When it comes to retirement planning, most of the emphasis is placed on accumulating the largest retirement portfolio possible.
That is certainly important – in fact it’s probably the foundation of all good retirement planning.
However there’s a lot more involved in retirement planning.
I’ve put together a master retirement plan, that includes ten individual sub-plans, all of which will have a major impact on your life in retirement.
The idea is to look beyond simply building a big enough retirement portfolio, and focusing on the many other factors that will affect your life – and your finances – once you retire.
By knowing what these factors are, you can develop plans for each of them. And when retirement does come, you’ll be ready no matter what happens.
1. Plan for Decades – Not Years!
When planning for retirement it’s important to look beyond the first few years. People are now living for decades after retiring, and you’ll need to be prepared to cover that extended time span.
For example, if you plan to retire at age 65, you should plan to be able to support yourself for at least another 20 years – people living to be 85 is no longer uncommon. In since women generally live longer than men, you might want to consider planning out through age 95. That’s 30 years!
Even if you don’t think you will live that long, maybe because people in your family historically haven’t, you must still be financially prepared for the possibility.
From an investment standpoint, that means you will need to continue to have some emphasis on growth in your portfolio. That will enable you to make sure the assets you have in your 60’s will last well into your 80's.
2. Your Social Security Benefits
When it comes to Social Security, many people cling to the dated notion that you simply wait until you turn 65, file for benefits, then start collecting them for the rest of your life. While that is still possible, there is actually an entire strategy which exists around getting your Social Security benefits.
This is mostly about when to collect those benefits, and that will have a major impact on how much your benefits are.
For starters, 65 is no longer the standard retirement age. The Social Security Administration has been gradually increasing what it refers to as the full retirement age, or simply FRA. That’s the age at which you will receive full Social Security benefits.
For people born between 1943 and January 1, 1955, the FRA is 66. If you were born between January 2, 1955 and December 31, 1959, it will be 66 plus an additional two months for each year you are born after 1954. If you were born after December 31, 1959, it’s 67.
If you retire at any time before your FRA your benefits will be reduced proportionately. For example, while you can still begin collecting benefits at age 62, the amount you’ll receive will be limited to no more than 70% of the benefit you would receive if you waited until you reached your FRA.
Conversely, if you delay collecting benefits until after your FRA, your monthly benefit will increase by 2/3 of 1% per month, or 8% per year. If you delay collecting benefits until you reach age 70, you can increase your monthly benefit by 24% (IMPORTANT: there is no additional benefit for delaying past age 70).
This is why the timing of collecting your Social Security benefits is so important. If you’re able to continue working past age 62, or even past your FRA, you will receive a larger income as a result of the delay.
Spousal benefits. Social Security benefits for a spouse carry two options. The lower earning spouse can either collect benefits based on their own work history, or he or she can collect 50% of the benefit paid to the higher earning spouse. The advantage here is the lower earning spouse will automatically collect the higher of the two calculations, as long as the higher earning spouse has already begun collecting benefits.
As a general rule, Social Security benefits are roughly equal to 40% of the pre-retirement income of a middle income worker. Since monthly benefits are capped, that percentage will be lower for higher income people.
The point to consider here is if Social Security will provide 40% of your income, then you will need to be prepared to have other sources providing the remaining 60%.
3. Shifting Your Portfolio Away From Mainly Growth
Once you reach retirement age, you will need to begin implementing a gradual shift in your overall investment strategy.
Since you’ll be at the point where you’ll begin to withdraw income from your retirement portfolio, you will no longer have the benefit of many years to ride out a major decline in the stock market. This means you will begin shifting your asset allocation from pure growth oriented investments, to assets that emphasize income and capital preservation.
This is the process you need to already have underway by the time you retire, but it doesn’t stop there. As you get older, the percentage of your portfolio that is in income-based assets will need to increase. This is not only because you will need more predictable income, but also because as each year passes your investment time horizon will grow even shorter. That will give you even less time to recover from market falls.
Where exactly you should invest your money for income and capital preservation is a topic all its own…
4. Specific Income Generating Investments
Fortunately, there are a lot of options in this area. Consider the one, or the combination of several, that may work best for you.
Bank Investments. These can include certificates of deposit (CDs) and money market funds. Neither pays much in the way of interest, given today’s low interest rate environment, but both offer absolute safety of principal. Since interest rates are so low right now I am recommending people stick to online savings accounts that pay a little higher interest. Your total deposits at any one bank institution are insured up to $250,000 by the FDIC.
US Treasury Securities. You can directly invest in US Treasury securities through Treasury Direct, the US Treasury‘s investment portal. There you will find a variety of interesting fixed income investment opportunities, including bonds, notes, bills, and E/EE Bonds. They can be purchased in denominations for as little as $25, and carry virtually no risk of principal if held to maturity. Treasury inflation protected securities (TIPS), and I Bonds not only pay interest, but also make annual adjustments to principal based on the Consumer Price Index (CPI). That’s interest income, plus inflation protection.
