Fourth-Quarter To-Dos for Retirees

Jason Stipp: I'm Jason Stipp from Morningstar. As we approach the fourth quarter, retirees should begin to compile their Q4 checklists and to-do lists here to offer some tips is Morningstar's Christine Benz, our director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: Retirees should compile very specific checklists. They have some more specific things than investors at large, and you say the first thing they should do is check out Medicare open enrollments. Even if there are already happy with their Medicare, they still should do a little bit of shopping?

Benz: Right. Mark Miller, who is a contributor to Morningstar.com and really focuses on Medicare and Social Security for us, says that retirees should reshop their Medicare Part D prescription drug coverage every year, in particular, just to make sure that they're in the right plan for them because prescription drugs that one might be on might change from year to year. What may have been covered perfectly in the past, may not be in the future. Just do your homework to make sure that the drugs that you're currently on will in fact be covered in 2014 under the plan that you choose.

Stipp: I know he's written about some variance in the fees for some of the policies and the Medigap policies. There can be substantial differences in some years so it just pays to tune in and shop around.

Benz: Exactly. You can reshop that supplemental coverage that you have as well just to make sure that your plan is cost-effective and as comprehensive as you can possibly afford.

Stipp: Also on the topic of health care, Christine, you say it's important to make sure you are tracking your health-care expenditures. This is important because you can write off a certain amount those expenditures that exceed a certain percentage of your AGI, or adjusted gross income, but that percentage has changed?

Benz: It did change, starting in 2013 for people under age 65. In the past, it had been anything of over 7.5% of your adjusted gross income could be deductible. It went to 10% for people under age 65 starting in 2013. But the good news is, if you are over age 65, you have a bit of a grace period until that higher threshold kicks and you'll have the next several years. For 2013 and the next several years, your threshold will remain 7.5%. If you have out-of-pocket health-care expenses that are over that threshold, you'll be able to deduct them. It's really a pretty broad basket; it includes insurance premiums and prescription drugs and even can include transport to and from medical care that you might need.

Make sure to document those expenditures. In my experience helping my parents with this, pharmacies are really good about providing a year-end statement of out-of-pocket drug costs. You may be able to get some help; you may not have to do all of the documentation yourself.

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Stipp: If you're over 65, and you're thinking "I'm not going to hit that 10%," think again because that actually didn't go up for you yet.

Benz: It's 7.5%.

Stipp: Christine, something else you said to keep in mind for your checklist is do a little bit of prework on your RMDs, required minimum distributions. This is something obviously that a lot of retirees are facing; [they should go] ahead and get a leg up on that.

Benz: Right. A lot of people do this at the very last minute in the closing days of a given calendar year. You actually want to think about where you will go for those required minimum distributions, and my advice is always to knit this in with your rebalancing process.

I would imagine that a lot of people are looking at their portfolios' total asset allocations right now and certainly the accounts where they need to take RMDs from, and they might see an overweighting in equities. A great way to get that back into whack is to think about taking those required minimum distributions from your equity accounts. And I think what people might not realize is that they actually have quite a bit of leeway about where to go for those distributions.

As long as you’re taking the right amount from all accounts of that same type, you can be pretty precise about where you go for those dollars. In this case I think for many people it will mean tapping those equities which have had a very nice run here.

Stipp: What about RMDs that I don’t think I need to spend? What should I do with that money?

Benz: We often hear from people who say "My RMDs are going to cause me to go above my desired withdrawal rate." Those might be people who are using that 4% rule to guide their in-retirement distributions. The good news is that you don’t have to spend those RMDs. I know some people kind of use them as mad money, and that’s fine if you can afford to do that. But you can reinvest those proceeds that you’re pulling from your IRAs and your 401(k)s. And you can put them into a taxable account; anyone can do that. But if you have enough earned income to cover the cost of a Roth IRA contribution, you can actually put the money into a Roth IRA. It could be that your spouse maybe has earned income even if you are retired, so, that’s another option, as well.

Stipp: Something else retirees and actually a lot of investors might be doing around this time is looking at the interest-rate sensitivity and the performance of their bonds over this last year, and it’s been pretty rocky. What should I be looking at and what should I be thinking about as I assess the performance in my fixed-income investments?

Benz: There has been so much concern, Jason, as we’ve had this little interest-rate shock in the May, June period of 2013. I do think it’s a good time to do kind of an assessment of how your portfolio behaved during that particular period because a lot of people thought, "Well if I have long-term Treasury bonds, of course those will be hit hard in a rising-rate environment." But we actually saw a broad swath of securities get hit pretty hard. Emerging-markets bonds, Treasury Inflation Protected Securities, and municipal bonds all had pretty sizeable losses. 

My thought is that you’re looking at your bond holdings' total losses during that May, June period and you’re seeing losses that are larger than what, say, the Barclays Aggregate Bond Index had during that period, you should know that you have a fair amount of interest-rate sensitivity packed into your portfolio, and you may not be comfortable with that level of risk.

On the flip side, however, I think maybe investors are a little overly concerned with taking all of the interest-rate sensitivity out of their portfolios, and in some cases my concern is that what they are getting instead is more credit risk and more equity sensitivity then perhaps they bargained for.

We've seen this real mania for bank-loan investments. It's a great asset class to own in a rising-rate environment, but you will have a fair amount of equity sensitivity. My thought is that it's a balance. Don't go out of your way to purge your interest-rate sensitivity altogether because in doing so, you may really reduce the overall diversification of your portfolio.

Stipp: Having a diversified portfolio means that you will have something, likely some portion, that is having losses when something else is having gains. If you try to eliminate the losses altogether, everything has gains, so that means everything could probably have a loss at some point, as well.

Benz: Exactly. I wrote a piece a couple of weeks ago just saying you need ballast for your portfolio, and it's wise to kind of rethink what that ballast looks like. Maybe it is shortening up the duration of your bond portfolio; maybe it's heightening credit quality. But you don't want to do without ballast; you need it. Just make sure that you're not supplanting one type of risk for another type of risk, which in a lot of investors' cases right now is extra credit sensitivity and equity sensitivity.

Stipp: Fourth quarter is a very important time for personal finance and investment planning. Thanks for joining us with these tips today, Christine.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.