Mind the age gap with retiring spouses
An age difference may mean nothing when it comes to falling in love, but it can cause some major drama when couples start to retire.
That’s because a big gap puts a lot more pressure on a couple’s finances to support a stable, and likely lengthy, retirement.
Ensuring that the younger half of the pair will have sufficient income to last the duration of his or her life — and perhaps, several years as a widow or widower — is the most crucial aspect of planning for these couples. But how you shore up the couple’s finances to handle such a lengthy timeline can involve a number of different strategies from maximizing Social Security benefits, to setting the correct balance for their investment portfolio, to finding smart ways to stretch the assets they already have.
Investing for a very long retirement: As the older spouse approaches retirement, the typical advice goes something like this: he or she ought to hold a conservative portfolio with a larger share of bonds than he or she did earlier in life. But with a decade-younger spouse, that standby advice likely won’t work given the extended drawdown period their savings will need to sustain.
“I find clients don’t really do the math and realize that their retirement savings need to last beyond their own life, say for another 15 years, to include the life expectancy of the younger spouse,” says financial planner Kristin Sullivan of Sullivan Financial Planning in Denver.
Working out the correct balance means factoring in the risk level the couple is comfortable with as well any fixed-income assets or other financial products they may own, but in general their equity exposure will need to remain higher than that of a similar retirement-age person with a same-age spouse.
These age-gap couples need to maintain more aggressive portfolios in order to capture enough growth to support both spouses’ retirement timelines and outpace inflation. But they shouldn’t swing to the other extreme, either, cautions David Blanchett, head of retirement research at Morningstar. A market crash that coincides with one spouse approaching retirement could hurt the longevity of the entire portfolio.
Instead Blanchett thinks a 50/50 split between equities and bonds is a good place for a retiree to be today. If the younger spouse happens to be the top breadwinner, though, Blanchett thinks the couple can be invested even more aggressively.
The couple’s withdrawal rate would also need to be scaled back to a more modest percentage than the typical 4%.
“It is often unwelcome news,” says Sullivan. “Normally, when a couple retires together in their 60s, we use a 4% withdrawal rate as a starting point. But when a couple — one in their 60s, one in their late 40s — wants to retire, the withdrawal rate drops to what is appropriate for the youngest person, so 2% to 2.5% as a starting point.”
Blanchett has found that this 2% withdrawal rate is accurate if the same framework that gave us the 4% rule is applied, where a couple retires at the same time and withdrawals are made at a constant amount for 30 years, or in these cases, more. But he says this rule of thumb won’t apply to many couples with a large age gap, especially if they retire at different times and a younger spouse continues to work for part of the couple’s total retirement timeline.
“As long as a couple is willing to adjust over time, I think 4% is OK,” says Blanchett. “If they have no flexibility to cut back on spending, then I’d say 3%.”
He adds many couples do not solely rely on investment income, so even if the portfolio dwindles to zero, most couples have fixed sources of income from Social Security or a pension they can also rely on.
Safe withdrawal rates can vary significantly depending on how much guaranteed income a couple has. For instance, a couple with 95% of their income guaranteed could take out 6% a year, while a couple with only 5% guaranteed income should expect to use 2%.
Using forward-looking investment return projections rather than historical returns in your financial modeling will also significantly decrease the percentage that would be safe for the couple to spend each year.
Get the timing right: While most couples want to retire relatively close together, spouses born a decade or more apart will need far more guidance on determining when they can both call it quits. An early retirement for a young spouse can be very costly.
The couple’s portfolio will come under increased pressure as it must support even more years of retiree life.
An early exit could also drastically reduce the size of the younger spouse’s Social Security check, particularly if he or she is in their peak earning years or has worked fewer than 35 years. Because Social Security benefits are calculated by averaging a person’s 35 highest-earning years, someone who is currently a high earner — but wasn’t in previous years — misses the chance to raise their average with that larger late-life income. Similarly, falling short of that 35-year mark means zeros will be factored into the calculation for the missing years, dragging the younger spouse’s average earnings down.
If the younger spouse retires before they are eligible for Medicare or has been reliant on the older spouse’s health insurance plan, he or she will need to buy their own health insurance or, if available, the older spouse can continue employer coverage in retirement to provide benefits to the spouse.
