Retirement Planning

Approaching retirement can be one of the most uncertain steps in your financial life.  For most people, you become accustomed to a fixed income from employment, and when those monthly deposits stop coming in, it can be stressful.  This highlights the importance of working with a professional in the years leading up to retirement so you can develop a plan and make adjustments that increase the likelihood of a successful retirement.  While the list below is not comprehensive of everything that should be considered for retirement planning, it can give you an idea of some of the more common planning points.   

Planning Points

• When to start Social Security
• How much to withdraw from savings
• Sequence to draw from account types
• How to structure investments
• Changes to the estate plan

When to Start Social Security

Some retirees may have no other significant assets or sources of income and may be forced to start receiving Social Security immediately upon retiring.  However, if you can defer, it could be beneficial.   One thing to be aware of is that if you start receiving Social Security while you’re still working and have not yet reached your full retirement age (FRA), your benefit will be reduced by $1 for every $2 earned over $24,480.  From the time you attain full retirement age (usually between 66 and 67) until age 70, each year you delay results in an 8% increase in your benefit.   Deciding when to initiate the benefit generally hinges on life expectancy: the longer the life expectancy, the more beneficial it is to delay.  A common strategy for a married couple who are both eligible for Social Security is for one spouse (usually the one with the lower benefit) to start their Social Security benefit earlier, while the other spouse (usually the one with the higher benefit) delays.  Finally, if you do not need the Social Security benefits to cover your expenses and choose to invest them, you may consider starting the benefits earlier.  Generally, you would consider starting the benefit earlier as the expected return of the investment portfolio increases.  

How Much to Withdraw from Savings

There are no guarantees when it comes to retirement, and the best approach is to work with a qualified financial planner to determine what a safe withdrawal rate looks like for your specific circumstances (and to consistently update that plan over time).   However, if you’re just looking for an idea of what might be prudent as you near retirement, you might start with the 4% rule.  The basic premise of the rule is that if you retire at age 65 and your portfolio is invested in a fairly balanced approach (50/50 or 60/40), there is a high probability that it will last for 30 years if you withdraw 4%.  If you retire with $1 million in savings at the age of 65, you would withdraw 4% ($40,000) in the first year, and then increase that dollar amount by inflation each year following (assuming 2.5% inflation, which would imply a draw in year two of $41,000, year three of $42,025, etc.).   This method is simple and creates a consistent source of “income” that can help you maintain your standard of living in retirement.  If a larger portion of your expenses is discretionary, you could also consider a dynamic spending approach, in which you spend more when your portfolio performs better and less in poor-performing years; however, it is important to be able and willing to cut spending in those poor-performing years.   Finally, another method is to simply have a financial planner run a Monte Carlo analysis regularly and adjust spending based on the probabilistic outcomes.   It might be useful to run the numbers for each approach, then decide on a spending level between the higher and lower spend rates.  Ideally, when you add up your social security benefit, any other retirement income (pension, rental income, oil royalties, etc.), plus your portfolio withdrawal, that would be enough to maintain your pre-retirement standard of living.

Sequence to Withdraw from Accounts

A common question that arises, even after a retirement plan has been set up, is which accounts do I withdraw from?  Many retirees will have two or three account types (brokerage, pre-tax or traditional retirement accounts, and Roth retirement accounts).  Assigning a basic strategy to the withdrawal order can create meaningful differences in the longevity of the total portfolio.   A common rule of thumb is to draw from your taxable account first, then from your pre-tax or traditional account, and lastly from your Roth account.  The idea here is to maximize the tax-deferred (or tax-free, in the case of a Roth) growth timeline.  If you have significant assets in pre-tax or traditional dollars, and you delay any draws from that account until required minimum distributions start, it could result in a ballooning out of taxable income (higher RMDs forcing you into a higher tax bracket).  For this reason, it can sometimes be advantageous to draw from the taxable account (brokerage) and the pre-tax or traditional concurrently, spreading out your tax liability over time.  Another good strategy to consider is drawing from your taxable assets to live on while simultaneously drawing down pre-tax or traditional dollars for Roth conversions.  (Usually, the best time to do Roth conversions is following retirement, but before social security and RMDs start, as you may be in a lower tax bracket during that time relative to once those two sources of income come into the retirement picture.)  

Structuring Investments

This may well be one of the most important decisions as retirement approaches and should be on the agenda for discussion with a qualified financial planner.  For most accumulation years (working years), risk tolerance is higher and the time horizon is longer, so the strategy is usually straightforward.  However, as you approach retirement, it becomes important to find the right investment strategy that balances asset preservation and asset growth.  When we discussed the 4% withdrawal rate (above) it assumed that the portfolio is invested in a diversified fashion with a minimum of 50%-60% in equities.  A lower equity exposure could result in insufficient growth to extend the portfolio’s longevity for 30 years, and a higher equity exposure could lead to excess volatility, causing the portfolio to deplete too early.  A common rule of thumb in the industry is to tie your asset allocations to the time horizons for which liquidity will be needed.  For example, if you plan to withdraw $40,000 per year, you would keep enough in a money market or a similar cash-equivalent investment to cover one to two years of that draw ($40,000 - $80,000).  The money needed for living expenses for years three through seven ($40,000 x 5 = $200,000) may be invested in a diversified bond portfolio.  For a $1 million portfolio, you would have years 1-2 ($80,000) in a money market, years 3-7 ($200,000) in bonds, leaving $720,000 to invest in stocks.  This would result in 72% in stocks, 20% in bonds, and 8% in the money market.  If you wanted to tilt the allocation more conservatively, you could keep the $80,000 in a money market and increase the bond allocation to $280,000 (28%), bringing equity exposure down to about 64%.   This would mean that on day number one of retirement, you would have nine years before you would need to start liquidating equities, which should help deal with volatility in earlier years.   Despite these rules of thumb being widely accepted, it is still important to work with a qualified financial planner to ensure investments are structured prudently to last your lifetime.  

Changes to the Estate Plan

It is not uncommon for an individual or married couple to draft their will(s) earlier in life (usually when children are introduced to the picture).  However, it is quite possible that things have changed between when those original plans were made and when you retire.  For that reason, retirement is a good time to review your estate plan and ensure it remains appropriate for your current circumstances.   For example, you may have named an Executor who is no longer part of your life, or who is no longer qualified to serve, and may now wish to change the Executor to another individual or to a corporate Executor.  You may have originally not been concerned about probating your will, but now wish to avoid the hassle, expense, and delays of probate (by implementing a revocable trust).  Perhaps at the time you drafted your original will, you did not have a taxable estate ($15 million for an individual or $30 million for a married couple who elect portability).  If you do now (or between now and life expectancy) believe you may have a taxable estate, it could be beneficial to consider a gifting strategy, establish an irrevocable trust, or set up a family limited partnership.  Hopefully, if you have children, they are self-sufficient; if not, you may need to consider passing assets to them in trust rather than outright, using a testamentary trust or a special needs trust.   It’s also important not to miss the “little” things: review your payable-on-death (POD) beneficiary designations and make sure you have the appropriate power of attorney and medical directive documents in place.  Reviewing your estate plan can not only give you peace of mind entering retirement, but it can also make it meaningfully easier on your spouse and your heirs if you lose capacity or pass away unexpectedly.