The process for planning a comfortable retirement should begin early in your career. Today’s pre-retirees must consider a myriad of issues, in addition to determining if they have enough capital to maintain their financial independence throughout retirement. While the amount of capital is central to the planning process, other key considerations may be overlooked if they do not have a direct bearing on the spend goal.
It is critical to discuss all of these subjective components in detail to help ensure that your retirement plan is both comprehensive and aligned with your long-term objectives. Before making plans to travel the world, lowering your handicap or focusing on your favorite nonprofit endeavor, consider these five key financial matters. (For more, see: What is the Size of the Average Retirement Nest Egg?)
1. Time Horizon and Lifestyle Changes
It’s essential to clarify when you’re going to begin to draw from your portfolio. While saving for retirement is no small task, the compounding effect of adding to your portfolio as a pre-retiree and benefiting from compounding interest is a significant factor in creating a meaningful nest egg. Your desired timeframe to stop saving and to begin withdrawing money is critically important.
Additionally, anticipated lifestyle changes should be factored in prior to retirement. It’s ideal to make decisions that will result in large financial outflows - such as moving, renovating a home or purchasing a second home - while you are still earning an income and there is some flexibility in your budget. A significant outflow of capital may deteriorate your portfolio and compromise your ability to achieve other objectives in retirement, especially if the outflow is more significant than anticipated. The clearer your budget and short- and long-term spending goals are before you retire, the more likely a smoother transition into retirement.
Lastly, your ability or willingness to work and generate income throughout retirement may have a substantially positive impact on your nest egg. Potential capital outflows and inflows can have a significant bearing on the final outcome of your retirement spend goal, so it’s important to include these considerations in early modeling stages.
2. Liability Management
As you approach retirement, it is important to analyze your debt in terms of the outflow it represents, in addition to determining if you will continue to maintain the same levels of debt after you retire. There is a tax implication to consider as well, as mortgage debt provides a modest income tax deduction.
It is also vitally important to make sure that your future borrowing facilities are in place before you retire, even if you don’t anticipate using them. Credit facilities, such as home-equity lines of credit, are very difficult to establish once you have stopped earning income. You may be unable to acquire a home-equity loan once you are retired, regardless of your asset level or the amount of equity in your home. Given the 2018 tax laws, deducting home-equity interest may be much more difficult, as well. Consider setting up a security-based loan against your non-IRA portfolio. It may be more tax efficient than a home equity line of credit. At this time, net investment interest expense is a deduction up to the amount of taxable investment income your portfolio generates. (For more, see: Retirement Investment Strategies by Age.)
3. Wealth Transfer
Focusing on wealth transfer planning can also help you align your financial affairs with your retirement goals. Despite the recent increase in the unified credit provisions per the 2018 tax law changes to $11.2 million per person, it’s important to review and update key wealth transfer documents as you approach retirement. Remember, even if your assets are below the level of exposure for federal tax, states have their own inheritance taxes.
Make sure that your beneficiary designations are still consistent with your wishes, and that your living will, healthcare directives and powers of attorney are up-to-date and relevant in the state in which you reside. Many people who change residences when they retire fail to recognize that each state has specific nuances when it comes to these documents. Lastly, review your wealth transfer plan with your financial advisor to help ensure that your assets are set to move to the people, and in the portions, that you desire.
4. Benefits in Retirement
There are numerous income tax and state tax issues that come into play as you transition employer-sponsored plans and benefits into your own IRAs. You should also have a very clear understanding of the benefits, if any, that will still be available to you as a retiree. These could include insurance plans and deferred compensation payment schedules.
However, the two primary areas of focus should be Social Security and Medicare benefits. Many people are not eligible for Medicare until age 65, and the earliest they could access Social Security is age 62, with most receiving a full benefit after age 66. Marital status, your level of past compensation, as well as your spouse’s, will influence a number of preretirement decisions. It’s also vital to understand your Medicare benefits as you approach your early 60s. For many, Medicare will provide only a portion of the benefits that were provided under a robust employer sponsored healthcare plan. For this reason, it is wise to research Medigap policies in your early 60s that will help bridge the gap between your existing needs and what Medicare will cover.
5. Portfolio Composition and Risk Tolerance
When you get closer to the point of needing regular income from your portfolio (about two or three years before you retire), the portfolio should be positioned in such a way to help minimize risk and volatility so that your standard of living is not compromised. This defensive posturing should be in conjunction with a retirement income withdrawal strategy to help you replicate your income stream as you begin to live off of your portfolio.
The composition of your portfolio may also change if there is a change in your tax status. Many retirees are in a slightly lower tax bracket than while they were working, so a detailed review of your asset allocation and asset location strategies, as well as the fixed-income portion of your portfolio, is important. The goal is to achieve high returns with the least amount of risk, so if you have investments in tax-free bonds or tax-sheltered investments, your needs may change in a lower income bracket.
Retirement readiness involves more than capital accumulation. (For more, see: When Retirement is Around the Corner.)
Disclosure: The Sarian Group is a group of investment professionals registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered though HighTower Advisors, LLC.