Annuities. These are investment contracts purchased through an insurance company. They come in a variety of forms, and can be established to provide an income for either a specific period of time, or even for your entire lifetime. Annuities can be the perfect addition to your overall retirement plan if you are not covered by a traditional pension plan for your employer. An annuity can provide an income arrangement very similar to that of a pension.
You can even convert funds from an IRA or 401(k) to an annuity, that will provide you with a guaranteed income. And since your contributions and investment earnings were tax-deferred, income distributions will be taxed at ordinary income tax rates upon distribution.
There are various types of annuities:
- Fixed Annuities. These annuities are a lot like bank CDs, in that they are very liquid, and they allow you to withdraw interest income without paying penalties. There are no fees on fixed rate annuities, although they typically do contain a surrender charge in the event that you withdraw more than the amount specified in the contract, or if you terminate the agreement early. They can provide you with a guaranteed income for any time period you choose, or even for the rest of your life.
- Fixed Indexed Annuities (or FIA). This are like fixed rate annuities, but with an investment provision. You set up a certain term, as well as a minimum interest rate. But an FIA also allows you to link your investment to the stock market, which allows you to earn an even higher rate of return. And not only can you participate in stock market index gains (typically the S&P 500 index), but you’ll also be protected from any losses to your principal investment. This is a way to participate in both income and growth with your investment.
- Annuity with a guaranteed lifetime withdrawal benefit (GLWB). This is a rider that you can attach to any type of annuity. It will provide you with an income that will last for the rest of your life, and allow minimum withdrawals without having to annuitize is the contract. Note: this could be a FIA (mentioned above) or a variable annuity (which I'm not a big fan as I wrote in Forbes here).
You might also consider adding an investment type life insurance policy to your investment mix. Such policies allow you to accumulate cash value in the policy on a tax-deferred basis, much like defined contribution plans. They can be an excellent addition to your retirement portfolio mix if you routinely max out your retirement plan contributions.
5. Creating a Housing Plan
Since housing is typically the largest single expense in most households, it should be considered carefully in light of your overall retirement plan. At a minimum, you should plan to pay off your mortgage and own your home free and clear by the time you retire.
That will keep the cost of your current home to an absolute minimum. It will also provide you with an unencumbered major asset that you may want to liquidate in favor of cash at some point after you retire.
But you should also at least loosely consider the possibility of changing your housing situation entirely.
There are several reasons why this may be either necessary or desirable:
- Downsizing to a smaller, less expensive home to reduce basic living expenses.
- Moving to an area that has a more favorable climate or preferred recreational amenities.
- Moving to an area where the general cost of living is lower.
- Living in a location which is close to all your shopping to reduce the need to drive.
- Moving to a state that has a more advantageous income tax regime for retirees.
- Moving to be closer to your adult children and grandchildren.
- Moving into a home that will require less repair and maintenance on your part.
- You may want to free up some of the equity in your home to put into income producing investments.
- You may decide that the home you raised your family in is simply too large for a retired person or couple.
- You may even consider renting for a time, while you decide exactly where and how you want to live.
Complicating your considerations is the fact you may also want to have a second home in a specific location. That may also motivate you to think about downsizing your primary residence in order to make room in your budget for the second home.
Fortunately, if you do plan to sell your home, and you have a considerable amount of equity, the IRS allows you to exclude up to $250,000 on the gain on the sale of your primary residence from taxation. For married couples filing joint, the exclusion is $500,000.
6. Never Ignore Inflation!
It’s important to understand inflation doesn’t stop when you retire. And since you can fully expect to live for 20 or 30 years after you retire, you will have to adjust your financial situation for rising prices.
As a general rule, you should assume inflation will continue at about 3% per year. That’s approximately what inflation has averaged over the past 30 years. What that means is general price levels will roughly double in about 25 years after you retire. You’ll have to prepare your retirement portfolio and your income for that outcome.
Fortunately, Social Security benefits are indexed to inflation, so you will automatically keep up with that income source. And some of your fixed asset allocation should be invested in TIPS securities as discussed above, that way you will not only earn interest income, but your asset principal will be adjusted to reflect higher price levels.
However, inflation means your retirement portfolio will have to account for inflation, and that will require you will have at least some reliance on growth oriented assets, like stocks and real estate.
One way to do this is through Fixed Indexed Annuities as discussed in #4 above. But you can also invest in high dividend yielding stocks, growth and income mutual funds, and real estate investment trusts. All have above average income yields, but also have the ability to participate in gains in the equity markets.
The growth these investments generate will help your portfolio to keep up with inflation, while you are living on the income they produce.
7. Income Taxes – Why They May Not Be As Low As You Think
When planning for retirement, you should consider the very real possibility that you could be in a higher income tax bracket than you are right now. This can come about for one of two reasons:
- Your income is higher in retirement, due to your having multiple income sources, and/or
- Income tax rates increase by the time you retire.
