each day,10,000 baby boomers retire and begin receiving Medicare and Social Security benefits. ARE YOU READY?

Provided by Robert A. Laraia

Your portfolio lacks significant diversification. Many baby boomers are approaching retirement with portfolios heavily weighted in equities. As many of them will have long retirements and a sustained need for growth investing, you could argue that this is entirely appropriate. If your retirement is near at hand, however, you might want to consider the length of this bull market and the possibility of irrational exuberance.

The current bull has lasted about twice as long as the average one and brought appreciation in excess of 200%. It could rise higher: as InvesTech Research notes, two-thirds of the bull markets since 1955 have gained 20% or more in their final phase. Few analysts think a “megabear” will follow this historic rally, but even a typical bear market brings a reality check. The lesser bear markets since 1929 have brought an average 27.5% reversal for the S&P 500 and lasted an average of 12 months.(2)

A poor quarter makes you anxious. You start watching the market like a hawk and check up on your investments more frequently than you once did. Some of this vigilance is only natural as you near retirement; after all, you have far more at stake than a millennial investor. Even so, this is a sign that you may be uncomfortable with the amount of risk in your portfolio. A portfolio review with a financial professional could be in order. A semi-annual or annual review is reasonable. One bad quarter should not tempt you to abandon a strategy that has worked for years, only to examine it in the face of sudden headwinds.

You find yourself listening to friends & pundits. Your tennis partner has an opinion about when you should claim Social Security. So does your dentist. So does a noted radio personality or columnist. Their viewpoints may be well-informed, but they are likely expressing what they would do as they share what they feel you should do. If you seem increasingly interested in the financial opinions of friends, acquaintances and even total strangers, or the latest “hot tip” on the market, this hints at anxiety or restlessness about your financial strategy. Perhaps it is warranted, perhaps not. It may be time to re-examine some assumptions.

You wonder about the demands your lifestyle may make on your finances. You want to travel, golf, and have fun when you retire, and those potential lifestyle expenses now seem larger than they once were. Here is another instance where you may want to double-check your retirement savings and income strategy.

You see what were once “what-ifs” becoming probabilities. You sense that you or your spouse might face a serious health issue in the not-so-distant future. It looks as if you may end up raising one of your grandchildren. It seems likely that you will provide eldercare for a sibling who may move in with you. These life events (and others) may prompt a new look at your financial assumptions.

You think you will retire to another state. Say you retire to Florida. There is no state income tax in Florida. So your retirement tax burden may decrease with such a move (though some states have higher property taxes to offset the lack of state taxes). To what degree will geographic considerations affect your retirement income, or need for income? Such geographic factors are worth considering.(3)

You wonder how deeply inflation will impact your retirement income. A recent Morningstar analysis of retiree spending data compiled by the federal government noticed something interesting: for the typical retiree, spending declines in inflation-adjusted terms between age 65 and age 90. So the assumption that retirees increase household spending over time in light of inflation may be flawed. Of course, inflation has been mild for the past several years. If inflation spikes, however, that assumption might prove wholly valid.(3)

Looking at your retirement strategy anew has merit. As the years go by, priorities change and needs arise. New questions call for appraisals of old assumptions. Reviewing your approach to investing and saving at mid-life is only rational, for your retirement strategy must suit the objectives you now have before you rather than those you set in your past.   

And what about tax efficiency?

Will you pay higher taxes in retirement? Do you have a lot of money in a 401(k) or a traditional IRA? If so, you may receive significant retirement income. Those income distributions, however, will be taxed at the usual rate. If you have saved and invested well, you may end up retiring at your current marginal tax rate or even a higher one. The jump in income alone resulting from a Required Minimum Distribution could push you into a higher tax bracket.

While retirees with lower incomes may rely on Social Security as their prime income source, they may pay comparatively less income tax than you will in retirement – because up to half of their Social Security benefits won’t be counted as taxable income.(1)

Given these possibilities, affluent investors would do well to study the tax efficiency of their portfolios as some investments are not particularly tax-efficient. Both pre-tax and after-tax investments have potential advantages.

