Do you remember watching your child take their first bike ride without training wheels? You undoubtedly coached them, steadied them, worked them through the early swerves, but at some point, you let go and they were sailing along the pavement on their own.
Replacing your income in retirement can feel like the first time you let go and let your child ride free. You were supported by a steady income and workplace benefits for decades. But now, you are on your own, buoyed by your steady savings over the years. Are you ready to ride free and clear?
Define Your Ideal Retirement
The absolute first step to securing your retirement income is to determine what type of retirement you would like to live. How do you want to incorporate your values into your retirement plan? What are your goals, wants, and needs? It’s more than likely you will need to make a list and start prioritizing what’s important to conquer first.
The next step is to take a fine-tooth comb to your spending. If you wanted to continue your current lifestyle, how much income do you need? What are your core expenses, and what are discretionary purchases that could be adjusted, up or down, depending on your investment and income options?
Finally, it’s important to note that while overall spending may not increase in retirement, the composition of your spending will change over time. A common way to delineate expenditures is to break them up into three decades: the “go-go” years (from 65 to 75), the “slow-go” years (from 75 to 85) and the “no-go” years (85 to 95). Spending on fun items like golf, fishing, and dining out amp up during your “go-go” years, while healthcare spending increases appreciably during your “no-go” years.
Make Smart Investment Choices
While your parents may have enjoyed a company pension coupled with Social Security through retirement, it’s likely the case that the burden has been placed on you to create your own retirement income through long-term, tax-deferred investments. Without a company or pension paycheck hitting your bank account monthly, how do you translate your investment portfolio to your income needs? First things first — create an emergency fund. Your emergency fund should cover at least six months (or even a year) of expenditures and should be invested in secure, cash investments like FDIC-insured bank accounts or money-market mutual funds.
OK, so we have one-year of income covered. What’s next? We advocate creating a bond ladder to cover at least five years of planned expenditures. Why five years? This allows you to weather larger market downturns without having to sell your equity investments at the lows. For example, a portfolio of 60 percent equities and 40 percent bonds has never had a down five-year rolling return over the past 70 years.
But what do I invest in? Easy! Low-cost, long-term, diversified investments. Don’t try to pick individual stocks yourself. While having an investment play account can be a fun idea, do you want to risk your income needs for the next few decades on these concentrated bets? You can find the risk and return you need by choosing broadly diversified funds and ETFs with low expense ratios. Let the market work for you; don’t try to fight the tide.
Review Your Guaranteed Income Options
Relying on your investment portfolio and depleting a portion of it every year can be a scary proposition. What if you run out? If this is a deep concern for you, there are guaranteed income options you can avail. The most common approach is to create a thoughtful Social Security claiming strategy. While the idea of drawing immediately may sound appealing, your benefits increase for each month you delay receiving retirement benefits between full retirement age and age 70. Speak with your tax, legal, or financial advisor to understand what strategy works best for your household.
Annuities may offer value for those who are very conservative and feel uncomfortable taking market risk throughout their retirement; they also serve a purpose to protect against longevity risk, or the risk of depleting your portfolio. It’s important to note that each annuity is a unique contract between you and the carrier, and there is a plethora of options: immediate vs. deferred annuities, qualified vs. unqualified annuities, QLACs, fixed vs. variable annuities, etc. Similar to your Social Security claiming strategy, speak with your tax, legal, or financial advisor before purchasing an annuity.
Watch Out for Common Retirement Spending Shocks
There are several investment and spending risks to pay attention to during retirement. One of the biggest is getting through the “Fragile Decade,” or the five years prior to and just after you retire. Why is this decade such a big deal? It has a disproportionate effect on your investment portfolio, and thus, your ability to generate the income you need through retirement. Given this, we strongly advocate for a more conservative approach as you start to ponder your eventual exit from the workforce. Prudent planning today is crucial to avoid having to draw from your equities when the market experiences a downturn.
Healthcare costs, whether expected or unanticipated, can also cause a permanent impairment to your income plan. Usual healthcare costs in retirement — even with Medicare — are considerable, with Fidelity estimating that a 65-year-old couple retiring in 2019 can expect to spend $285,000 in healthcare and medical expenses throughout retirement. And a long-term healthcare event can be especially damaging to your income plans. These costs, not covered by Medicare, can take a large chunk of your portfolio if they are needed. There are several strategies to implement this spending shock, from reverse mortgages to long-term care insurance.
Finally, retirees need to contend with the pernicious effects of inflation. Even if you park your portfolio at the bank, you still are taking investment risk. If inflation averages 2 to 3 percent (a reasonable to conservative figure given current CPI rates), cash today will be worth half its value in 25 years. Half its value!
Retirement Planning with Harbor Crest Wealth Advisors
Planning your retirement can feel like a scary proposition. How do you just let go and enjoy the ride with what you’ve built? There are many strategies to maximize your income in retirement and they interact with each other, from an investment, tax, and estate planning perspective. Getting clear, unbiased financial advice is critical to making sure your hard-earned savings are working for you over the next few decades.
Make sure you can make the most of your time in retirement by preparing for it now. If you would like to learn more about retirement planning, sign up for our newsletter.