This will require some type of income tax diversification planning on your part. Two ways to do this through your retirement portfolio include:
- Keep some of your investments outside of a tax-sheltered retirement plan. Withdrawals from non-tax-sheltered plans will not be taxable, since neither the contributions nor the investment earnings were tax-sheltered in any way.
- Invest in a Roth IRA. If you are at least 59 ½ and have had the plan for a minimum of five years, both the contributions and investment income can be withdrawn free from income taxes.
Taking those two steps won’t shield all of your investment income from taxes in retirement, but they will cut down on exactly how much is subject to tax.
Fortunately, you will have a built-in tax break with your Social Security benefits. Many taxpayers won't have to pay any tax at all on the benefits. But if you are single, and have taxable income of at least $25,000, or married filing joint with a taxable income of $32,000 or more, up to 85% of your Social Security benefits will be taxable.
8. Making Your Distributions Last a Lifetime
After spending your working life accumulating a large retirement portfolio, the job will shift in retirement to creating a distribution plan that will provide you with an income for the rest of your life.
There are different ways to do this. Perhaps the most common method discussed is the safe withdrawal rate. If you withdraw no more than 4% of your retirement portfolio in any given year, your portfolio will never deplete. In theory, this works well. But it does require a minimum annual investment return of at least 7% (4% to cover your withdrawals, and 3% to account for inflation).
That may not work as well as you think. The problem is that it does not recognize the impact of investment market declines. It also disregards years in which you have negative investment returns, or even returns that failed to cover your withdrawals. In a worst-case scenario, you could be withdrawing 4% each year of a declining investment base.
So while you can consider the safe withdrawal rate as a general guideline, you may need to make adjustments in the strategy on an annual basis. For example, in years when the market is in decline, you might not want to make withdrawals at all. In such years, you might want to have non-retirement assets that you can draw from the make up the difference.
Still another strategy is to make smaller withdrawals in the early years of your retirement. For example, you could decide to withdraw no more than 2% per year until you reach age 70.
9. Health Care – The Retirement X Factor
Statistically at least, healthcare costs become even more significant as we age. Even with the best Medicare supplement plans, senior citizens are never completely insulated from the high and rising cost of healthcare. And since they tend to be more frequent users of the healthcare system, they are more exposed to these costs. It’s also a situation which unfortunately tends to become more pronounced as you get older.
So how do you prepare for healthcare costs in your overall retirement plan?
- Make good health a priority in your life – start now, even if you are not close to retirement age. As the saying goes, an ounce of prevention is worth a pound of cure. Start those prevention efforts now.
- Sign up for Medicare as soon as you turn 65.
- Add a private source Medicare supplement plan to your basic Medicare plan. Medicare doesn’t cover everything, and the supplement will generally pay for what Medicare doesn’t.
- Add a Medicare prescription drug plan to greatly reduce the costs of most prescriptions.
- Make sure you have a very large emergency fund – apart from your retirement portfolio – available for those years in which uncovered medical expenses are particularly high.
- Plan to maintain a life insurance policy on each spouse for the rest of your lives. The death of one spouse, following a long medical event, often devastates the finances of the surviving spouse. Life insurance proceeds can replenish those funds.
It’s impossible to know ahead of time exactly what your medical costs will be in retirement. But that’s exactly why you should at least have a loose game plan – with multiple options – in place for when the time arrives.
10. Planning For Long-term Care
The downside of people living so much longer today is that the likelihood of needing either assisted living or full on long-term care increases substantially with age. Assisted living alone typically costs in the range of $40,000 per year, but a nursing home stay can easily cost $80,000 per year, and even more in high cost locations.
Unfortunately, Medicare does not cover long-term residency in either an assisted living facility or nursing home. And while Medicaid will cover these costs, they will only do so after you have exhausted all of your financial resources. If one spouse is in a facility, and the other isn’t, this can leave the non-institutionalized spouse is an extremely difficult financial position.
Long-term care insurance is becoming increasingly necessary as people live longer. A long-term care policy is much less expensive if you buy it well before you retire, and while you’re still healthy. The later that you buy a policy, the more expensive that it will be.
There are different long-term care policies, with different provisions. For example, while it may be possible to buy a policy that will cover very long-term institutionalization, it will be a very expensive policy. Plans that limit coverage to two or three years will be much more affordable. Most plans also have a per day expense cap, that may or may not be sufficient to cover the actual cost of care.
But even if a long-term care policy doesn’t cover 100% of the cost of a long-term stay at the facility, it will be a major advantage if it covers at least most of it.
If you’re building up your retirement portfolio, that’s the obvious first, best step in your retirement plan. But while you’re doing that, spend some time considering all of the other retirement issues, and what you can do right now to be prepared for the when the time comes.