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To Afford Retirement, Cut Your Taxes, Fire Your Broker, And Get a Part-Time Job

By Jonathan Clements

The Wall Street Journal, June 2, 2004

If you're retired, financial success boils down to one simple notion: You don't want to run out of money before you run out of breath.

Sure, that means picking the right investments. But you also want to ax unnecessary expenses so you have more money for the things that really matter to you -- whether it's taking a cruise, buying the medications you need or visiting the grandkids. To that end, try these four strategies.

Going broker. If you retire with a $1 million portfolio and use a 5% withdrawal rate, you will be pulling out $50,000 a year.

Doesn't sound like much? Here's salt for the wound: If you hire a broker or financial planner, your total annual cost might amount to 2% or 3% of your portfolio's value. In other words, while your portfolio is putting $50,000 a year in your pocket, it's enriching Wall Street to the tune of $20,000 or $30,000 annually.

Indeed, if you are paying Wall Street that much, you might not be able to sustain a 5% withdrawal rate. "Once you get to retirement, it really becomes a stark choice," says John Ameriks, a senior investment analyst at Vanguard Group in Malvern, Pa. "Does it go to the broker or does it go to you?"
My advice: If you use a broker or planner, make sure the combination of the adviser's fee, mutual-fund expenses and other costs doesn't amount to more than 1.2% a year of your portfolio's value.

True, that's a tough standard to meet. But advisers who really care about their clients should be able to average that 1.2% over five or six years by favoring funds with rock-bottom annual expenses and, if they recommend load funds, by buying front-end-loaded A shares and then getting clients a discount on that sales charge.

Trading down. Like Wall Street, your house is likely devouring a healthy chunk of your savings each year. Maintenance costs, property taxes and homeowner's insurance vary enormously from one part of the country to the next. But between these three costs, you might be paying $3,000 a year for every $100,000 of home value.

That's why trading down can be such a smart move. Let's say you sell your $400,000 split-level and buy a $200,000 townhouse, coughing up a 5% commission along the way. Result: Not only will you free up $180,000 of home equity, but also you will trim your housing expenses by $6,000 a year. Figure in lower utility bills, and your annual savings should be even greater.

If you plan to trade down, do it early in retirement, so you can start clocking the cost savings as soon as possible. And pick your new home carefully. You don't want to end up moving again, triggering another brutal round of real-estate transaction costs.

Trimming taxes. When retirees write to me about taxes, they have two chief complaints.

First, these seniors discover their Social Security benefits are taxable. Second, they find that they're paying taxes at a surprisingly steep rate, thanks to the "required minimum distribution" rules that kick in at age 70½. These rules, which force seniors to make big retirement-account withdrawals, often push them into a higher tax bracket.

What to do? To slash your tax bill in retirement, consider the following strategy: Suppose you plan to retire at age 62. As you approach that age, pile up enough cash in your taxable account to cover at least three years of living expenses.
That will allow you to make it through your initial retirement years without selling investments, spending retirement-account money or claiming Social Security. Instead, upon quitting the work force, your only taxable income will be the interest and dividends kicked off by your taxable-account investments.
Now that you've shrunk your income, go to work on your individual retirement account, converting big chunks to a Roth IRA. Yes, you will have to pay income taxes on the sums converted. But the tax bills should be relatively modest and, with any luck, you will be able to pay Uncle Sam out of the cash you accumulated.

"The issue of how much to convert each year is important," says Pittsburgh accountant and estate-planning lawyer James Lange. "If you're regularly in the 15% income-tax bracket, you don't want to convert so much that you end up in the 25% or 28% tax brackets."

In return for all this financial maneuvering, you should get three benefits. First, now that the money is in a Roth, you will get tax-free growth. Second, your regular IRA will be much smaller, so your required minimum distributions and the related tax bills should also be smaller.

Finally, once you are done with your Roth conversions, you can claim Social Security. At that point, not only will you get a larger monthly check because you delayed benefits, but also the tax on those benefits should be smaller, thanks to your lower taxable income.

Keeping busy. What's the fourth strategy? It's a little more prosaic.
Think about how much you spend during a one-week vacation. Now, imagine being on vacation 52 weeks a year. The danger: Once retired, your spending could spin out of control.

To combat that threat, take a part-time job, whether paid or volunteer. If the work is paid, that will bring in extra cash. But even if you are simply volunteering for a few hours each week, that will keep you busy -- and keep you away from the shopping mall.