Will your 401k and Social Security benefits be enough to live your ideal retirement?
For some it may, while for others it may be a disappointment in their golden years not having enough saved.
Whether you are retiring early in your 50’s or late 60’s, everyone needs a retirement income plan.
How are you going to re-create your paychecks once you stop working? Where is income going to come from? How do you make sure you will have enough?
In this article I am going to address the common dangers of retirement income planning and why a competent professional advisor brings tremendous value in making sure you do not run out of money.
- What is a Retirement Income Plan?
- No Plan = Problems
- Factors to Consider
1. What is a Retirement Income Plan?
Retirement income planning is defined as how a retiree carefully plans to re-create their paycheck by utilizing current investment assets and wisely selecting when to turn on Social Security benefits, pension and annuity payouts, ultimately making sure their hard-earned money does not run out.
A simple way to envision retirement planning is the analogy of hiking a mountain. Any hiker will admit that it’s not the climb that is the most difficult, rather the way down from the top that proves most challenging.
Your climb up the mountain can be looked at as the working years as you accumulate savings with the goal of reaching the top of the mountain, retirement. The journey however does not stop at the summit. Anyone can quit working and retire. The question is can you stay retired with the funds you saved up? The path down the mountain is where retirement income planning begins.
Descending the mountain requires you to cautiously watch your steps to avoid hurting yourself, conserve your water and most importantly find the safest path to the bottom.
On your journey down, more important than ever is strategizing when to withdraw from each retirement account along with prudent decisions on social security benefits, pensions and satisfying the annual required minimum distributions (RMDs) the IRS requires you to take from IRAs, 401ks, 403bs, etc.
Using a mountain guide or CFP practitioner can serve as a valuable resource for you to get down the mountain safely in one piece.
Similar to if you are not a lawyer you most likely wouldn’t represent yourself in legal matters or if you are not a medical professional you wouldn’t treat your own medical problems. Why try to plan for your retirement alone? Consult with a professional that has done it countless times.
A competent tour guide or advisor can demonstrate their expertise to you by avoiding accidents and missteps on the way down.
Common pitfalls include withdrawing too large a percentage from your portfolio, lack of portfolio diversification to hedge your market risk and no RMD planning with IRAs, 401ks, etc.
2. No Plan = Problems
Can you wing it and be okay?
Is it worth the risk?
You only get to plan for your retirement once. There are no do-overs unless you want to go back to work in your 70’s.
Whatever the size of your nest egg, retirement will likely mean very big changes in your financial life. The paychecks stop but the bills keep going and may likely increase (ex. Medicare Part B premiums, low COLA adjustments to SS benefits, etc.).
To start, consider how your financial priorities will change in your life as you age. In your 40’s you may be saving for retirement and funding your children’s college tuition expenses. In your 50’s there’s a chance you are taking care of your parents and their medical needs. Babysitting grandchildren may be part of your weekly routine.
What do all these changes mean?
Your cash flow constantly changes.
If retired, you won’t be contributing into your 401k anymore, losing the tax deduction. If your house is fully paid off, you may not have the mortgage interest to deduct as well.
Most importantly, you won’t be at work Monday-Friday earning an income. Chances are if you are not making money you are most likely spending it.
In retirement every single day is a Saturday. Think about it.
With this new lifestyle comes an initial increase in spending until you get used to the retiree daily routine.
In addition, many retirees fail to understand a key retirement risk called Sequence of Returns Risk. This is the risk of withdrawing money from your retirement accounts during a negative or down stock market.
Historically, every 8-10 years the stock market eventually goes down (ex. 2000-2002, 2008). It is almost a certainty during those 30-40 years a retiree will encounter multiple down markets.
Example – It is 2007 and you have $1,000,000 in your 401k. The plan is to withdraw 4% ($40,000) per year to live off of from this account. The next year, 2008 happens and the stock market loses nearly 40%. Assuming your $1,000,000 was invested in the market it is now worth $600,000. Your 4% withdrawal off this smaller balance is now $24,000 instead of $40,000. A pay cut of $16,000 in retirement. This is Sequence of Returns Risk.
A retirement income plan would properly diversify the 401k portfolio, possibly insert accounts protected from the market and put together a withdrawal plan from each account to satisfy the annual RMD (required minimum distribution).
When we sit down with clients to discuss income planning we typically ask:
- Is the income you need before or after taxes?
- How much in guaranteed income sources do you have? (pensions, social security, annuities, etc.) What are you doing to fill the income gap?
- How do you invest your money to last for the next 30-40 years?
These are just a few questions you need to consider. If you have an advisor and are unable to get answers to these questions, I would question the value that advisor provides to you.
A common misconception people have is that they will not live very long and therefore do not need to plan.
However, what if you do in fact live until say 100 years old? Are you financially ready? Would your family take care of you as they are starting their own lives and families?
All these scenarios and more can be discussed with a professional CFP to properly put together a game plan of what you need to do month by month, year by year in order to live that ideal lifestyle.
3. Factors to Consider
I find most retirees have these three common goals.
- How to make my money last in retirement?
- How do I protect my principal or current nest egg?
- How do I minimize taxes as legally possible?
In working with clients our team develops a personalized retirement income plan that addresses all three of these common goals.
Retirees find a sense of relief by having a written plan that outlines where they are today and what they need to proactively to get by in retirement and not have to worry.
Having no plan is planning to fail. It’s that simple.
The nuts and bolts of the retirement plan we construct consists of a list of current accounts and their performance in real-time, what the target return is for each account and what order to withdraw from accounts in regards to RMDs, taxes and inflation all baked in.
Another valuable tool for clients is the Monte Carlo simulation which stress tests your portfolio to see what impact a negative stock market like 2008 can have on your retirement income planning.
Just like diversifying a portfolio of different stocks, varying the types of retirement accounts is most effective to protect a retiree from the stock market, inflation risk and outliving their money.
A plan is useless if not periodically reviewed. We typically review with clients twice a year in order to make adjustments and take proper action if life changing events occur.
Liquidity is a key component of every income plan. In other words, making sure people have access to their money when they need it most helps with unexpected expenses that everyone encounters from time to time.
Protecting yourself from unnecessary risk in the stock market is crucial in retirement. We work with people by giving them a second opinion on how they are invested and provide objective feedback on what may be better for them and their specific situation.
In conclusion, what is there to lose in getting an expert second opinion? From investments to social security and health care planning to taxes and withdrawals, there are just too many variables to consider in retirement. Chances are if you are not thinking of all the different factors you will get blind-sided by one of them.
Consult with a Certified Financial Planner, the PhD equivalent in retirement planning. As an independent CFP that is legally obligated to act as a fiduciary for your best interests, I can give you that much needed second opinion through a no-cost review. Contact me below.
The above article is informational in nature only. Individuals should always consult with their tax advisor regarding their personal tax situation.