Retirement facts you need to know to stay ahead
Managing finances in retirement is very tough for 93% of all Americans. Below are a couple of the key areas you must focus on in order to do well for yourself during your retirement years.
Maximize your Social Security
In order to receive the maximum amount from this valuable resource, you really should take Social Security as late as possible. This is especially important if you are the breadwinner and have a younger spouse. Unfortunately, 72% of Americans voluntarily take SS before reaching full retirement, thus effectively short-changing themselves and depriving them of significantly more money during retirement for themselves and their spouses.
The older you take your SS, the higher your monthly amount, and the more you will receive if you live to be an “average age”. Should you or your spouse live longer than average you will continue to receive the higher amount of SS throughout your life time thus resulting in significantly more total money over your lifetime than had you taken SS at 62 (the soonest possible) or at full retirement age (66 for most people). Therefore, you are better positioned to receive the maximum total amount of money from SS if you (the breadwinner) begin SS as late as possible, preferable at age 70 (the latest age possible). By doing this you permanently lock in the higher monthly amount possible and position you and your spouse (if you have one) to reap the very maximum amount possible from this very valuable retirement resource.
While you will generally receive the most total money from SS the later you take it, the exact opposite is true of the Reverse Mortgage. The sooner you take it (min. age is 62) the more total financial benefit you will derive from it. Therefore, it is smart to switch to a Reverse Mortgage as early as possible, while waiting to claim SS as late as possible. In addition, the relief of a monthly mortgage payment and or cash distribution from a Reverse Mortgage will allow you wait to claim your SS until it becomes the highest monthly amount possible.
Reduce your income tax liability
It is surprising how much of your retirement savings can be eaten away by income tax obligations. Remember, when you look at your qualified retirement savings account it is important to remember that you do not “own the entire account” because you have a silent partner who also has a “vested financial interest” in your retirement account and that is your Uncle Sam. However, how big of a “partner” you make Uncle Sam largely depends on you. I highly recommend that you focus on making him a very small partner so that you can receive the maximum benefit out of your retirement account possible.
Any money taken out of a qualified retirement account such as IRAs, 401Ks, 403B, etc. is subject to income tax on both a Federal and State level. The more you take out of these accounts each year the higher up the progressive tax bracket you push yourself. For example, if you take $18,650 your marginal tax bracket is about 16.7% for a married California couple. However, if the same couple takes out $75,900 they will find themselves pushed into the 29.5% marginal tax bracket (almost double!) and find that significantly more of their hard earned retirement savings is now lost to extra income taxes that possibly could have been avoided. Of course you have to take the required minimum withdrawals based upon your age (RMD), but any amount over that is an “elective decision left up to you”. Therefore it is very important to take minimal distributions from your qualified retirement account in order to owe less in Federal and State income tax and to leave more money left over for you and your spouse.
If these “minimal distributions” from your retirement account are not enough for you to make financial ends meet (and most of us simply do not have enough retirement savings to get by on RMDs) your best bet would be to use both “tax-free” sources in combination with your qualified retirement sources in order to minimize your income tax liability (thus giving less money to Uncle Sam and leaving more money for yourself). Sources of tax-free money can be from Roth accounts, other non-qualified accounts, some real estate rentals may provide tax-free distributions, and annuities among other things may be partially tax-free.
One more source of “tax-free” money is the Reverse Mortgage. You actually benefit 3 ways from a Reverse Mortgage; 1) Any money received from the Reverse is tax-free (whether it is a lump sum or a monthly distribution) and obviously tax-free money spends much further than taxable money so you get much more utility out of it (it will buy more goods and services than the same amount of taxable money does). 2) The Reverse eliminates any current monthly mortgage payment. Because you no longer have a monthly mortgage payment you must make, you can now get by with significantly less money each month while still maintaining the exact same life style that you enjoy now. Living the same lifestyle, but on less money each month allows you to “preserve and prolong” any retirement or savings account you have. This helps to ensure you do not run out of money before you or your spouse pass away. 3) Lastly, by eliminating your monthly mortgage payment and thus using less money each month, you should now find yourself in a lower income tax bracket which reduces the amount of money that is owed to Uncle Sam and leaves more money for you or your heirs.
Capital Gains
In order to preserve as much of your wealth as possible for you, your spouse and your heirs, there is one more very important tax that you need to avoid, Capital Gains tax. For those of us who own a home that is significantly more valuable today than what we paid for it originally (and that is almost all of us) you should pay particular attention to this section.