“It is a temporary cost that we help clients realize if they can cover,” says financial planner Robert DeHollander of DeHollander & Janse Financial Group in Greenville, South Carolina. He notes that the exact cost will vary depending on a person’s health and other factors, but generally, he plans on $1,000 a month for out-of-pocket medical expenses. “People who’ve had coverage through employers their whole life are stunned to see it,” he adds.
Another important consideration hinges on what happens if the older spouse does retire and the younger one keeps working. DeHollander says he’s had to play the role of therapist before when resentful feelings develop as one spouse goes off on vacations with friends or spends the day gardening, while the other works.
“The person still working and earning an income may begin to see their dollars going to these other fun things, and hard feelings develop,” adds DeHollander. “It is important the couple sets clear expectations for how the funds of the one working will be used and discuss how they both feel about their new roles and about what they’ll do with their time.”
The reverse can also be true, cautions financial planner Danielle Howard of Wealth by Design in Basalt, Colorado. A working spouse may derive a lot of enjoyment, identity and purpose from their work, and that can rattle a newly-retired spouse who is feeling adrift and purposeless with their own time.
“We had lots of financial discussions, but honestly the bigger impact on us has been expectations around what his day looks like to support a working wife, as well as how does he stay engaged, creative and active in life with meaning and purpose,” says Howard, who not only advises age-gap couples, but is also part of one herself, with a husband 11 years her senior.
RMD tax planning: There is a small window between retiring and turning age 70 in which an older spouse’s IRA can continue receiving contributions through the younger working spouse, allowing a couple to fully fund two IRAs, says Dave Cherill, a CPA and member of the American Institute of CPAs personal financial planning executive committee.
Clients may know that when they reach age 70 1/2, they’ll need to begin taking required minimum distributions from IRAs and employer-sponsored retirement plans, but they may be unaware of a provision in the tax code meant specifically to benefit them.
Couples with at least a 10-year age difference can use a separate RMD calculation table that allows the older spouse to withdraw less than a peer with a similar age spouse, Cherill says. But to take advantage, the younger spouse must be the beneficiary on a traditional IRA, 401(k), 403(b) or 457 plan that the older spouse owns.
The larger the age difference, the more the RMD shrinks — meaning your clients can keep more of their money growing in these tax-deferred accounts for longer.
If your clients don’t need the RMDs to pay for current expenses, advise them to be strategic in how they spend them. Using that RMD income for living costs could free up additional money in a younger spouse’s paycheck for maxing out a 401(k) or other workplace plan, or a health savings account.
Because Roth IRAs have no age cutoff, RMDs or other income could be funneled into these accounts, as long as one spouse earned income from a job within the year. But to qualify for a Roth, the pair’s joint income must be below $199,000. The amount you can contribute begins to phase out for couples earning more than $189,000.
This strategy moves one spouse’s retirement withdrawals back into the other spouse’s retirement savings. It could also help prevent a couple from moving up a tax bracket: the bump in income from the RMD is offset by the reduced taxable income the younger spouse will report by contributing to tax-deferred accounts.
Alternatively, a couple could do away with the hassle of calculating RMDs altogether by opting to convert a traditional IRA to a Roth IRA and gain a 0% tax rate on the funds in retirement, a move that could mean a larger nest egg for the younger spouse.
Clients who are already in the highest tax bracket and will continue to have high incomes in retirement should consider making such a conversion now. The latest changes in tax law reduced the top individual income tax rate from 39.5% to 37%, and because income tax rates are unlikely to be lowered further in the future, clients should consider locking in that lower rate through a Roth conversion now, as opposed to paying taxes on RMDs each year at an unknown, future tax rate.
Couples who are not high earners could also benefit from doing a conversion now as several income tax rates have lowered, but they should time such a move with at least one spouse’s retirement when the household income will likely dip. This strategy could result in big tax savings if they can move down an income-tax bracket. Staggering the conversion by converting a portion — say 20% of the IRA per year over five years — can also help keep couples from accelerating into a higher tax bracket, Cherill says.
Either way, you’ll need to be careful with any conversion advice as the newest tax laws took away a provision that formerly allowed people to “undo” the move by re-characterizing a Roth IRA to a traditional IRA within a set time frame.
Couples who lack the funds to pay the tax bill resulting from a conversion shouldn’t make this switch. Neither should couples where the younger spouse is under age 65 and will be buying subsidized health insurance through a public exchange, as the resulting income increase from a conversion could reduce the assistance they’re eligible to receive.
Pension: If the older spouse is entitled to a traditional pension, you’ll need to figure out if the couple will see more value from taking it as a joint-and-survivor annuity.
