Life in the work lane means keeping your nose to the career grindstone. You work hard over many years, balancing work and family while accruing a comfortable nest egg for your retirement.
Along the way, you probably benefited from the discipline and focus that comes from working with a financial advisor. Their guidance was helpful in growing your portfolio and other assets to where they are now.
This life stage is called the “accumulation phase,” and its long-term priority is with the growth of your financial assets. Yet it’s just as important to plan for the backend, or when you start drawing on your nest egg for retirement income.
After all, life changes quite a bit when you retire. Your sources of income will change once you hit the golden years, whether you were a full-time executive, you ran your own business, you worked in a government capacity, or you steadily climbed the ranks as a salaried employee. And not only that.
There is also the matter of “distributions” from your portfolio. Withdrawals have tax implications, especially if money is taken from accounts or vehicles that had special tax treatment as you accumulated funds within them.
And don’t forget the question of longevity, which poses the potentially costly risk of outliving your retirement money. With the numbers of people living to their 90s, and even to 100-and-beyond, increasing by the year, there runs the possibility of a nest egg being mismanaged for long-term income needs.
Better to Plan Now Than Later
Ask almost any retired person about when to start making retirement planning a priority, and they would tell you, “You need to think about it now!”
For mature working-age investors, that benchmark often begins at age 50. It’s a point at which to think about and plan for how you will shift from the accumulation phase of your financial life to its latter phases:
- The preservation phase, or when you begin to protect the capital and assets you have accumulated for the end-goal of future income.
- The distribution phase, or when you finally spend down the savings and assets you worked so hard to accumulate over your career.
What your retirement spending will look like depends on many variables, including your current level of spending and what you hope to enjoy as your retired lifestyle. Using your current spending picture as a work-off, your first steps should include: putting together a 30-year retirement spending timeline (at minimum) and figuring out what you will need to live comfortably and securely.
Even so, a recent survey by Kiplinger indicates that a majority of middle-career to mature-age Americans don’t have an efficient retirement spending plan.
The poll found that fewer than 50% of investors ages 35-64 had a withdrawal plan for retirement. That is a big deal, considering an optimal time to start establishing a withdrawal plan is at least 10 years before you retire.
Timeline for Retirement Planning
The purpose of a withdrawal plan is to show you will reliably and consistently have the income you will need to cover a 30-year-or-longer retirement.
It’s about the net: what net income you will have after taxes, fees, and inflation. So, how should you plan this out? First, awareness of important timelines. Here are the key age milestones that you need to be aware of to make sure your planning is on track:
- Age 50 – You can begin to make catch-up contributions to your qualified employer-sponsored retirement plan and to an IRA
- Age 55 – You may be able to access money from a 401(k) plan without early withdrawal penalties
- Age 59.5 – You can now withdraw money from your 401(k) or traditional IRA without early withdrawal penalties
- Age 62 – You can start claiming Social Security
- Age 65 – Eligibility for Medicare begins at this age
- Ages 66/67 – Full Retirement Age under Social Security for most folks
- Age 70 – This is the final age until when you can delay taking your SS benefits
- Age 70.5 – You have until next April 1 to take your first Required Minimum Distributions (RMD) from tax-qualified accounts
Modeling Your Distributions in Context of a 30-Year Plan
Next come putting together a battle plan (“The Plan”). Again, the goal of this plan is to create, at minimum, a 30-year outlook for retirement spending and spell out what you will need to live comfortably and securely.
This will most likely be a spreadsheet that integrates a balance sheet and an income statement. That way you can list all of your assets, all of your projected income accounts, and all of your expenses across a projected 30-year retirement lifespan.
The Plan will become your master tool for managing the financial affairs of the household throughout retirement.
A 30-year plan for retirement income and spending in an Excel spreadsheet may look like this, yikes!
What if this isn’t a strategy you can do yourself? Or you don’t have the confidence to feel truly more self-assured and confident about your financial future?
Then now is the time to establish a working relationship with a financial professional. And here’s an important distinction. Instead of a strategist for the “accumulation” phase, look for someone who understands the “preservation” and “distribution” phases of retirement.
Your prospective financial professional should have the expertise to help you develop strategies for reliable, consistent retirement income streams. While you may be quite capable of developing a plan yourself, they can also review your plan, look for shortcomings, and provide alternative ideas.
Not only that, your financial professional can keep you up-to-date on changing laws and regulations with respect to your financial picture. That includes planning for federal and state income taxes, which can get complicated, and for changing regulations that impact your retirement bottom-line.
Also, be sure to account for inflation of 2%-3% in your retirement spending.
Putting the Spending Question into Perspective
Two primary questions that come to mind are: “How much money will I need to live comfortably?” and “What are some best practices for how I should take withdrawals from my tax-qualified accounts?”
