When saving for retirement, how critical is it to know your number?
Fidelity, ING and many other Wall Street based financial institutions stress knowing your number. But is that the right way to go about planning for retirement?
In a recent Harvard Business Review article, Nobel Prize winner Robert C. Merton argues that this is exactly the wrong approach to retirement planning. Why?
Decision making, especially decisions about our money, are full of behavioral bias. With the shift from an income-focused retirement planning approach, like pensions and defined benefit plan use, to a rate-of-return-focused retirement planning approach asking questions such as “how much can I make in my 401(k) or what is my number?”, savers are pushed to take on more and more risk, which means more exposure to market loss. The result can be catastrophic if your timing is off just a little bit.
I agree with Mr. Merton that our focus should shift back to an income-based retirement planning approach. Instead of striving to take on more and more risk, a retirement plan should determine how to generate sufficient risk-free income to support your lifestyle during retirement, because the ultimate goal of your retirement plan is to provide income regardless of how much capital you have saved for your retirement.
Maximizing income from your investments is a very different investment approach, requiring very different investment strategies than maximizing rate of return.
At TFG Wealth Management, we specialize in developing and implementing retirement income plans. But unlike the Wall Street crowd that is limited to market-based solutions or the typical annuity salesman that wants to put all your money into an annuity, we use investment options from all sources, banks, insurance companies and the market.
So when I say know your number, it’s not about how big your retirement account is. Rather, it’s about how much income you can generate from your retirement savings.
Interested in discussing ways to maximize your retirement income? Give our office a call at 215-968-1755.
Planning your retirement income is a very difficult and challenging task. You can’t afford to mess it up. You need to do it right the first time.
Here are five factors to keep in mind when creating your retirement income plan. Each can endanger your finances during your retirement.
1. You might live a long time We all know that people are living longer, but what does that mean to you?
If you are 65 years old and single, you can expect to live to 86, according to the Internal Revenue Service. You have a fairly good chance of living even longer. This means that you need to anticipate making your money last a long time. Small mistakes early on can compound into large mistakes over many years.
2. Expect to spend a lot of money on healthcare Every year, Fidelity Investments projects how much a 65-year-old married couple should expect to spend on their healthcare during their retirement years. They assume that each person is on Medicare, but they also assume that no long-term care is needed.
Even though Medicare covers a ton of medical bills, the average couple spends $240,000 on healthcare during retirement. That’s right, a cool quarter of a million dollars. Over 25 years of retirement, that’s about $10,000 per year. If you need long-term care, it’s a lot worse than that. So make sure that you overestimate how much money you need for healthcare.
3. Watch out for inflation For the past several years, inflation is almost nonexistent, but don’t expect that to last much longer. Just one trip to the gas station tells us that inflation is back. Remember the late 1970s and early 1980s, when a fixed-income was so disastrous? With prices going up every year, a fixed income buys less and less.
At just 6% inflation, prices double every 12 years. If you spend close to 25 years in retirement you can expect to see prices double twice. That means you need four times the income to buy the same stuff at the end of your retirement compared to the beginning of your retirement. Of course, a 6% annualized rate of inflation is very high. It isn’t likely that such alarming price appreciation continues for decades. But make sure that you factor inflation into your plan.
4. Taxes follow you into retirement, too While you worked, you probably heard the wisdom about saving money today while you are in a higher tax bracket. The reason: When you take it out later during retirement, you are in a lower tax bracket. That isn’t always the case nowadays.
Many retirees find themselves paying more tax today than they did when they were working because they actually did a good job saving for their retirement.
Imagine you are getting ready to retire. As you shift from working to retirement, do you want to move into a lower standard of living or the same? If you want the same standard of living, your income needs to be about the same (or greater to account for health costs and inflation).
Also, with no kids in the house and the house paid for, your deductions are all gone. So you have about the same income, with no deductions. That’s not good for your tax bill.
Compound that with required minimum distributions from fully taxable retirement accounts – at age 70½ you must start withdrawing money. Then you have an equation that works really well for the Internal Revenue Service and not so well for you. Taxes are a real threat to a retiree’s standard of living.
5. Changing with the times When you were working, you probably had a retirement plan that provided a menu of mutual funds to invest in. It was easy. You just picked the best performers and didn’t worry about it. Retirement plans are designed for growth and accumulation. You use them to build up your nest egg so you can comfortably retire someday.
The problem is that when you retire, your financial tools are no longer appropriate for the most of your portfolio. Those same mutual funds might be too risky to hold during retirement, for example. You need to learn about different financial tools such as Roth individual retirement accounts, rollovers, conversions, dividend stocks, exchange-traded funds and money market funds that focus on both wealth preservation and income.
Dealing with a long retirement, healthcare costs, taxes, inflation and learning how to invest all over again is a daunting task. TFG Wealth Management provides our clients with the strategies they need to realize their financial goals in challenging times.
If you would like to discuss issues affecting your retirement, please give me a call at 215-968-1755 or contact me by filling out the contact form on this site and I will get back to you.