For all but the wealthiest retirees, ensuring that your savings and investments will last long enough is important. So determining whether you\u2019ll be able to maintain your desired lifestyle and level of spending is essential to a secure, comfortable retirement.<\/p>\n
Let\u2019s look at how you can develop a solid income plan for your retirement, and then make sure the plan is more or less bullet-proof.<\/p>\n
The first place to start in understanding your income needs in retirement is with your core living expenses. These are the costs that you\u2019ll incur year-in, year-out, with little or no variability over time. They include your rent or mortgage (if you have one), property taxes (if you own your home), insurance, utilities, food and dining expenses, clothing and personal care expenses, and so on. The easiest way to calculate your core living expenses is to track what you spend on these essentials for a few months.<\/p>\n
In addition to your core living expenses, you\u2019ll want to estimate what your healthcare expenses will be in retirement. This figure can vary significantly, depending on your health history, and whether you require services not covered by Medicare.<\/p>\n
Medicare provides health insurance for those 65 and over. As you probably know, Medicare Part A covers inpatient hospital stays, care in a skilled nursing facility, hospice care, and some home health care, while Medicare Part B covers certain doctors’ services, outpatient care, medical supplies, and preventive services, and Medicare Part D helps cover the cost of prescription drugs.<\/p>\n
While Medicare covers most of your healthcare needs, it isn\u2019t comprehensive coverage. Medicare doesn\u2019t cover expenses like long-term care, most dental care, eye exams, cosmetic surgery, hearing aids, and more. So, if you\u2019ll need services that Medicare doesn’t cover, you’ll have to pay for them yourself unless you have other insurance that covers them.<\/p>\n
Over the past several decades, healthcare costs have been rising faster than the overall rate of inflation. For this reason, in our clients\u2019 financial plans Springwater inflates health care costs at a different rate than core living expenses.<\/p>\n
Your core living expenses and healthcare costs are, of course, just your baseline spending. Naturally, there will be lots of other things that you\u2019d like or need to spend money on in retirement. These other financial goals can include travel and vacations, periodically replacing your cars, necessary home maintenance, charitable giving, weddings for your kids, college for your grandkids, and so on.<\/p>\n
A robust financial plan will prioritize these goals, attach \u201cprice tags\u201d to them, and also try to identify when you\u2019re likely to incur the expenses. Retirement travel, for example, might be an annual expense, while you might only plan to replace your cars every seven to ten years.<\/p>\n
Figuring out what you\u2019re likely to spend in retirement is only part of the picture. You also need to know what your sources of income in retirement will be.<\/p>\n
Social Security<\/strong> Defined Benefit Pension<\/strong> Taking Withdrawals from Your Investments<\/strong> While it\u2019s a clich\u00e9 to say \u201csave early, save often\u201d, we have yet to meet a client who regrets saving too much for their retirement. So, it makes sense to accumulate as much as possible over your working career to provide income in retirement.<\/p>\n Income Distribution Planning<\/strong> Income distribution planning<\/strong><\/a> is the process of determining from year to year the most tax-efficient way to withdraw from these different accounts the income you\u2019ll need. By working with your CPA and financial advisor to optimize your withdrawal strategy and reduce your overall tax burden, you can \u201cextend the life\u201d of your portfolio.<\/p>\n Let\u2019s assume that you\u2019ve determined you\u2019ll need, say, $100,000 in income each year in retirement. And let\u2019s assume that Social Security for you and your partner will provide $50,000 per year. With no defined benefit pension income, that means that your portfolio will need to generate the shortfall of $50,000 per year. If you\u2019ve accumulated $1,000,000 across your investment and retirement accounts, is that sustainable? In other words, can you safely withdraw $50,000 from your portfolio in your first year of retirement, increase that amount each year to keep up with inflation and not lose purchasing power, and not have to worry about running out of money?<\/p>\n Over the past several decades, academics, economists and financial professionals have produced reams of research on this topic: a \u201csafe\u201d withdrawal rate<\/strong><\/a>.