CHAMPAIGN, Ill. — The current generation of new and soon-to-be retirees comprises the first cohort with substantial retirement savings but little guidance for using those funds to meet day-to-day living expenses, says a new paper from a University of Illinois retirement expert.
More Americans today approach retirement with a patchwork of different defined-contribution retirement accounts – such as a 401(k) or an individual retirement account – and must decide how and when to withdraw funds from these accounts to pay for housing and health care costs, donate to charities or leave for heirs. This task represents the biggest financial planning challenge that retirees face in the years and decades ahead, said Richard L. Kaplan, the Peer and Sarah Pedersen Professor of Law at Illinois.
According to Kaplan, a nationally recognized expert on U.S. elder law and retirement issues, baby boomers have been admonished for virtually their entire working lives by employers and financial service companies to save, save, save for retirement.
“But now when it comes to spending that money, guidance is less forthcoming and that void is what my article tries to fill,” he said.
The balances in a retirement portfolio almost always represent the largest pool of money that retirees have ever had responsibility for managing and disbursing, Kaplan said. Stretching those assets so they last the remainder of the primary beneficiary’s lifetime is the most obvious challenge – one that’s fraught with tax consequences.
According to Kaplan, tax considerations also are critically important in determining how retirement funds should be used to pay health care costs in retirement, especially long-term care expenses.
“Too many new retirees think that once they have enrolled in Medicare, their health care cost worries are over,” he said. “But Medicare imposes a dizzying array of monthly premiums, annual deductibles and copayments for physician fees and prescription drug expenses beyond its almost complete lack of coverage of long-term care costs. The good news is that those costs will often generate a substantial income tax deduction, which can offset the tax on retirement plan withdrawals.”
In addition, many retirees find that they have accumulated more than they need and want to use their retirement funds to make charitable donations, Kaplan said.
“Once again, the tax rules are hugely important and clearly incentivize so-called direct transfers from certain retirement accounts to charitable organizations,” he said. “The good news here is that the rules are fairly clear and were made permanent at the end of last year.”
Finally, some retirees will want to leave a portion of their retirement funds to their children and grandchildren, Kaplan said.
“Retirement funds other than Roth-type accounts are not an ideal mechanism for testamentary purposes, as I explain in my paper,” he said. “Nevertheless, in some circumstances, leaving such funds to heirs after the retiree and that person’s spouse have passed away can provide significant income tax savings.”
Kaplan’s paper was published in the NYU Review of Employee Benefits.
Editor’s note: To contact Richard L. Kaplan, call 217-333-2499; email rkaplan@illinois.edu.
The paper “What Now? A Boomer’s Baedeker for the Distribution Phase of Defined Contribution Retirement Plans” is available online.
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