What’s a pre-tax investment? Traditional IRAs and 401(k)s are classic examples of pre-tax investments. You can put off paying taxes on the contributions you make to these accounts and the earnings these accounts generate. When you take money out of these accounts come retirement, you will pay taxes on the withdrawal.(2)

Pre-tax investments are also called tax-deferred investments, as the invested assets can benefit from tax-deferred growth.

What’s an after-tax investment?

A Roth IRA is a classic example. When you put money into a Roth IRA during the accumulation phase, contributions aren’t tax-deductible. As a trade-off, you don’t pay taxes on the withdrawals from that Roth IRA (as long as the withdrawals are considered qualified). Thanks to these tax-free withdrawals, your total taxable retirement income is not as high as it would be otherwise.(2)

As everyone would like to pay less income tax in retirement, the tax-free withdrawals from Roth IRAs are very appealing. Given the huge federal deficit, the pressure is on to raise tax rates in the coming years – and in that light, after-tax investments look even more attractive.

It is also possible to convert a traditional IRA to a Roth IRA, so many investors are considering paying taxes on a Roth conversion today in order to get tax-free growth tomorrow.

Certain tax years can prove optimal for a Roth conversion. If a high-income taxpayer is laid off for most of a year, closes down a business or suffers net operating losses, sells rental property at a loss or claims major deductions and exemptions associated with charitable contributions, casualty losses or medical costs … he or she might end up in the lowest bracket, or even with a negative taxable income. In circumstances like these, a Roth conversion may be a good idea.

Should you have both a traditional IRA and a Roth IRA? It may seem redundant, but it could actually help you manage your marginal tax rate. It gives you an option to vary the amount and source of your IRA distributions in light of whether tax rates have increased or decreased.

Smart moves can help you reduce your taxable income & taxable estate. An emphasis on long-term capital gains may help, as they aren’t taxed as severely as short-term capital gains (which are taxed at the same rate as ordinary income). Tax loss harvesting (selling the “losers” in your portfolio to offset the “winners”) can bring immediate tax savings and possibly help to position you for better long-term after-tax returns.

If you’re making a charitable gift, giving appreciated securities you have held for at least a year may be better than giving cash. In addition to a potential tax deduction for the fair market value of the asset, the charity can sell the stock without triggering capital gains. If you’re reluctant to donate shares of your portfolio’s biggest winner, consider this: you could donate the shares, then buy more of that stock and get a step-up in cost basis as a consequence.(3)

The annual gift tax exclusion gives you a way to remove assets from your taxable estate. In 2015, you can gift up to $14,000 to as many individuals as you wish without paying federal gift tax. If you have 11 grandkids, you could give them $14,000 each – that’s $154,000 out of your estate. The drawback is that you relinquish control over those dollars or assets.(4)

Are you striving for greater tax efficiency? In retirement, it is especially important – and worth a discussion. A few financial adjustments could help you lessen your tax liabilities.

Remember, It’s not what you make it’s what you KEEP!

Robert A. Laraia, Founding Partner, Northstar Wealth Partners can be reached at www.nstarwp.com or 888-886-7737.Securities offered through LPL Financial, member FINRA/SIPC.  Investment advice offered through Northstar Wealth Partners a registered investment adviser and separate entity from LPL Financial.

*The Roth IRA offers tax deferral on any earnings in the account. Withdrawals form the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRSs. Their tax treatment may change.

This article is for informational and educational purposes only and should not be relied upon as the sole basis for an investment decision. Consult your financial advisor/tax/legal consultant regarding your personal circumstances before making any investment decisions.

Citations. 1 – ssa.gov/planners/taxes.htm [2/23/15]; 2 – denverpost.com/business/ci_27383286/ira-vs-401-k-which-is-better [1/25/15]; 3 – desmoinesregister.com/story/money/business/2014/11/01/jim-sandager-donate-shares-directly-charities/18304273/ [11/1/14]; 4 – accountingweb.com/article/ how-make-most-federal-annual-gift-tax-exclusion/224201 [12/18/14]

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