<\/p>\n The first studies indicated that an initial safe withdrawal rate was about 4%. In other words, using the example above, you could have withdrawn $40,000 in your first year of retirement (not $50,000, though), adjusted the amount each year for inflation, and been fairly confident that you could sustain this spending for 30+ years. Importantly, those studies assumed a reasonable exposure to stocks in the hypothetical portfolio \u2013 you can\u2019t just hold low-risk cash and government bonds.<\/p>\n More recent academic research has suggested that a safe withdrawal rate may be both higher and lower than 4%. A higher withdrawal rate is supported by the ability to invest in higher-returning assets classes (like small cap, value and emerging markets stocks) that weren\u2019t part of the initial studies. A lower withdrawal rate is supported by the fact that the returns on bonds are much lower than they\u2019ve been historically, and retirees are living longer than ever before (meaning that a 30-year horizon isn\u2019t long enough).<\/p>\n Once you\u2019ve determined what you\u2019d like \u2013 and need \u2013 to spend in retirement, and you\u2019ve hopefully concluded that your withdrawal rate from your savings and investments is sustainable, it\u2019s important to \u201cstress test\u201d your assumptions. This involves assessing whether your spending plan can withstand changes to one or more of your most important assumptions.<\/p>\n Life expectancy<\/strong> Have you estimated your life expectancy?<\/p>\n Inflation<\/strong> Have you measured your investment risk capacity and tolerance?<\/p>\n Taxes<\/strong> Can your spending plan for retirement hold up in a higher-tax environment?<\/p>\n Investment returns<\/strong> Have you checked whether your future return expectations are realistic?<\/p>\n Variability of returns<\/strong> Then, at the same time you\u2019ve made the switch, the value of your accounts from which you\u2019re taking distributions falls by 30%, 40% or even more. It\u2019s like a portfolio \u201cdeath spiral\u201d \u2013 taking money out of a portfolio that\u2019s falling in value. <\/p>\n Huge market drops are always painful, but they\u2019re less impactful on your retirement plan if they occur later in life. One strategy for mitigating this risk is to have a reverse mortgage or other credit line in place when you retire. Then, if the stock market plummets early on, you can draw on the borrowing line for income, allow the investments in your portfolio to recover in value, and avoid a portfolio death spiral. <\/p>\n Have you assessed whether your retirement plan can recover from a 2008-09-like shock?<\/p>\n As you can hopefully see, figuring out how much you can comfortably spend in retirement is a multi-faceted exercise. And once you\u2019ve made your calculation, you\u2019ll want to \u201cstress test\u201d your retirement income plan to make sure it can withstand a variety of challenges.<\/p>\n If you’re looking for help with planning for retirement, consider working with a Certified Financial Planner<\/strong><\/a>\u2122 (CFP\u00ae), Certified Public Accountant<\/strong><\/a> (CPA), a Chartered Financial Consultant\u00ae (ChFC\u00ae) or an RICP (Retirement Income Certified Professional\u00ae). Advisors who hold these designations have met rigorous educational, experience and ethics requirements.<\/p>\n <\/p>\n","protected":false},"excerpt":{"rendered":" For all but the wealthiest retirees, ensuring that your savings and investments will last long enough is important. So determining whether you\u2019ll be able to maintain your desired lifestyle and level of spending is essential to a secure, comfortable retirement. Let\u2019s look at how you can develop a solid income plan for your retirement, and […]<\/p>\n","protected":false},"author":2,"featured_media":6476,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","_mi_skip_tracking":false,"footnotes":""},"categories":[3,5,152,11],"tags":[66,70,86,107,117,118,132,140],"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/6467"}],"collection":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/comments?post=6467"}],"version-history":[{"count":0,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/6467\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media\/6476"}],"wp:attachment":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media?parent=6467"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/categories?post=6467"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/tags?post=6467"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
