Most people are uncertain as to when, or even if, they can retire
Today, most retirees need to plan for as much as a 30 to 40 year retirement period. In thinking about retirement, the most common question financial advisors field is whether or not personal assets are sufficient to support that long of a retirement horizon.
As with each stage of life, retirement has separate and distinct risks. It is important to plan for and reduce those risks through proper insurance coverage, investment allocations, and budgeting. Below is an overview of retirement issues to consider when preparing for retirement.
Your 50s and 60s
Now is the last opportunity to sock away retirement funds. Try to boost your retirement savings goal up to 20 percent or more of your income. Ideally, you’re at your peak earning years and some of the major household expenses, such as a mortgage or child-rearing, are behind you, or soon will be.
Workers age 50 or over may invest extra dollars into their employer’s retirement plan once they’ve maximized their regular contributions. The catch-up amount is $5,500 for 2010 and will be adjusted for inflation in the future.
You may also put extra dollars into your IRA if you are over age 50. The catch-up amount is $1,000 for 2010. Once you maximize contributions to your retirement plans, save additional money in investments that don’t create much taxable income.
Investing at this stage typically needs to be somewhat more cautious. Time is starting to work against you, since you have fewer years of earning power to make up any losses. Planners recommend shifting a portion of your higher-risk investments into less volatile (and usually lower returning) assets such as bonds, although bonds have different types of risk including what may happen to interest rates in the future.
Most planners recommend maintaining a substantial exposure to stocks even in retirement. You have many years ahead, both to reach retirement and enjoy retirement itself. You will need some assets that can help you stay ahead of inflation and preserve the purchasing power of your income.
What kind of retirement?
It’s also time to focus on what kind of retirement you want and what financial resources you have to pay for it. Do you plan to stay home and garden, or travel the world? Work part-time? Go back to school? Start a new hobby? Move to a vacation spot? This is the time to start dreaming of what your new life will look like and to start putting “price tags” on those dreams.
The choices are many and so are the costs associated with them. Planners often advise people to “practice” their retirement. Want to move? Vacation there several times—in all seasons. Try out that hobby you’ve always thought about.
Share your dreams with your spouse. It’s important that both of you explore and work out differences. What if one wants to travel and the other wants to stay home?
Calculate what your dream retirement will cost— but watch out for rules of thumb. Arbitrarily figuring you’ll need only 70 or 80 percent of your pre-retirement income may prove too low, or too high. Expenses also can vary during phases of retirement: typically high at first (all that travel and fun), lower in the middle, then higher later if health declines.
Realistically, calculate what financial resources you will have to pay for your retirement. Also, begin thinking about how you will roll over your retirement assets so you will either preserve their tax deferral or reduce potential taxes.
Want to retire early—that is, before “normal” retirement age? The big challenge—a problem most of us are glad to have— is that we’re living longer. Retire in your mid-fifties and you could live 40 years or more in retirement. For a longer retirement period, you’ll need a larger nest egg than if you retired later, yet you’ll have fewer years to build that nest egg. Early retirement means smaller monthly Social Security benefits. The same applies to traditional pension plan benefit amounts.
If you retire early, you may need to replace corporate benefits you lose, such as life insurance and, if you work part time or on your own during retirement, disability insurance. You also may need to come up with health insurance to cover the gap until you qualify for Medicare at your normal retirement age. Retiring before age 59-1/2 also can present a tax problem, since taking money out of your retirement plans may trigger a 10 percent tax penalty if not done correctly. And you could still have major expenses to fund, such as a mortgage and college. The challenges of early retirement are not just financial, however. What are you going to do all those years? Many CFP® professionals find their retired clients returning to work, often part time, out of boredom.
Although early retirement may sound appealing, be sure you’ve thought through the financial and non-financial issues before taking the plunge.
CAUTION: While still in your 50s or early 60s, evaluate whether long-term care insurance is appropriate for you. Failing health requiring long-term care is often the biggest single drain on a retirement nest egg. Medicare does not pay for extended long-term care. Without insurance, you’ll have to pay out of pocket until you’ve spent most of your assets and can qualify for Medicaid assistance or Veterans Administration benefits.
Retired at last...
Retirement planning doesn’t end once you retire. Like any financial plan, it requires periodic adjusting. Two of the most important decisions are how much to withdraw annually from your nest egg, and from which accounts.
Considerable research in recent years has concluded that retirees should be more conservative than once thought in how much they withdraw.
Retirees routinely used to withdraw from their nest egg six to eight percent or more a year, adjusted for inflation. Now, say some experts, withdrawal rates should range from three to six percent in an effort to protect you, as much as possible, from running out of money. The withdrawal percentage depends on how much you’ve saved, the investments you are using, your age and other factors. Retirees who withdraw at higher rates should be prepared to immediately cut back should their accounts suffer from a significant market downturn, or should their personal circumstances change for the worse.
In addition, consider putting enough money into a liquid money market account to cover your withdrawal needs for at least a year (maybe more), so you don’t have to withdraw money from your investments when the market is adjusting downwards.
Besides adjusting your investments during retirement, you may need or want to adjust your lifestyle. Is retirement turning out as you envisioned? Did that “practice” you did just before retirement work out? How do you feel about yourself and your life now?
As noted earlier, it’s common today for retirees to return to work—perhaps out of financial necessity, or possibly for something stimulating to do. Playing golf every day or traveling all the time can get boring for some. Besides work, you may want to consider going back to school or doing volunteer work. Keeping mentally, physically and socially active is key to building an enjoyable retirement, say experts.
From which accounts?
The general advice is to first take money out of taxable accounts in order to keep assets in retirement accounts growing tax deferred. This may involve some reallocation of your investments. For example, consider putting equity investments into taxable accounts and utilize the lower capital gains rates for withdrawals. Put bonds that produce income into tax-deferred accounts because bond income is taxed as ordinary income.
Once you reach 70-1/2, your choices are further complicated because you may be required to start minimum distributions from your IRAs and retirement plans. Withdrawals may also trigger taxation of Social Security benefits. A qualified tax professional can illustrate different strategies and their potential tax implications.
In what should you be invested? You will probably want to be more conservative than before retirement. Yet that does not mean abandoning stocks. With potentially 20 or more years in retirement, inflation can eat away at lower returning assets. Even at a modest three percent annual rate, inflation could cut your standard of living in half in 24 years. Planners may recommend that the portfolio hold at least two to three years of living expenses in cash, CDs and short-term bonds that can see you through a stock market decline. Beyond that, there is no special rule of thumb for allocation of stocks, bonds, cash and other assets. Much depends on your other sources of income, risk tolerance, age, financial goals, such as leaving money to children, living expenses, tax rates, and other factors.
This firm is not a CPA firm.
Financial Life Advisors (FLA), a Registered Investment Adviser, and Jim Oliver & Associates, P.C. (JOA) are under common ownership and control. Team Oliver is used to describe collaborative services of both firms. Professional tax services are provided by JOA and investment advisory services are provided by FLA, each under separate agreements.