Capital Gains tax is a tax when you sell your home for more than you paid for it. For example, let’s say you bought your home some time ago for $100,000 and now it is worth $700,000. Your “gain” is the difference between your “basis” (the amount you originally paid for it, including any closing costs, and any improvements you made to it (but not repairs) and the amount that you sold it for (less the cost of selling it). In our example if your basis (what you paid for it) is $100,000 and you sold it for $700,000 you have a $600,000 capital gain. Currently the tax code allows you to escape the first $250,000 per person, so a married couple could deduct the first $500,000 of gain and only owe taxes on the $100,000 at about 30% (for Fed & CA). Therefore they would owe about $30,000. However, if the same home was owned by a single individual or if your spouse has passed away more than 12 months ago, you only get $250,000 tax free. In this case you would owe capital gains tax on the remaining $350,000 or about $105,000.
Being mindful and aware of this tax is extremely important for everyone who owns a home that is worth $250,000 more than they paid for it (if they are single) or more than $500,000 than they originally paid for it if they are married. This also becomes increasingly more important as your gain exceeds the above numbers.
I helped a very nice couple in Laguna Beach who had bought their home (which they loved) years ago for $350,000 and was now worth well over 3 million. Being low on retirement funds, they had listed their home for sale and thought that was their best financial move for retirement. Fortunately, they contacted me to discuss their retirement prior to accepting any offers. I immediately saw the folly of selling the home and pointed out that if they sold it, they would likely owe about $645,000 (rough numbers) in capital gains tax. Fortunately, the wife was very sharp and summarized it like this: “so, if we sell now we have to write a check for taxes in the amount of $645,000, but if we don’t sell now, it’s like we have a ’free’ $645,000 to spend on ourselves instead of handing over to the government”. She then asked if they were just “postponing the taxes” (I told you she was sharp). I went on to explain that they can completely avoid this tax and either use this money for themselves or give it to their heirs.
Your “basis” in your home is initially set when you purchase your home and also when an owner passes away. I explained to this couple that if they hold title correctly (please call me to understand how you must hold title to receive the fullest benefit), when the first of the couple passes away, the home receives a “full step up in basis”. This means that the new basis is reset to the current value of the home when the first person passes. Therefore, if they wait (and hold title correctly –this is important) and sell the home after the first one of them has passed, they can sell the home with no capital gains tax and fully escape giving that $645,000 to the government. Additionally, the home will undoubtedly be more valuable years from now than today, so the likely savings on capital gains will be even higher.
Let’s look at the previous example to see how valuable this strategy really is. Again, their original basis was $350,000 and now worth 3 million today and their tax liability if sold today was about $645,000. However, let’s say they wait until the first spouse passes which is 5 years from now and the home has increased during that time to $3,828,800 based on 5% annual appreciation. This increase in value would have increased the capital gains tax to almost $900,000. However, because of the favorable step up in basis to the then current value (and holding title correctly) selling after the first spouse passes does not cost them a single dime in capital gains tax. It does not take a rocket scientist to determine that keeping almost about $900,000 more for yourself or your heirs rather than giving it to Uncle Sam million is a good deal.
The survivor could sell immediately after their spouse passes without any taxes owed, but could also continue to reside in the property as it goes up in value and if sold later would still get his or her $250,000 capital gain exclusion in addition to the previously discussed step up in basis, thus deriving yet more tax free income.
Lastly if they survivor continued to live in the home for another 10 year after their spouse passed, the home could be worth about $6,236,000 due to a 5% appreciation and the same thing would apply again. If the survivor sold while she or he were alive they would owe capital gain tax between the new basis of $3,828,800 (home value at the time the first spouse passed) verses what the survivor sells the home for 10 years later, say for $6,236,000. Even after the exclusion they could still owe $647,000 if sold while the survivor is alive. Again, if the survivor keeps the home until they pass, the heirs receive the property with another step up in basis and completely escapes this tax altogether.
If you have been paying attention, the total tax saved by the two step ups in basis amounted to a total of $1,547,000 ($900,000 when the first spouse died and $647,000 when the second spouse died). That my friend is a lot of money and I am sure you would rather keep that money for yourself or your heirs rather than give it to Uncle Sam.
If you have followed along, you undoubtedly understand that keeping and continuing to live in your home is probably your very best financial move for both you and the benefit of your heirs. Please keep in mind that the Federally insured Reverse was developed for this exact purpose and works perfectly as you remain the owner of the home (just as you are now), and still give the home to your heirs once you pass. Therefore, using a Reverse Mortgage in order to keep a highly appreciated home is your secret to legally avoiding capital gains tax and retaining more wealth for you and or your heirs.
Reverse Mortgages
There are currently over 18 different versions of the federally insured Reverse Mortgage available. It is important to speak with a very knowledgeable expert in this field to make sure that you are choosing the version that will bring the most financial benefits to you possible, while incurring the least amount of cost. The key to a more successful retirement is knowledge and correct use of that knowledge. I believe that I am the most qualified person to help you in both of these areas.
To learn more about your retirement options or have your questions answered, please contact me on my direct line at 949 440 2002 and I will be happy to answer each and every one of your questions fully and honestly.
Sincerely,
