After working – and diligently saving – for decades, retirement is finally here. And with it, the opportunity to travel more, to spend more time on your hobbies, to spoil your grandchildren, or perhaps to volunteer more time to causes important to you.
If you’re like many new retirees, though, you may feel a bit of uncertainty about the transition from working career to retirement. You may be asking yourself, “Have I saved enough for retirement?” Or, “How should I invest once I’m retired?” Or, “What risks can affect my retirement plans?” These concerns are normal, and over the years the Springwater team has been helping clients plan for retirement, we’ve heard them often. It’s natural to wonder – or even worry a bit – whether you’ve planned for everything.
So, let’s review four keys to a secure retirement.
1 | Align Your Income and Expenses
A foundation of every good retirement plan is a cashflow projection, or budget. Well before your retirement date arrives, you should have a clear idea of what you plan to spend on your core living expenses, as well as on variable or one-time expenditures.
Your core living expenses are the costs that you’re likely to incur every year in retirement. These would include spending on housing – like rent or a mortgage payment (if you still have a mortgage), utilities, various types of insurance, food and clothing, and so on. If you’ve not yet done so, track these expenses for a few months and then extrapolate them to a full year.
In addition to your core living expenses, you’ll spend money on periodic or one-time purchases. These outlays would include periodic home maintenance, replacing your car(s) when they’re ready, travel, and charitable giving, to name just a few. Start by estimating when you’ll incur these expenses, and where possible attach a price tag to them. For example, you might plan to spend money on travel every year, on new cars once a decade, and on a new deck or roof for your home just once.
Once you’ve built a clear picture of your fixed and variable expenses, you should turn to calculating your income sources in retirement.
Most of us will be able to claim a Social Security benefit in retirement, and those that can’t will probably be entitled to a defined benefit pension that’s at least as attractive. Social Security is an incredible program, in that it provides you with a guaranteed, inflation-adjusted stream of income that you can’t outlive. If you calculated the present value of your projected Social Security benefit, you’d be amazed at the value.
For most of us, Social Security will replace only about 30-40% of our pre-retirement income. So, you’ll need other sources of income in retirement to ensure that you’re able to cover your projected expenses.
You may be one of the lucky people who’s entitled to receive a defined benefit pension at retirement, in addition to Social Security. Most likely, though, you’re not, and so you’ll need to have saved during your working years, with the goal of converting those savings into retirement income when you stop working. More on how much of your savings you can safely withdraw each year below.
The goal, of course, is to have your projected income in retirement exceed your expenses. If it does, you’ve put yourself in position for a comfortable retirement. If it doesn’t, you’ll need to look at ways to reduce your expenses.
After you’ve aligned your income and expenses, you should review your portfolio’s investment mix, or asset allocation, to ensure that it’s appropriate for your plan.
2 | Get Your Asset Allocation Right
Let’s say that you’ve decided to retire at age 65, and that you’ve managed to save $1 million for retirement across your various plans and accounts. How much can you safely withdraw from your portfolio, to supplement your Social Security benefit and possible pension income, and not have to worry about depleting your savings too soon?
There are a number of very important factors that play into the answer to this question. They include how long you plan to live, the investment rate of return on your portfolio, and the future inflation rate. Here, we’ll focus on the impact of your asset allocation on the answer.
At Springwater, we often say to our clients that they “should take no more investment risk than is necessary to make [their] plan work”. Why? Because when someone looks back on their life, they’re unlikely to say, “I’m so glad I got a 6.5% return on my portfolio.” But they are likely to appreciate the fact that they lived a happy and fulfilling life, and that they were able to do all the things they’d wanted to.
So, you should create an investment mix for your portfolio that’s likely to produce a return sufficient to allow the withdrawals you’ll need for the goals you’ve defined.
Let’s look again at our example, where you’ve saved $1 million by age 65. Let’s also assume that you plan to live another 30 years, to age 95. Finally, let’s say that you want to withdraw $40,000 from your portfolio in your first year of retirement, and that you plan to increase that amount each year in the future, to keep up with inflation. Is this a realistic plan? Can you safely start off withdrawing 4% of your $1 million, and not run out of money before age 95?
Historically, a 4% withdrawal rate would have been considered fairly safe, with a few caveats. One of the most important caveats is that your portfolio would need to maintain a meaningful exposure to stocks. Meaningful here means somewhere in the range of 50-60% or so.
Today, the answer isn’t so clear. One reason why is that returns on fixed income investments (like cash, CDs and bonds) are at or near historical lows. This means that some percentage of your portfolio will generate a negligible return. In the past, you could have expected a return of 3-5% or more on your fixed income. So, while owning bonds and cash still help reduce your portfolio’s overall risk level, they don’t currently produce much return.
Note also that increasing your allocation to stocks, say from 50% to 80% or more, doesn’t automatically increase your “safe withdrawal rate.” This is because of something known as “sequence of returns” risk. The higher your allocation to stocks, the more volatile your portfolio’s returns from year to year. And if you get very bad returns early in retirement, your portfolio’s value may decline so far that it doesn’t recover.
Most financial advisors have sophisticated software that they can use to help you determine a “safe withdrawal rate” for your portfolio, given the asset allocation that’s appropriate for you.
