Wade Pfau: How to Pick the Best Retirement Income Strategy for Each Client

But Social Security is actually a very good investment when delaying benefits rather than taking them at 62 and throwing the money into the stock market — the usual [plan] when looking at [this claiming option].

With Social Security as an investment, you need to focus on the possibility of living a long time. If someone is living into their 80s, they may be looking at the implied return of an inflation-adjusted 3% to 5% by delaying Social Security.

And if somebody is living into their 90s, it can get up to [the level of] what we think of as average stock market returns.

But when delaying Social Security benefits past age 65, people can suffer a big shock, you write, if they don't know that Medicare enrollment isn't automatic in that scenario. Please elaborate.

One of the worst mistakes that can occur for retirees is that they didn't realize they had to take action to sign up for Medicare or that they thought they had some other insurance and that meant they didn't have to sign up.

There's only one situation where you can delay signing up for Medicare, and that's when someone is actively employed — or their spouse is — by a [company] that has 20 or more employees and has health insurance from that employer.

Otherwise, at age 65, Medicare becomes the primary payer. You may have some other insurance — like COBRA, veterans' benefits [etc.] — but by law, that becomes secondary insurance; and it may not pay enough if you don't have primary insurance.

So people can inadvertently get themselves into a situation where they don't have primary health insurance after age 65. 

If they don't catch that during the initial enrollment period, they have to wait until a general enrollment period, which could delay coverage for up to 15 months; so you'd be without primary health insurance for that whole period.

Should advisors make clients aware of this big potential error? 

Any advisor who's providing financial planning services beyond just simple investment management should at least be reminding their clients about this because it has huge financial implications.

It falls under the purview of any advisor who's portraying themselves as doing more for their clients than just managing investment strategies.

"Social Security is the best annuity money can buy," you write. How so?

If you claim at age 70, you're missing eight years of benefits than if you started at age 62. But by starting at 70, you're getting [about] 76% higher Social Security benefits for the rest of your life. The implied payout rates are much higher than any commercial annuity.

Annuities can be effective in filling a retirement income gap if the client doesn't have enough "reliable income to meet their core longevity expenses," you write. How does an advisor broach this topic with the client?

Start with a discussion of retirement income style awareness. Someone who has more confidence in the stock market as a source of growth will rely on that because they'll think of a diversified portfolio as producing [all their needed] coverage.

But someone who has a more "safety first" mindset would feel more comfortable having some sort of contractual protection to support spending and would want to fill that gap with either individual bonds or an annuity.

Often, people don't know how much they'll potentially spend in retirement or don't have a budget in mind. Does that come under the umbrella of filling a gap? 

It's more of an asset allocation question: How much should I put in stocks? In bonds? In an annuity? 

Then you'll allocate part of your retirement assets to annuities in the same sort of way as allocating stocks and bonds.

At what age is it best to buy an annuity?

It's pretty reasonable to start thinking about annuities as part of a financial plan in the five to 10 years leading up to retirement.

Then, if you're still pre-retirement, you can use a deferred annuity so that you build up additional deferral within the annuity before payment begins.

Or if you want to fill a gap, you can look at that question when you're at retirement age or any point after retiring.

The House Ways and Means Committee has approved legislation that would eliminate backdoor Roth conversions as of Jan. 1, 2022. This is part of the Democrats' reconciliation bill. What do you expect will happen?

It's hard to say exactly what the final tax package will look like, but the backdoor Roth contribution may go away. That's how it's looking right now. 

My book will be [quickly] updated with any tax reform changes.

In our June 1 interview, you talked about the Social Security Tax Torpedo. Please briefly review that issue. 

The Torpedo is one of several aspects of the tax code that puts you in a higher tax bracket without your realizing it. 

This is more an issue for people who may have a couple of hundred thousand to a couple of million dollars and not for the super-high net worth. If you're wealthy enough, you're going to be paying taxes on 85% of your Social Security. There's no way to avoid it.

The Tax Torpedo will get worse after 2026, when we're scheduled to go back to the tax rates as they were in 2017 [before the sweeping GOP-led tax overhaul].

How deeply should advisors get involved in the details of clients' retirement planning?

That's up to the advisor on a case-by-case basis. Many issues border on things that advisors don't usually do. So they might look to outsource some of it, such as long-term care options.

An advisor can decide whether or not they want to count [such areas] as part of their practice. If not, they can try to provide some resources for clients.