Get Your Retirement Back on Course

Saving for retirement can be a challenge in the best of times. After a year like 2020, the task may seem almost insurmountable. Millions of people—including many older workers—were furloughed or downsized. Many families had to raid their savings to pay for health care. And even near-retirees who managed to avoid those hazards face years of record-low interest rates, which threaten to lower returns on the money they’ve worked so hard to save. Below, we help you get your retirement plan out of the rough and onto the fairway.

Problem: You lost your job, or your income was cut.

Solution: Consider starting a business or finding part-time work or a gig-economy job.

One of the most effective ways to shore up your retirement security is to work as long as you can, but sometimes life intervenes. Even before the pandemic, many older workers were forced to leave their jobs earlier than expected, due to downsizing, health problems or family circumstances. The Employee Benefit Research Institute’s annual retirement confidence survey has consistently found that about half of the respondents retired earlier than they had planned. The pandemic will likely lead to an even higher number of early retirees, as older workers are pushed out and are unable to find new employment.

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Faced with a sudden loss of income, you may be tempted to file for Social Security. Many took that route in 2008 and 2009, during the Great Recession, when the percentage of workers who claimed benefits at age 62 rose following several years of declines. Although claiming early could enable you to postpone tapping your retirement savings, it will permanently reduce your benefits by up to 30%.

Another way to reduce the risk you’ll outlive your savings: Use your career skills to start your own business or find a part-time job. You probably won’t earn enough to replace the salary and benefits you received while you were working, but even a reduced amount of income can go a long way toward improving your retirement security. According to a study by the Center for Retirement Research at Boston College, 62-year-olds who earned income from nontraditional jobs were able to close gaps in their retirement savings by age 67 or 68. “Even jobs that do not offer health and retirement benefits can help substantially in closing the retirement security gap,” the study concluded.

Income from a part-time job or self-employment could also help you pay for health insurance, which can be extremely expensive for early retirees, says Patti Black, a certified financial planner with Bridgeworth Wealth Management in Birmingham, Ala. And there are psychological benefits to a phased retirement, Black adds. A part-time job will give you time to figure out what you’d like to do when you stop working altogether. “A lot of my clients tell me that seven days a week is a lot of time to play golf,” she says.

Problem: You tapped your retirement savings to make ends meet.

Solution: Resolve to replace that money as soon as your circumstances improve.

The Coronavirus Aid, Relief and Economic Security (CARES) Act enacted last spring contained several provisions designed to make it easier for people to tap their tax-advantaged retirement plans. The legislation allowed people who were affected by the virus or had suffered financial consequences as a result of the pandemic to withdraw up to $100,000 from their 401(k) or other employer-provided retirement plans, and it waived the 10% early-withdrawal penalty for participants younger than 59½. Taxes on the withdrawals will be spread out over three years. The law also increased the amount workers could borrow from their plans, raising the maximum from $50,000 to $100,000 (these provisions were set to expire on December 31).

Only a small number of savers took advantage of these relaxed withdrawal provisions. Mutual fund giant Vanguard Group said about 4.5% of its 401(k) plan investors took a coronavirus-related distribution between March and September. Fidelity said 3% of participants in its plans took hardship withdrawals by end of the second quarter, with an average withdrawal of $12,000. (According to a Kiplinger/Personal Capital poll conducted in early November, the number of retirement plan participants who took a hardship withdrawal was much higher, at 31% of respondents.)

Even a modest withdrawal will reduce the amount you’ll have when you retire. So as soon as your finances improve, take steps to repair the damage. As long as your employer allows it—and most large employers do—you’ll have up to three years to repay the funds you withdrew. The repayment will be treated as a tax-free rollover. If you repay the dist­ribution after you’ve paid taxes on it, you can file an amended return and get a refund.

Similarly, although the CARES Act gives you six years instead of five to repay a 401(k) loan, the sooner you repay it, the sooner you’ll be in a position to take advantage of market gains on a bigger balance.

