When developing a retirement plan, it is important to understand when and how expiration dates can affect decisions. Some expiration dates fall under strict regulations while some are vague and more sensible.
Fixed Expiration Dates
Social Security retirement benefits can be claimed from age 62 to 70. A delay to claim benefits past the age 70 can be made, but there is no benefit in doing so. The benefit amount will not increase after age 70. These mandated expiration dates are fixed.
Flexible Expiration Dates
In contrast, there are no expiration dates for asset allocations. A contributor can change their asset allocation any time for as long as they live. Asset allocation, as a general rule, should be updated whenever a change in financial situation warrants it. The same rule applies to spending rates.
There are decisions that the expiration date is neither fixed or flexible, but rather will no longer be available. For example, a decline in health or a depletion of retirement savings.
Many people who set an age for purchasing a fixed annuity set the limit at age 90 or 95. The only problems with waiting too long for this purchase is the risk that there may not be enough savings to do so. Another risk in waiting too long is if current investments perform poorly or savings are spent too quickly, a person may find that at age 80, they may no longer be able to purchase the amount needed to sustain their lifestyle in later years.
If interest rates fall significantly, any future annuities may become more expensive. Deferred annuity options are available in order to lock in payments, but inflation is still a risk. A good portfolio that brings positive returns in the interim is needed.
The Best Time to Purchase an Annuity
The expiration date for purchasing an annuity varies from person to person based on the time when that person no longer has enough savings to purchase the amount of annuity desired. Although this date is flexible for an entire group, such as retirees, it is fixed based on the time that a person losses wealth or annuity costs increase more than the person’s savings.
The stock market or declining interest rates can gradually eat away at earning potential for savings. The future cost of an annuity and how much savings a person will have in the future cannot be determined or predicted. Therefore, if an annuity is to be purchased, it is better to do it sooner than later.
The Best Age to Purchase an Annuity
A study conducted by Milevsky and Young in 2006 showed that there is an optimal age to purchase an annuity, theoretically. Factors such as gender, risk aversion, and waiting longer than the optimal age to purchase the annuity can affect the value of an annuity. For some insurers, the maximum age for annuity purchase is 90 to 95, but by that time, the option to do so may disappear.
Reverse Mortgage
For those looking to obtain an HECM reverse mortgage where both spouses have reached the age of 62, this is a viable option. However, if a person lets their house fall into disrepair, money may be needed to bring the house up to FHA standards. Ability to maintain the home and pay taxes may also need to be proven. If finances fall to the point where these basic requirements cannot be met, the loan may be denied.
Using the equity built up in a home to pay for appropriate housing in late retirement may not be available if spending began too early. Over time, if this equity is used too quickly, there might not be enough left to make that decision when the time comes.
If a financial crisis occurs late in retirement, an HECM reverse mortgage may take too long to be approved. It is much like a regular mortgage in the time it takes to become approved (about 3 months). This is problematic if during this time, the house falls into disrepair or the money is needed immediately.
Another risk of waiting too long to borrow an HECM reverse mortgage is not often considered. Many homeowners who have lived in their homes for 30+ years may not realize that their neighborhood is not as desirable as it once was and that their home value has steadily declined. As a retiree’s wealth dwindles along with their home value, they are set up for disaster if their health also declines.
There is good news though. By opening an HECM line of credit and keeping it separate from spending the money, the cost is minimal and the gain is great. The only risk involved is the temptation to spend the money now, instead of saving it for later retirement. There are actually benefits to opening a line of credit in this manner. First, it is like a growing line of credit, the home’s value is locked-in which protects the borrower, and there is immediate access to an existing line of credit with little or no wait time in case of an emergency.
Limits to Retirement Options
There are two tiers of income tax that may limit the options afforded to retirees. Early retirement may be funded solely from savings. Then, when eligible for Social Security benefits, up to 50% of these benefits can be taxed, thereby increasing the income tax rate. By age 70 ½ the Required Minimum Distributions (RMDs) from any IRAs will need to begin which pushes up the Social Security tax rate even higher. This tax is often referred to as the “tax torpedo” because up to 85% of benefits are taxed!
It is important to understand what decisions a retiree can make, if there is an expiration date on these choices, and is this choice reversible.
- Social Security Benefit Claiming – Expiration: Age 70 – Irreversible
- Long Term Care Insurance – Expiration: when unable to qualify medically – not reversible
- Fixed Annuity – Expiration: when depleted savings or interest rate declines – is reversible if wealth increases or interest rates rise
- Roth Conversions – Expiration: when taxes make them unattractive – is reversible if tax rates improve
- Use of HECM to change retirement housing – Expiration: if home equity declines below limit or when property taxes and home maintenance become unaffordable – not reversible
It is important for all retirees to understand their options and how it affects them later on in retirement. A knowledgeable retiree is a powerful retiree.
Geoff Thompson 