3 | Hedge Against Big Risks
To paraphrase the poet Robert Burns, the best laid plans can go awry. Even if you’ve accurately calculated your retirement income and expenses, and you’ve got the right asset allocation in place to generate the additional income you’ll need, there are still risks that could jeopardize your plan. Let’s review a few of the biggest risks to your secure retirement.
Longevity
By and large, we’re living longer than ever before. And if you live a healthy lifestyle, the odds are that you’ll live beyond your actuarial life expectancy.
That means that your savings will need to last longer, perhaps decades longer, than you planned for. How can you hedge against the risk of living longer than you originally planned?
First, remember that Social Security includes a cost of living adjustment, or COLA. The Social Security COLA is updated every year, and it’s intended to ensure that recipients’ benefits more or less keep up with inflation.
If you think it’s likely that you’ll live longer than your actuarial life expectancy, you should strongly consider delaying your Social Security benefit beyond your Full Retirement Age, and possibly as long as to age 70. Your Social Security benefit goes up by 8% each year you wait to claim it after your Full Retirement Age. This means that your benefit at 70 is 24% higher than at age 67. Of course, if you retire before claiming your Social Security benefit, you’ll need resources to live from before you claim your delayed benefit.
Defined benefit pensions are another great hedge against longevity, because most offer you a “lifetime” benefit option at retirement. Not all defined benefit pensions offer a COLA to keep up with inflation, though, so if you have one you should clarify whether it does.
You can also look into converting some of your accumulated retirement savings into a lifetime stream of income, via an annuity. Research has shown that annuities can make a retirement plan stronger, particularly if longevity is a concern.
Needing Care
While we’re generally living longer, we’re not necessarily experiencing a high quality of life in those later years. This is particularly true for people who have a family history of needing care later in life, at home or in a facility.
In 2020, the cost of in-home care in Portland, Oregon was about $4,500 per month, and the cost of a semi-private room in a nursing home was about $7,800 per month. For Santa Cruz, California, these figures were $6,300 and $9,200 per month, respectively. In addition, these costs have been rising much faster than the overall rate of inflation for many years.
Assuming you don’t have the resources available to pay for 24-36 months or more of care without jeopardizing the strength of your retirement plan, we’ve found there are two good ways to hedge against the risk of needing care. They are long-term care insurance and a reverse mortgage.
Long-term care insurance helps pay for the care you need when you’re unable to perform so-called activities of daily living. The long-term care insurance landscape has changed considerably over the past several years, and today’s policies are different than those written in the 1990s and 2000s. You can find some very helpful information about long-term care insurance here.
Some people think that their risk of needing care is so small, or the period that they’ll need it so short, that it doesn’t make sense to buy LTC insurance. For them, a reverse mortgage can be a solution to access funds for care, without drawing down on their retirement savings. To learn more about how reverse mortgages work, and how you can use one to hedge against the risk of needing care later in life, watch this informative conversation.
Inflation
If you’ve been paying attention to the financial media lately, the topic du jour is inflation. After hovering between 0% and 1% for the better part of a decade, inflation has finally started to pick up. A strong economic recovery after the Coronavirus pandemic and unprecedented government spending to support the economy have meant that prices are rising faster than they have in some time.
Some inflation is good for an economy; in fact, most economists and central bankers worry much more about deflation than mild inflation. But inflation, generally speaking, erodes the purchasing power of your income and savings. How can you hedge against the possibility of inflation impacting your retirement plan?
First, remember that your Social Security benefit has a cost of living adjustment. So while some retirees do find that their Social Security COLA doesn’t fully reflect the price increases they see on a daily basis, your benefit will be adjusted.
Also, you can buy US government bonds that offer a return that’s adjusted for inflation. These include Treasury Inflation Protected Securities, or TIPS, and Series I bonds. You can compare TIPS and Series I bonds on the TreasuryDirect website.
Probably the easiest and most cost-effective way to ensure your retirement income keeps up with inflation is to ensure that you’ve allocated enough of your portfolio to stocks so that you can safely increase your withdrawals. This means properly diversifying your portfolio within and across a broad range of asset classes, and maintaining a meaningful exposure to stocks. Keeping the bulk of your investments in bonds and cash, and planning to “live off the interest and dividends”, simply won’t work in today’s investment environment.
4 | Estate Planning
An important part of planning for a secure and comfortable retirement is estate planning. An estate plan is a comprehensive set of documents that include a will, an advance health care directive, a durable power of attorney, and, possibly, a revocable living trust.
Your will and your trust make clear your wishes for the distribution of your assets after you pass away. Your health directive and power of attorney allow you to appoint someone to make health- and finance-related decisions on your behalf, if you’re unable to.
While there are most certainly financial aspects to (not) having your estate plan in place, it’s arguably more about the peace of mind that the documents provide. And peace of mind is a hugely important part of a comfortable and secure retirement.
Looking for Guidance?
If you need help planning and investing for a secure and comfortable retirement, consider working with a Certified Financial Planner™ (CFP®). Advisors who hold this designation have met rigorous educational, experience and ethics requirements.
If you’re looking for help with your retirement plan, contact us today to see how our team at Springwater Wealth can help you.