Even if you managed to avoid taking a hardship withdrawal or loan, you may have been forced to stop contributing to your retirement plan, or you may have reduced the amount you sock away. As the economy recovers, look for ways to improve your cash flow so you can step up your savings game. While record-low interest rates are causing savers angst, you may be able to generate extra cash by refinancing your mortgage. Marguerita Cheng, a CFP with Blue Ocean Global Wealth in Gaithersburg, Md., recently helped a couple who are in their late fifties refinance their 30-year mortgage at a 2.5% rate. Lowering their mortgage payment will free up money they can use to increase contributions to their retirement savings and build up their emergency reserves.

If your savings still fall short of your retirement goal, use the time you’re spending at home to track your discretionary and nondiscretionary expenses. You may discover that some of your must-haves are no longer as critical as you once thought. That can offer a good trial run for retirement. A popular and time-tested guideline for retirees is the 4% rule, which says that you should withdraw 4% from your retirement savings annually, increasing the amount each year by the previous year’s inflation rate. But depending on what happens in the markets—and the makeup of your portfolio—you may have to pare back withdrawals during down years. That’s easier to manage if you have a good handle on your spending. The 4% withdrawal rate works if retirees “are willing to make cutbacks when times are bad,” says Gage Paul, a CFP with Western Reserve Capital Management in Hudson, Ohio. The good news is that you can increase withdrawals—to 5%, for instance—when times are good, he says. Vanguard offers an online worksheet for retirement expenses.

Problem: You’re worried about market volatility, but low interest rates are dampening fixed-income returns.

Solution: Shift to investments that are slightly riskier but provide a higher yield.

Despite one of the worst economic downturns in U.S. history, the stock market has held up remarkably well. The March bear market ended almost as quickly as it started, followed by a sharp stock rally. Savers who resisted the urge to bail ended up with double-digit returns for the year as investors bet on the prospect for vaccines and an economic recovery.

But the stock market isn’t always so generous, and a bear is always lurking around the corner. To lower the risk of losses, many near-retirees (along with people who have already retired) invest a significant slice of their portfolio in government bonds and other fixed-income investments. Because of record-low interest rates, though, returns from those investments have been wretched. The 10-year Treasury note pays 0.97% a year, which means fixed-income investors won’t be able to keep up with inflation.

One way around this problem is to move more of your savings to investments that provide a higher return in exchange for somewhat higher risk. Examples include dividend-paying stocks, real estate investment trusts and convertible bonds. Depending on your risk tolerance and other sources of income, you may also want to shift from the traditional 60-40 portfolio—60% stocks and 40% fixed-income investments—to one with a higher allocation to stocks. You may be in a position to invest more in stocks—a 70-30 mix, for instance—if you have a guaranteed source of income, such as a pension, that covers basic expenses. That way, you can avoid withdrawals during downturns.

Another option is to invest part of your savings in a single premium immediate annuity. When you buy an immediate annuity, you give an insurance company a lump sum in exchange for a monthly payment for the rest of your life or a specified period of time (see How to Create Income for Life).

Problem: You’re concerned about health care costs in retirement.

Solution: Invest in a health savings account.

The pandemic demonstrated that even otherwise healthy people can suffer from devastating illnesses, along with catastrophic costs that can decimate retirement savings. And while Medicare provides health insurance for retirees, it won’t cover all of your bills. Fidelity Investments estimates that the average 65-year-old couple who retired in 2020 will need to pay $295,000, after taxes, to cover health care expenses in retirement.

One of the most effective ways to save for those costs while you’re still working is to stash money in a health savings account. To qualify for an HSA, you must enroll in a high-deductible health insurance plan, which is defined as a plan with a deductible of at least $1,400 for an individual account or $2,800 for family coverage. In 2021, you can save up to $3,600 in an HSA if you have individual coverage or $7,200 if you have family coverage. Workers 50 and older can contribute an additional $1,000. Contributions are pretax (or are tax-deductible, if your HSA is not employer-sponsored), the funds grow tax-deferred in the account, and withdrawals are tax-free for qualified medical expenses, without a time limit.

