Spokane Journal of Business

Income-to-asset ratio can guide retirement timing

Cost of living expected to double in 24 years of being in retirement

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Whether you’re already retired or it’s moving closer to reality for you, there are some things you should consider when managing your investments.

Up until retirement, you simply accumulate assets. You get paid and a portion goes to your retirement plan. When employment income stops and retirement is a reality, you need to be prepared as best you can.

And yet, according to the American Association of Actuaries, about 80% of folks not yet retired have expressed anxiety that their assets may not provide the income they need to last through their retirement. Further, on a relative basis, Social Security isn’t providing as much income replacement as in the past. And, of course, there’s inflation to consider. Even if you use the 3% U.S. average annual inflation rate going back to 1926, this means your overall costs will double in 24 years.

As that eminent sage, as Mr. Yogi Berra put it, “If you don’t know where you’re going, you might not get there.” In other words, you need to know where you are and what you have now so that you can allocate your assets to your best benefit.

Those include knowing how many assets you have available for retirement. How will you generate enough income from those assets to help support your living expenses? Have you considered that your assets need to cover a long life, or lives, as in a 20- to 30-year average after you retire? Most people wildly underestimate both their own longevity as well as the spiraling cost of their care in the last decade of life.

Knowing which assets are reliable, meaning they will continue to provide income over your life, is a key. These include your Social Security, any pensions, and some annuities.

We know that the cost of living has gone up in just about every year of our lives. Indeed, the Consumer Price Index has been compounding at around 3% for the last century. Were it to continue to do that during our three decades of retirement, we could expect to see our living costs go up very nearly 2 1/2 times.

Due to inflation, a purely fixed-income investment strategy—focusing as it does on preventing your principal from fluctuating—may leave you seriously exposed to the long-term erosion of your purchasing power. Put simply, a fixed-income strategy may not sustain us through a long-retired life of rising living costs.

It’s equally as important to determine those average annual living expenses. Determine the must haves—mortgage and real estate taxes, medical/Medicare, utilities, food, and car payments, insurance, and gas—plus some amount for discretionary expenses. Divide that total by 12 and you’ve got a good idea what you need to keep everything flowing.

Now, add up your investable assets, retirement assets, and personal assets, plus any pension, rental, or royalty income. Don’t include your residence value as it’s nonliquid and generally not included in these calculations. Do include your Social Security payments—actual or anticipated. Now you can start focusing on what to do to help you manage your way to the life you want in retirement.

Further, using annuities can help mitigate some market risk over time, as well as providing steady, predictable income sources over your life and, if applicable, to that of your spouse as well.

There is a math formula to help you see how you’re tracking. It’s called the income-to-asset ratio. Add your total expenses. Next, subtract your Social Security income. What’s left is the income needed from your assets to cover those expenses, that is, the withdrawal rate. Now, divide the amount of income you need by the current value of your portfolio.

For folks between 55 and 64, an income-to-asset ratio of 3.5% to 4.5% is a good range. For those 65 to 74, the ratio goes to 4% to 5.5%. And for those even closer to maturity, as in 75-plus, that number is between 5% to 6.5%.

Two things need to be considered once you’ve got your answer. First, with your asset base as-is, how long can it support you? What amount of average annual growth do you need to, at least, maintain your coverage? Next, if the numbers aren’t favorable, what can you do? Cut expenses? Take less income from your assets? Part-time employment? Win the lottery?

You still must deal with the future potential for rising interest and inflation rates, as well as markets that may not perform as you’d like for a while. 

Having a solid asset allocation strategy that you stay with can go a long way to helping you deal with these challenges. What you might consider doing in case your retirement reality undershoots historical probability can include:

•Postponing retirement for a year, or two, or three, because you think you may be cutting it too close.

•Scaling back planned spending for the first couple of years of retirement, until you get some real-world experience of it.

•Starting with a couple of years’ living expenses in a money market fund, to be used in case of market setbacks early in retirement.

Managing your investments is only part of “retirement.” For example, in addition to determining what’s most important to you, where you live and who you spend time with are essential considerations. 

What are the laws in your new location about estate tax and taxes on retirement earnings? Is it a community property state? Is there a state income tax?

Another major point—and usually your highest expenses later in life—is covering unexpected medical costs. Do you have a Medigap plan of some sort? Have you investigated long-term care? In addition to the traditional long-term care policies, several annuities are now available specifically to help you have money for your care.

If you’re in a position to leave a legacy, first thing is to have a will in place. If you haven’t reviewed yours in the last 10 years, it may be helpful to revisit it to ensure you have things going where and how you’d like them to. If you’ve remarried since your will was created, be sure to check your beneficiaries—both in the will and your retirement plans.

Many people aren’t aware that beneficiaries designated in an insurance contract, annuity, or retirement plans have precedence over whomever you place in your will.

You also can consider planning for outright gifts today. You can establish trusts that will take the assets out of your estate. You can set up donor-advised funds to allow you both a deduction and control over who gets what and when.

The late George Burns, in his book “Living It Up”, wrote, “I don’t believe anybody should retire, no matter what his or her age is.” 

If you believe that, then just consider the ideas expressed here as nice to know.

If you’re retired, or plan to be, then I trust you shall benefit from them.

  • Michael Maehl

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