Figuring out a few things early in retirement planning
Determining total cost of post-work life is first step
Michael MaehlSeptember 22nd, 2016
Before getting too deeply into your retirement planning, you need to have a few things figured out.
You should have some good idea as to how you want to live, where you want to live, and what activities will be part of your life. Knowing these, you may now be able to determine how much it will actually cost to be retired.
According to a survey conducted last January of more than 2,000 adults on behalf of Franklin Templeton Funds, the top retirement concern across the spectrum was income.
More than half of those surveyed were concerned about being able to successfully manage their retirement assets, and about 30 percent said their top retirement concern is—or will be—running out of money.
This result isn’t new news. What it does reveal is the widespread apprehension that’s out there about retiring. Related to that is the issue of just how long will we actually spend in retirement.
The wonder of modern medicine is that our collective chance to enjoy a long life has been greatly increased in a relatively short time. In 1900, the average life expectancy for both sexes was 47. By 1950, it had increased all the way up to 68. As of 2010, the average life expectancy is more than 78, according to the U.S. Centers for Disease Control’s 2011 life-expectancy tables.
While that’s great, what can you do to help ensure that you don’t fit into that 30 percent group worried about their money? Let’s consider that.
For those folks who today are 80 and older, 70 percent of their income comes from Social Security benefits. For those who qualify for those benefits, it’s important to understand that, in addition to your past work income history, the other biggest factor in determining your monthly payout is the age at which you file.
When it comes to Social Security, the key term is full retirement age. At that age, you can file and receive the full benefit to which you’re entitled. For those born between 1943 through 1954, that age is 66. If you’re born between 1955 and 1959, that age increases by two months per year. For folks born in 1960, or later, that FRA is 67.
The good and bad news about Social Security payments is that, except for any future cost of living adjustments, your monthly amount is fixed. You can begin payments as early as age 62. However, your benefit amount will be much less than the amount you’d receive by waiting until full retirement age. It does increase incrementally each year up to your FRA. Claim early, at 62, and receive less each month, but for many more months. Claim later, at 70, and get a higher benefit, but for less time. There is no wrong time to file. Just remember, you only get one chance to decide.
I see no real threat to the continued ability for us to receive these payments. Social Security’s accounting shows the agency will continue to collect more than it pays out for the next few years. Then, it will still have its trust fund—kind of its own savings account—to draw from until 2034. After that, it will be taking in less than it pays out, but will still be able to fund 79 percent of benefits, at current levels. I believe the ages for full retirement age will be raised in the future simply because we’re living longer.
With your personal savings and various types of retirement plans, we know that future values tend not to be as predictable. However, it’s here that you can allocate your holdings such that you have the opportunity to provide additional income.
Here are some general thoughts and guidelines for you to consider. Understand that your own risk tolerance, needs, and goals will help you decide how best to set up your holdings. Or you can use a trusted adviser to help you do so.
Pensions: Pensions are fewer in number in today’s world. Nonetheless, they can be a great assist to your strategy as they too are fixed in the amount you receive over your life. The bad news is that, if you have a spouse, and unless you opt for a joint life payout, whatever the amount you receive will end when you do. If you select the joint life, depending on the provider, the benefit to your spouse can be less than your amount or remain the same. I suggest you look into that before committing to a payout schedule.
Savings: The best solution here is to save as much as you can while you’re working—whether in savings, per se, or into other investment assets. The bigger your pool, the less quickly you’ll have to drain it.
Even in retirement, it’s best to keep three to six months of living expenses readily available in savings, money markets, and the like so you wouldn’t have to sell anything, or as much, to meet a near-term need for cash.
Retirement plan assets: Traditional IRAs, 401(k)s and 403(b)s are the same in that the assets you have in them grow tax-deferred. That means that, until and unless you take anything out, there is no income tax due on growth, dividends, or interest. However, whenever you do make any withdrawals, the amount taken out is added to your taxable income in the year you do so.
A Roth IRA—or a 401(k) with a Roth component—is different in that you make or made after-tax contributions to them. Therefore, you can withdraw your contributions any time without additional tax. And, if that account has been alive for five years or more, the earnings are considered to have grown 100 percent free of federal income tax.
Regardless of the taxation, how can you manage your assets to meet your needs?
To begin, be sure to include a factor for inflation in your homework. If you overlook that, you may find yourself being pressed to meet your needs over time. At Opus, we use a 3 percent annual cost-of-living increase when we project cash flows.
Next, consider the so-called 4 percent rule. That is a rule of thumb used to determine the amount of funds to be withdrawn from a retirement account each year.
Now, look at your total balance of assets. Assume a certain annual appreciation rate for your assets allocated to retirement. Allow for tax and inflation. Look at the result and multiply it by that 4 percent. If that number meets your annual expenses, you’ll likely be in pretty good shape. If the answer is much less than your needs, then you need to consider changing or amending things such as savings rate, portfolio mix, and lifestyle.
In most instances, in order to meet these longer-term needs, you’ll have to accept some degree of increased risk to achieve them. While it’s best to not accept any more market risk than is necessary to meet your goals, the majority of retirement-oriented assets need to include some growth-oriented investments such as stocks.
While all prices can fluctuate, whether stock or bond, stocks tend to do so to a greater extent. However, inasmuch as this retirement portfolio is designed to provide you with funds over a long period, your stock component can provide you an inflation hedge while the bond and related investment portion can provide current cash flow.
Do not just focus upon current returns, or yields, when arranging your holdings. Higher or fixed income issues tend to have little growth potential. Stocks can provide some current income from dividends, as well as offering you the chance for growth.
Whether bull market or bear market or one that seems not to change, a well-allocated quality portfolio of your entire retirement asset base will do much to provide you the potential to enjoy the long retirement that you’ve worked so hard for.
Michael Maehl is a financial adviser and Spokane-based senior vice president of Opus 111 Group LLC, a Seattle-based financial services company. He can be reached at 509.747.3323. Securities and Investment Advisory Services offered through KMS Financial Services, Inc.