If you’ve ever built a house, you know it's easy to get caught up in the details: lights, appliances, floor coverings and finishes. Deciding on all these things can be exhausting. Planning retirement can feel a bit like that. But just like building a house, in retirement, the right foundation creates lasting value.
Having Enough Income in Retirement
Everyone needs income. For most retired folks, that income comes from a combination of Social Security benefits and personal savings. Some groups also enjoy old-style pensions, but those are becoming rare. Teachers, railroad workers and many government employees (local, state, and federal) some of the few groups that still have pension benefits.
The key to income success is coordinating monthly expenses with monthly income. In many homes, personal savings includes both pre- and post-tax dollars. Choosing a withdrawal system to minimize taxes can make a big difference, similar to the ability to adjust for changing circumstances. Two non-traditional products are increasingly popular.
Deferred annuities can be used to ensure future income. A single premium today will promise regular income for later years, up to 85 or 90 years of age. With one of these specialized insurance products, you won’t outlive your money.
Reverse mortgages can also be used to supplement income. Scrutiny has squeezed many of the costs and disadvantages from these loans, and they can be successfully used to tap home equity for better purposes. Be wary of aggressive sales techniques, and approach your regular mortgage professional for help. (For related reading, see: The Reverse Mortgage: A Retirement Tool.)
Retirement Plan Distributions
Although pensions are less common, other types of retirement plans are plentiful: profit sharing, 401(k) plans, tax-sheltered annuities (453 plans), deferred compensation (457 plans) and individual retirement accounts (IRAs) abound. Additionally, both simplified employee pensions (SEP) and SIMPLE (savings incentive tax plan for employees) plans are IRA-based retirement plans.
Most plans provide a single large retirement payment that requires special consideration. First, the typical distribution may be larger than any other financial transaction and is a daunting amount for many retirees. Second, any portion not rolled into an IRA faces both federal and state income taxes.
Third, various IRA rollover alternatives can impose high fees, investment restrictions, and/or surrender charges. Some employers allow retirees to remain in an employer plan. If plan fees are low and there are sufficient quality investment options, this can be a good choice for savvy investors. However, other people could benefit from professional help and broader choices. (For related reading, see: Common IRA Rollover Mistakes.)
The Right Amount of Risk
People now live for decades in retirement, and being too conservative is every bit as perilous as being too risky. Look back to 1988. How much was a new car then? How much was a month's rent or house payment? What do those things cost today? What will they cost in 2048?
People retiring today face a 30-year retirement horizon. If retirees invest a new car’s worth of money today, it still needs to buy a new car in 2038 or 2048. That’s the new investment challenge. Conservative investing—bonds, certificates of deposit (CDs), fixed annuities—probably won’t keep pace with the rising price of housing or automobiles.
A long-term diversified portfolio of blue chip stocks and bonds offers the best chance of keeping up. (For more from this author, see: Why You Should Become More Risk Tolerant.)
Everyone knows you should have basic estate planning documents – a will, powers of attorney and maybe transfer on death ownership for bank accounts or real estate. Beneficiary designations are often overlooked, but are critically important today. IRAs, other retirement accounts and insurance policies all transfer according to the most recent designation of beneficiary. There is no joint ownership and a will or trust won’t matter.
IRA rollovers and annuity accounts can impose a sizable tax liability on the beneficiaries. Not designating a beneficiary creates an estate issue and prompts accelerated taxable distribution from IRA or annuity accounts. Make deliberate choices about who gets what, and how.
Proper estate planning can minimize taxes and maximize gifts to family or charity. Take the time to get this right. (For related reading, see: In-Depth Guide to Estate Planning.)
The Importance of Flexibility and Simplicity
With today’s long retirement time horizon, it’s a genuine mistake to restrict flexibility. Products that impose sizable surrender charges or lock in serial payments are problematic. Circumstances change and you’ll want to change with them.
Many of us have far too many accounts. There are old 401(k) accounts for jobs we left years ago. There are bank accounts where we used to live and online accounts that seemed like a good idea at some point. This creates an absurd amount of unnecessary paperwork and coordination. Eliminate small holdings too. It can be fun to own shares of Disney, Harley Davidson or Facebook, but for most of us, those holdings are tiny relative to our overall portfolio. Fun perhaps, but unproductive and inefficient. Time to simplify life and get serious.
Taking the time to review your retirement income streams, distributions strategies, and investment and estate plans will enable you to create a solid foundation on which to build a retirement you can count on and enjoy.
(For more from this author, see: How to Create a Low-Risk, High-Return Portfolio.)