Last month, I wrote about the BlackRock Retirement Institute (BRI) recently published white paper titled "Spending retirement assets…or not?" which studied the financial behavior of past and current retirees. One conclusion of their research was that the retirement income strategies used in the past may no longer be effective. A surprising finding is that the financial behavior of retirees is essentially the same, no matter what their wealth level is - all retirees generate most of their retirement income from Social Security and pensions, and all retirees tend not to spend their life savings, which they then leave to heirs who often spend it quickly.
Security in retirement is all about income, and retirement income challenges now involve longer life expectancy, lower stock and bond yields, questions about social security and the disappearance of pensions from the workplace.
Better Planning for Spending: Go-Go, Slow-Go, No-Go
Standard retirement planning starts out with a target retirement income (such as 80% of pre-retirement income) and then increases the retirement income by 3% per year to consider the effects of inflation. In practice, retirees tend to spend the most in the first “Go-Go” phase of retirement when good health energy allows for lifelong dreams of travel and activity to be fulfilled. Go-Go retirement can extend into the 80s, when eventually things slow down and discretionary retirement spending tends to slow down too. The final phase of retirement is where medical costs, including possible long-term care, may appear.
Early Planning
It is very important to start your detailed retirement income planning no later than 5 years before your planned retirement date, but there are several areas you should address well before this countdown starts:
Max out your annual 401k contributions in order to create a nest egg to compliment your social security benefits. Many Americans enter retirement with their home equity and 401k accounts as their only real savings and maxing out 401k contributions (including catch-up if you are 50 or older) is a great way to put retirement savings on autopilot.
Balance Roth and Traditional contributions to create tax diversification. A simple 50-50 balance gives retirees the ability to better manage how and when they will be taxed in retirement. Having non-taxable Roth dollars also limits the effect of RMDs and provides additional estate planning opportunities.
Pay off all your debts including your primary home mortgage. This will greatly reduce your fixed monthly income needs, which both simplifies your finances and will boost your financial peace of mind in retirement.
Consider downsizing and relocating to be near family and a more ideal retirement climate. Some popular retirement states have no state income taxes which can also boost your retirement income.
Analyze your spending for the past 12 months and categorize as either fixed or discretionary. Minimizing fixed costs will give you the greatest flexibility in retirement.
Five Years Before Retiring
Here are a few things to consider when you are within 5 years of your planned retirement date:
Match fixed retirement expenses to guaranteed retirement income sources and don’t worry about inflation as your spending needs will likely stay level or even decrease as outlined above. An easy way to create guaranteed lifetime income is to purchase a fixed immediate annuity which effectively converts capital into lifetime income. If your income needs grow later in retirement you can always convert more of your savings into more income with another annuity. Fixed immediate annuities are very straightforward and can be purchased to cover one or two lives, depending on your circumstances. Rental real estate can be another excellent source of retirement income but can require a much more hands-on approach and involves a multitude of risks.
Invest your portfolio for total return and use it to fund your discretionary purchases. Once you have your fixed retirement costs funded, you can spend not only the income from the remainder of your portfolio but the principal as well, knowing that your needs will always be met.
Be Careful
There has been a lot in the news about improving disclosure and removing conflicts of interest in the financial industry. Here are some examples of financial products which may not perform in the manner you expect:
Annuity investment returns that aren’t because the returns that are advertised don’t refer to your actual account balance but instead to an unrelated concept called your “income balance.” These can be very complex products that can also pay high up-front commissions to the annuity salesperson.
Cash value life insurance can be very expensive because the agents who sell these contracts can pocket the entire first year’s premiums as a commission which can be tens of thousands of dollars for large policies. Companies such as TIAA-CREF now offer commission-free permanent life insurance policies that you can arrange through fee-based financial advisors.
To Learn More
We provide a compassionate and confidential approach to help clients get their financial house in order. This includes strategies to create reliable retirement income that you cannot outlive and a thoughtful approach to passing along assets to the people and institutions you love. We can work on an ongoing basis or provide specific quotes for any of your one-time planning or investment needs and we always offer an introductory meeting at no charge to allow you ask us anything that is on your mind and get to know us better.