In response to the pandemic, Congress enacted legislation that expanded expenses that are eligible for HSA withdrawals. You can use the money to pay for over-the-counter drugs, and feminine hygiene products also qualify. But if you can afford to pay out of pocket for your unreimbursed expenses, it’s a good idea to let the money in your HSA grow, tax-free, until you retire. You can’t make contributions to your HSA once you enroll in Medicare, but you can use money in the account to pay for Medicare parts B and D, Medicare Advantage, and other out-of-pocket expenses.

If you plan to use your HSA as a savings vehicle, look for one that allows participants to invest in mutual funds and/or exchange-traded funds. Not all HSAs come with an investing option, but those offered by the largest providers typically do. If your employer plan doesn’t offer an investment option, you can open a second HSA with a provider that does and add money to that account in addition to your workplace contributions. You can research plans with an investing option at www.hsasearch.com.

Problem: Your home equity is a big portion of your retirement security.

Solution: Use your equity to generate retirement income.

Owning a home is costly: You have to pay property taxes, which always seem to be rising; maintenance; insurance; and, of course, the mortgage. But if you approach retirement with a large amount of equity, this investment could start to pay off in a big way.

If you still have a mortgage, you may be able to lower your expenses—and free up some cash—by refinancing. Rates on 30-year mortgages have hovered around 2.7% in recent weeks, a record low. The yield on 10-year Treasuries, the benchmark for 30-year mortgages, is expected to remain below 1% for the next few months, keeping mortgage rates low. But rates will likely rise when the pandemic is brought under control, so don’t wait too long to refinance if it makes sense for you. Cal­culate how long it will take you to break even on the up-front costs, particularly if you’re considering moving anytime soon. This year, your costs may include a new “adverse market” fee of 0.5% of the total loan amount for refinances backed by mortgage giants Freddie Mac and Fannie Mae. The fee, which doesn’t apply to loans of less than $125,000, is designed to offset losses associated with the COVID-19 pandemic.

Homeowners age 62 and older have more than $6.5 trillion in equity in their homes, according to data analytics firm Black Knight, and those homeowners can turn their equity into a reliable source of income with a reverse mortgage. A reverse mortgage can be taken as a lump sum, monthly payments or a line of credit. A line of credit may offer the most flexibility, and if you don’t use it, the untapped credit line will grow as if you were paying interest on the balance.

Low interest rates have made these loans even more attractive. Under the terms of the government-insured Home Equity Conversion Mortgage, the most popular kind of reverse mortgage, the lower the interest rate, the more home equity you’re allowed to borrow.

Even if you don’t need income now, a reverse mortgage line of credit can provide an important buffer during stock market downturns—and thus allow you to devote a larger portion of your portfolio to stocks. If the market goes into a tailspin for an extended period of time, you can tap the line of credit until your portfolio recovers. You don’t have to repay the money for as long as you remain in your home.

The up-front costs of a reverse mortgage tend to be high, so you shouldn’t take out a reverse mortgage unless you plan to stay in your home for at least five years. (You may be able to lower those costs by accepting a slightly higher interest rate.)

Social Security issues

Problem: You claimed benefits at 62 and regret it.

Solution: Withdraw your application or suspend benefits when you reach full retirement age.

Perhaps you claimed Social Security benefits earlier than you had planned when you lost a job or took some other hit to your income that left you short on cash flow, but now you’re back on your feet and don’t need the extra income. Or maybe you didn’t realize how much waiting to claim benefits would increase the amount of your monthly check. Claiming at 62 instead of your full retirement age (which is 66 for those born between 1943 and 1954 and gradually rises to 67 for those born in 1960 or later) reduces the amount of your check by 25% to 30%. For each year that you wait to apply after your full retirement age, up to age 70, you enjoy an 8% boost in delayed-retirement credits.