\nMost Americans will be entitled to receive a Social Security benefit when they\u2019re retired. Social Security is a really unique program, in that it provides a government-guaranteed stream of income that you can\u2019t outlive. Depending on how long you\u2019re likely to live, it may make sense for you to delay claiming your Social Security benefit<\/strong><\/a> beyond your \u201cfull retirement age\u201d, because for every year you do so up to age 70, your benefit increases by 8%.<\/p>\n
\nSome retirees are also entitled to receive a defined benefit pension, though the percentage of Americans so fortunate has been steadily declining for several decades. In simple terms, a defined benefit pension typically pays you a percentage of your last earned salary, calculated with a basic formula. For example, your benefit might be calculated as \u201c2% times years of service, times final annual salary\u201d. So, if you worked for 30 years and your final salary was $100,000, your pension would be calculated as: 2% x 30 x $100,000, or $60,000 per year. Defined benefit pensions are often, but not always, adjusted for inflation. If you\u2019re married, most defined benefit pensions will offer you the option to receive a lower benefit in exchange for extending the payment stream over the longest of your two lives.<\/p>\n
\nFor the vast majority of retirees, Social Security won\u2019t provide enough income to cover all of their retirement spending. And most Americans can\u2019t count on a defined benefit pension plan to provide an additional income stream. For these reasons, personal saving for retirement is a must. US employers sponsor a variety of tax-deferred retirement programs, including 401(k), 403(b), 457 and 401(a) plans. The benefits and features of these plans go beyond the scope of this review, but you can read more here<\/strong><\/a>.<\/p>\n
\nIf you\u2019re like most of our clients, you\u2019ll have accumulated savings and investments for retirement in a few different types of accounts: a tax-deferred account like a 401(k), a taxable account like a brokerage account, and perhaps a Roth retirement account.<\/p>\nWhat\u2019s a Safe Withdrawal Rate?<\/strong><\/h2>\n
What Factors Can Affect My Spending?<\/strong><\/h2>\n
\nIf you end up living longer than your plan assumes, you\u2019ll need more resources to provide income. One way to address this longevity risk is with an income annuity<\/strong><\/a>. You can purchase an annuity from a highly-rated insurance company, and opt to receive an income stream for life. Guaranteed income \u2013 like that from Social Security, a defined benefit pension, or an income annuity \u2013 makes retirement plans stronger. <\/p>\n
\nInflation is simply a measure of how quickly the prices of goods and services are rising over time. All other things being equal, if prices are rising, your money loses purchasing power over time. So, if inflation is higher than expected, your portfolio will need to grow more quickly to keep up, or you\u2019ll effectively end up with less income to spend over time. It\u2019s important, though, that you\u2019re comfortable with the investment risk that comes with the asset allocation you choose. A robust risk tolerance assessment<\/strong><\/a> can help you evaluate your capacity and tolerance for investment risk. <\/p>\n
\nMost economists and financial professionals would agree that tax rates will eventually need to be increased in America. The country has run chronic annual budget deficits for decades, and the cumulative national debt is now about $27 trillion. If state and federal income tax rates go up, it means that your retirement account withdrawals may be taxed more heavily, and you\u2019ll have fewer net dollars to spend. <\/p>\n
\nOne of the biggest challenges for investment professionals and self-directed investors alike is projecting future returns. For a variety of reasons, not the least of which is that no one has a crystal ball, estimating future returns is an inexact science. However, it\u2019s reasonable to assume that future returns are likely to be lower than historical returns have been. Reasons include the ultra-low interest rate environment, the low returns we can expect from bonds and other fixed income investments, and high current stock market valuations. <\/p>\n
\nFinally, there\u2019s a risk factor that you can\u2019t control, but can plan for. It\u2019s what\u2019s formally know as \u201csequence of returns\u201d risk, or \u2013 more simply \u2013 bad timing. Mathematically, the worst possible time to have a 2008-09 market crash occur is when you\u2019ve just retired. Why? Because you\u2019ve stopped contributing to your retirement accounts, and have switched to taking distributions.<\/p>\nConclusion<\/strong><\/h2>\n
Looking for Guidance?<\/strong><\/h2>\n
If you\u2019re looking for help with planning and investing for retirement, contact us today to see how our team at Springwater Wealth can help you.<\/strong><\/a><\/span><\/h2>\n