Your personal income needs will depend largely on what your retirement expenses look like, as you allocate income to cover those needs. The exercise of taking your current spending patterns, anticipating future spending, and preparing forecasts over a 30-year period, at minimum, can help answer this question.
Be sure to include planning for the needs of your partner in those projections.
In regard to the question of creating an efficient distribution plan, pundits and experts have discussed a few models. These income planning strategies can be discussed with the help of a financial professional, but here’s an overview.
Different Retirement Withdrawal-Spending Models
1. Constant Spending Model – This model works on the assumption that you will use the same amount of money each year for retirement. Your withdrawal amount will be adjusted annually for inflation. This “constant spending” approach is used from when you actually retire to retirement’s end.
2. Flexible Spending Model – projected expenses from different areas, from housing and insurance to grocery and entertainment, are put together into one withdrawal plan. Healthcare expenses generally rise as people age, for instance, while clothing expenses generally decline.
Once all projected expenses are combined into one plan, a number of factors are run, including inflation. Thereafter, the retiree gets recommended withdrawal amounts based on the combined numbers.
3. Evolving-Retirement Spending Model – This model takes the view that retirement distributions are a moving target. This is similar to the “go-go,” “slo-go,” and “no-go” phases we have discussed in earlier blog posts.
This framework divvies up the plan into the three phases of go-go, slow-go, and no-go. Calculations of distributions are then run for each stage. The spending projections reflect the expected lifestyle of the retiree at each stage.
In the go-go years (60-75), retirees may be more active or participate in more recreational activities: traveling, touring the country, or enjoying outdoor pursuits. Their spending picture shows that activeness.
Then in the slo-go years (age 75-90), retirees gradually wind down on activities that take them away from home. Costs relating to travel and recreation tend to decline. And in the no-go years (age 90+), medical needs along with long-term care needs arise, increasing health expenses.
Here are some general principles to consider with your withdrawal plan. Apart from your other assets, Social Security may provide another income stream.
You may start drawing Social Security at age 62, but you don’t have to. In fact, your benefit will increase by about 8% each year you delay claiming it. The latest age you can delay your benefits to is at age 70.
The Social Security Administration is good at communicating with beneficiaries on a regular basis. It will inform you of what your new monthly payment will be months in advance of each year so you can update your Plan.
For forecasting purposes, you might plan for a 2% increase to your Social Security payments each year, but check with your financial professional.
If you have a traditional pension with a lifetime annuity, you can project your distributions in a similar fashion.
Required Minimum Distributions (RMDs)
You may be able to access money from employer-sponsored retirement plans – 401(k)s, 457s, and 403(b)s – and IRAs and Roth accounts as early as 55 without penalties. But you must start Required Minimum Distributions (RMDs) by April 1 of the year after you turn 70.5.
For each account you have, you can model your RMD precisely by using the IRS Uniform Lifetime Table.
For as long as you hold these accounts through retirement, and unless the world comes to hell in a hand basket, we can reasonably expect these accounts will appreciate over the long term, since they are tied to the public equity markets. However, it also depends on the potential for sequence risk.
For instance, it’s conceivable your account might appreciate by 6% one year, and you might have a 4% RMD. It would mean you have a net 2% increase in the balance of your account.
But it could also go the other direction. There might be a downturn in the market and your balance could decrease, in addition to taking your RMD withdrawal.
Investors have to take a long-term view of this. Say a 401(k) balance had gone up and down many times over someone’s career but had eventually increased nicely over a 20+ year period. You could expect some level of volatility in your account for the next 30 years.
There is some risk involved here. You should have a discussion with your partner and your financial professional to determine what retirement strategy might make sense for you.
Managing Risk with a Private Annuity
How much of your nest egg you have in market-driven accounts can be a hard decision to weigh. Consider seeking an objective opinion on what makes sense for your risk tolerance, time horizon, and other financial variables with a knowledgeable financial professional.
Among other things it depends on: (a) how much you can tolerate downswings in equity market-based assets; b) the timeline of your retirement; and (c) how much time is left to safely anticipate a long-term growth rate on your assets.
One way to generate a guaranteed lifetime income stream, or to have more stability in your portfolio volatility, is through adding a private annuity to your portfolio. Annuities are the only private-sector financial products capable of generating a guaranteed lifetime income.
You should discuss whether this option or others might help you achieve your objectives. Once again, your financial professional can help you with this.
And they can also help you walk through the question of balancing growth versus security in your various income-producing assets over the stages of a 30-year retirement.
If you are ready for guidance from a financial professional, help is a click away here at SafeMoney.com.
Financial professionals can be located in our “Find a Financial Professional” section. Visit there to connect with someone directly. Should you need a personal referral, call us at 877.476.9723.