Whatever the reason for your remorse, you may have time to make amends. If you claimed benefits within the past 12 months, you can withdraw your application, pay back the benefits you’ve already received—including any benefits that a spouse or dependent claimed based on your record—and you’ll owe no interest or penalty. To request a withdrawal, fill out Form SSA-521 (you can download it at www.ssa.gov/forms/ssa-521.pdf) and mail it to your local Social Security office.

When you apply for benefits again, you’ll get the amount due to you for your age at that time. Make sure that your decision is firm, because you can withdraw your application only once.

If it’s too late to withdraw your application, or if you don’t want to return the benefits you’ve received, you have an alternative path to increase your future checks—although it’s not a complete do-over. Once you reach your full retirement age, you can ask Social Security to suspend your benefits until up to age 70. Your spouse or dependent will also stop receiving any benefits they were claiming on your record (an ex-spouse, however, may continue to receive benefits based on your record). Your checks will still be reduced because you claimed before full retirement age, but you’ll get the 8% delayed-retirement credit for each year past full retirement age that you wait to start receiving benefits again. Keep in mind that if Medicare Part B premiums were being deducted from your Social Security check, Medicare will bill you after you suspend benefits.

Problem: You don’t want to claim benefits early but need extra income.

Solution: If you’re married, have the lower-earning spouse claim benefits early while the higher earner waits until age 70.

Married couples have more to evaluate when it comes to claiming benefits—but they also have more options. Couples who want to pull in some income from Social Security should consider having the spouse with lower lifetime employment earnings—and who is thus entitled to a smaller Social Security check—claim benefits as early as 62. Meanwhile, the spouse with higher earnings waits until age 70 to claim benefits, capturing the maximum possible benefit. Having the higher earner postpone benefits is especially valuable because when one spouse dies, the other receives 100% of the highest benefit. “You’ll be really glad as you get older that you waited,” says Paula McMillan, a certified public accountant and member of the American Institute of CPAs Personal Financial Specialist Committee.

Consider other potential sources of income besides Social Security, too. One option is a reverse mortgage, which is available to homeowners 62 or older. A reverse mortgage allows you to tap into your home’s equity, converting part of it into a loan that you may take as a lump sum, line of credit or monthly payout.

Problem: You claimed benefits early and then went back to work, subjecting your benefits to the “earnings test.”

Solution: Keep your earnings below the exemption amount for the test—or wait until full retirement age to regain missed benefits.

Depending on how much they earn, those who take Social Security benefits before reaching full retirement age and have income from a job may face reduced benefits due to the earnings test.

Those who won’t reach full retirement age in 2021 can earn up to $18,960 for the year without worrying about the test. For each $2 you earn above that threshold, Social Security withholds $1 from your benefit checks. If you’re working part-time for an employer or are self-employed, keeping your income below the cap may be doable.

The year you turn your full retirement age, the test is more forgiving: The income exemption is higher—for 2021, it’s $50,520—and Social Security holds back $1 in benefits for every $3 you earn above that amount. The test applies only to the months prior to the one you hit full retirement age; after that, the test disappears. Turning your full retirement age comes with another gift of sorts, too: Social Security increases your monthly checks to make up for benefits you lost to the test.

Having income from a job—or from other sources, such as withdrawals from a traditional IRA or earnings from taxable investments—also increases the likelihood that a portion of your Social Security benefits will be subject to income taxes. Whether your benefits are taxable depends on your provisional income—the sum of your adjusted gross income, nontaxable interest and half of the amount of your Social Security benefits. If provisional income is more than $34,000 for those filing an individual tax return or more than $44,000 for married couples filing a joint return, up to 85% of benefits are taxable. If the total is between $25,000 and $34,000 for an individual filer or between $32,000 and $44,000 for joint filers, up to 50% of benefits are taxable (benefits are not taxed for those with provisional income below those thresholds). Several states tax Social Security benefits, too.