Such an option will reduce the size of the monthly check the older spouse could receive if they opted to only cover themselves, but it does mean payouts will continue as long as at least one of the pair is alive.
This can provide huge relief to age-gap couples as it gives them yet another way to ensure there will still be money left to last the duration of the younger spouse’s life. And because it is guaranteed income, there is less stress about how to save for those widow or widower years.
“For a lot of clients, the decision is emotional more than financial,” Sullivan says. “They like knowing that they have a check coming each month of their and their spouse’s life. Even when I run the numbers and tell people that taking the pension as a lump sum and rolling it over to an IRA shows better results, they don’t want to do it. They like the steady paycheck. It’s more comfortable and less risky to them.”
The pension-owner can usually opt for a 50%, 75% or 100% survivor benefit, meaning the spouse can receive that same percentage of the owner’s monthly check. Of course, the higher the spousal benefit, the smaller the initial monthly paycheck. The age of both spouses will also factor into the benefits and could further reduce the payout the pension-holder can expect. But the initial drop in pension benefits could be worth it over the course of the two lifetimes, particularly for couples that lack strong savings and will rely heavily on Social Security with little or no other outside income.
Finally, couples may need to consider opting for a joint-and-survivor annuity not for the income, but to save on medical costs.
“If both spouses worked and saved for retirement, there may be situations in which the surviving spouse doesn’t need the survivor pension benefit for income but does need it for access to health insurance,” says financial planner Marguerita Cheng of Blue Ocean Global Wealth in Potomac, Maryland.
Maximize Social Security benefits: Social Security is often the largest source of income for retirees, providing between 40% and 51% of their income, so effective modeling of when age-gap couples should begin drawing their benefits is critical.
Generally, if the older spouse was the higher earner, he or she should try to delay taking Social Security benefits until age 70. Waiting to tap those funds allows the retiree’s check to grow between 6.5% and 8% each year and means the younger spouse will be entitled to a higher survivor benefit, says Laurence Kotlikoff, economics professor at Boston University and creator of the software program, Maximize My Social Security.
Increasing that source of fixed income can provide a big boon to a younger spouse’s retirement lifestyle if they were the lower earner and will receive a smaller benefit, based on their own earnings history.
“I met a man who was diagnosed with cancer at 66. He made lots of money, but when he spoke with the Social Security office he was told to begin taking his benefits immediately,” Kotlikoff says. “It may seem obvious to do that. He wasn’t likely to live very long. But he hadn’t considered the implications for his wife. Doing so when they didn’t need the money reduced the benefit his wife could claim as a survivor by about 16% as he collected for two years.”
If a couple needs the cash flow and is unable to wait until age 70, Kotlikoff advises they try to at least wait until their full retirement age. Drawing benefits early could reduce their lifetime benefits and the survivor benefit far more than they realize.
Factor in long-term care: The threat of large medical bills looms as a possibility on all retiree’s futures, but for age-gap couples that threat takes on heightened proportions. An older spouse needing extensive long-term care could deplete the couple’s savings, leaving the younger spouse with little to live on for the remainder of his or her life.
Younger spouses may also act as caregiver to a sick husband or wife, perhaps reducing the expense of at-home care visits or other health-aide bills, but should they fall ill later in life, it is unlikely their older partner will be around to provide that same level of attention. They could end up footing high medical costs at the very end of their savings net.
For these reasons, it is crucial financial planners help age-gap couples create a long-term-care plan so they can ensure each spouse will be able to afford the help they might need without sending the other half into poverty.
There are different methods couples can use to safeguard against this: One common solution, long-term-care insurance, typically covers at-home assistance as well as nursing-home stays for a certain length of time. Steep premium costs mean this option is best used by those with investable assets between $250,000 and $2 million. Those earning more may prefer to skip the expense and simply self-insure.
Premiums increase with age so encourage age-gap couple clients to begin researching this option when the older spouse hits their mid-50s.
“I find that in your 50s is the sweet spot,” Sullivan says. “You don’t have many health problems yet, and the insurance coverage won’t be onerously expensive.”
Life insurance and reverse mortgages are other options planners sometimes recommend to help couples protect the retirement security of a younger spouse.
“Life insurance can sometimes be a better way to go,” says Richard Johnson, director of the Urban Institute’s program on retirement research. ”If a couple does end up draining all resources on the older person’s care, they have this payment at the end that can provide some security.”