Michael Maehl: Don’t start with numbers with planning retirement
Look first at latter-years lifestyle, then pencil it out
Michael MaehlApril 23rd, 2015
It’s been my experience over my career that people often will spend more time and effort planning for their annual two-week vacation than they will a 30-plus year retirement. My goal with this article is to help you consider parts of the proverbial bigger picture when it comes to laying out your successful approach.
To begin, and unlike most might suggest, you don’t start with numbers.
People always want to know, “What’s the number? How much do I need now to get me through retirement?”
It’s a fair question, but one that can’t be determined only with an analysis of your current investments. The reason for that is that you have to have a why before you get to the how many of what part.
What I mean is that you must think about what your retirement years mean to you prior to or during the creation, fine-tuning or updating of your investment strategy, not after. Try these self-questions to help get you started.
How do you feel about retirement? Is it the final curtain or the next phase? What will your social and physical lives be like? Are you wanting to become so low key and so relaxed that people mistake you for an organic lawn chair?
Or are you training for a 100-mile bike ride in Norway? Are you moving away or staying? Travel? Great. How often? Where? What method and for how long? New vehicles? And don’t forget that utilities, gas, food and insurance—all those kinds of various “stuff” that keep going up in price over time.
Retirement isn’t just a one-time thing. Needs and goals don’t stop at retirement. A major difference is, in most of our cases, no more regular income. So, let’s do our best with what we’ve got.
Most people I’ve talked with about retirement investing have thought of and treated their retirement savings as a one-size-fits-all ball ‘o bucks, not really focusing on how best to make their money work for them. By identifying specific goals first, and depending upon your needs and timing, you can invest to manage your overall risk and return better.
Throw out the old
Now that you’ve got a better handle on what’s on your retirement calendar, get rid of any formula using your age as a basis for how to allocate your retirement funds.
For example, if you use 100 minus your age, the difference is supposed to be the percentage that should go to stock, with the rest in bond-type issues. There are a couple really good reasons for not following this today.
Back in the 1980s, when we had 10-year U.S. Treasury Notes paying around 9 percent, maybe you could justify using these kinds of homespun formulas. With the current rate at about 1.9 percent, the math isn’t in your favor … and would take some time to become so.
The age-minus-100 rule seemed to work best when retirees could reasonably expect to earn 6 percent to 7 percent annually from their fixed-income investments. To potentially earn a higher rate of return today, most investors add stocks to their portfolio, especially the dividend-paying variety. Unfortunately, dividends aren’t guaranteed and the stock portion of any portfolio is subject to the risk of loss. This is a risk that some retirees may not be willing or able to take.
The reality is that many pre-retirees may not have set aside sufficient funds to retire in the lap of luxury. The good news is, in most cases, you won’t need to replace 100 percent of your pre-retirement income. A recent study conducted by Dimensional concluded that a hypothetical individual earning $75,000 just prior to retirement will typically need to replace 65 percent of that income, or $48,750, to sustain their pre-retirement lifestyle.
The assumed replacement rate varies with income. Someone earning over $100,000 would need to replace 50 percent of their pre-retirement income, and someone earning less than $50,000 would need to replace 80 percent. The reason replacement rates vary is due to the assumption that you will be spending less on taxes, less on savings, your kids will be moved out (hopefully), and your mortgage will be paid off (hopefully).
As far as where your retirement income will come from—again, this varies by income level. If you earned less than $50,000, a larger portion of your post-retirement income is typically derived from Social Security, followed by savings, 401(k), or even a part-time job. Higher earners—those making more than $100,000—will need to rely more on their personal savings and 401(k) to replacement pre-retirement income.
One of your biggest risks in retirement is the need to maintain your buying power over the entire period—and be sure to be thinking in terms of 30-plus years for that, please. Since bonds, by definition, can’t grow, one way to pursue a growth strategy has been to allocate a portion of your portfolio into a nicely diverse set of high-quality stocks or funds. Of course, with potential growth comes potential loss, so your financial adviser needs to take your needs, objectives and risk tolerance into consideration before recommending stocks.
For those not yet retired, keep loading up your 401(k), 403(b), and IRAs to the max you can each year. It’ll definitely help you moving toward your retirement goals. You may have to force yourself to continue to do it, even when you have financial challenges along the way or the markets drop and you consider not funding at all. There’s no way to really get back the earnings or principal if you do either of these. On the other hand, to not do either can prove expensive to the future you. You owe it to yourself to continue funding and ignore the market gyrations.
Pulling money out of any retirement-type plan before you’re 59 1/2 means that you’ll be hit with income tax and an additional 10 percent penalty on the amount withdrawn.
After 59 ½, money withdrawn from any retirement-type account is “only” taxed as ordinary income; no penalty. All withdrawals, penalized or not, are added to all your other annual taxable income for the year you took it out.
For the record, there are a few events that won’t trigger the 10 percent penalty. Those include unreimbursed medical expenses, a home purchase, college tuition, eviction, funerals, and some repair costs. Please consult a qualified tax professional regarding any premature withdrawals.
Be sure to do your retirement planning before anything else … yes, even vacation planning. You can always take out a loan for college, home repairs and many other events, but I sure don’t know of any lending institution that’ll let you take out a loan to fund your retirement.
Michael Maehl is an independent 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 or