Top economist and Wall Street gadfly Laurence J. Kotlikoff, PhD, believes that the way most of us go about planning our finances is all wrong. We let emotions and irrational fears sway us and, even worse, rely on conventional wisdom about personal finances, which often benefits only the financial industry. Instead, Kotlikoff—who doesn’t hesitate to chide financial-firm executives for bilking customers with misleading advice—says you will have greater security and a better life if you make choices about money the way a hard-nosed economist does—focus on how your financial choices will impact your long-term standard of living. After all, once you have established the lifestyle and level of income you enjoy each year, it’s immensely painful to be forced to scale back.
Bottom Line Personal asked Kotlikoff for his unconventional advice about housing, retirement, debt and investing…
Conventional wisdom: Pay off your mortgage as soon as possible if you are near or in retirement—but don’t use IRA or 401(k) money. That money should continue to grow tax-deferred.
Unconventional Wisdom: Consider tapping your tax-deferred accounts to pay off your mortgage. For most retirees today, retiring mortgage debt is the equivalent of earning a guaranteed 3% to 4% return. That will support your standard of living better than the fixed-income part of your retirement portfolio (10-year Treasuries recently yielded only 1.98%). Sure, you have to pay taxes on traditional IRA or 401(k) withdrawals, but you still can come out ahead, especially if you are in a lower tax bracket than you’ll be in down the road when you start taking Social Security. Once you own your home, your monthly bills drop significantly, and that makes it easier to ride out stock market turbulence with your remaining investments. Caveats: There’s less incentive to pay off your mortgage in retirement if you have a mortgage rate below 3% or if your itemizable deductions are high enough so that you don’t take the standard deduction on your taxes and need the mortgage interest payments for deductions.
Conventional wisdom: Hang on to your family home as long as possible after the kids move out and you retire.
Unconventional wisdom: Plan to downsize earlier than you think. Downsizing or moving to a less costly area can provide a higher, more secure standard of living. Time the sale of your larger home for when real estate conditions are favorable. And the windfall from the sale of your home can afford you better protection in advanced old age, enabling you to beef up retirement savings or purchase long-term-care insurance.
Conventional wisdom: Take Social Security benefits as soon as you are eligible. Most of us start taking payments as soon as we retire. Why: You hope to get back what you paid into the system before you die or before the Social Security trust fund is depleted and the government reduces everyone’s payouts.
Unconventional wisdom: Postpone taking Social Security payments as long as possible. Unless you have serious health concerns that will likely shorten your life or you have no other assets to live on, the advantages of delaying Social Security are too good to ignore. This is true even if benefits are cut by up to one-quarter down the road (an unlikely outcome). Each year you put off receiving your benefits increases your monthly lifetime payouts from 7% to 8%. And if you delay until age 70 (when annual increases in benefits stop), your monthly payout is about 75% higher than at age 62.
Delaying also allows you to maximize widow(er)s and eligible divorced widow(er)s benefits. If you die, your spouse—and your ex-spouses married to you for a decade or longer—are entitled to receive the higher of their own retirement benefit or your retirement benefit for life. And by spending down your tax-deferred accounts before age 70, the taxes you eventually will pay on your Social Security benefits will be smaller.
Also: It would take an act of Congress to reduce future Social Security payouts. Washington is unlikely to shortchange more than 70 million baby boomer constituents. More likely: The fund will be bailed out by raising taxes that the rich pay on their Social Security benefits.
Conventional wisdom: Beware of annuities—contracts that typically allow you to make a lump-sum payment now to an insurance company in exchange for eventually receiving a guaranteed monthly payout for the rest of your life. They are complex and have high fees. Plus, if you die right after paying the lump sum, you get nothing.
Unconventional wisdom: Even people who are annuity-averse may want to consider a Qualified Longevity Annuity Contract (QLAC). QLACs are deferred annuities that let you delay payouts until you reach advanced old age. That allows you to avoid living like a miser because you fear running out of money later on. QLACs are easy to understand and have no annual fees, and your payout amount is fixed and guaranteed for life. You can invest up to 25% of your tax-deferred retirement accounts (up to $145,000 in 2022) in a QLAC. In exchange, you’ll get an annuity that can start paying out as late as age 85. The amount will depend on your age when you purchased the QLAC, how much money you paid for it, your gender and how high interest rates were when you bought it. Wait to purchase a QLAC at least until age 72 when you are otherwise forced to take required minimum distributions (RMDs) from your taxable (non-Roth) retirement accounts. Payouts typically are bigger than what you could earn from a long-term bond portfolio that you might invest in on your own.
Even better: The IRS allows you to exclude the QLAC when calculating your RMDs, which start at age 72, allowing those taxable distributions to be smaller. You can add riders to your QLAC for “cost-of-living adjustments” to keep pace with inflation…and “return-of-premium” so that your spouse and other heirs will receive the initial amount that you invested in the QLAC if you die before you get any payouts.
Conventional wisdom: The older you get, the more conservative your portfolio should be—more bonds and less stock. Traditional formula to figure out your stock allocation: Subtract your age from 100. So a 65-year-old should have no more than 35% in the stock market. A 75-year-old, just 25%.
Unconventional wisdom: Increase your allocation to stocks as you age throughout your retirement. As you age and eat up your assets, more of your total resources become tied up in Social Security benefits. But receiving these benefits are akin to inflation-indexed bonds. To maintain a proper overall balance of risky and safe resources: Invest an ever larger share of your ever-declining investable assets in stocks.