A Rounded Approach to Retirement Income
However, there is more to retirement planning than just looking for how to generate the most income, or even match a typical amount of retirement income. It’s important to take a holistic approach. Consider what you want from your retirement, how you manage your finances, and the types of investments available to help you reach your goals.
Retirement Goals Drive Investing Strategy
Different goals require different ideas and strategies. Some investors want to maintain their current lifestyle throughout their sunset years. Others may want to leave a legacy, which requires a plan that can produce income well past retirement’s end. Defining what you want is the first step in being able to estimate an appropriate cost of living, which we believe is necessary when determining how much retirement income you need.
Remember, Expenses Can Change
Next, estimate how your costs may change immediately once you retire. For example, if you’re no longer commuting to work, you may spend less on gas. But now that you have more free time, you might spend more on discretionary items like travel. It can be helpful to look at expenses again a few months after you’ve retired to see how your estimates matched and whether any adjustments are necessary.
In an ideal world, you should have sufficient income in retirement to cover your expenses with some room to spare. That way, it could be easier to treat yourself to some of retirement’s non-essential rewards—fine wines, a boat, exotic vacations, a classic automobile or whatever else you’re interested in—while continuing to see your funds grow. However, it’s wise to continue checking your expenses relative to your investment plan so you can remain on track to achieve your long-term goals.
As the great Heraclitus said, “everything changes but change itself.”
Retirement is a big adjustment and can look very different for everybody. Retirement income planning should be flexible enough to anticipate potential changes in spending and lifestyle. Many factors can affect your retirement income, but there are some key items to consider:
Retirement Income Considerations
Not anticipating out inflation can erode spending power is one of the most common mistakes investors make. As prices increase, retirement income must also increase if you want to maintain or grow your nest egg over time. Inflation affects all forms of savings, especially investments that provide fixed income streams.
Increased medical costs:
It’s basic biology that our bodies are more prone to injury and illness as we age. So it is reasonable for retirees to assume they will face emergency or unplanned medical costs more often in their futures. Historically, medical costs have experienced higher inflation than other categories, so it’s important to plan ahead. Additionally, many underestimate the burdening costs of long term care, which can quickly drain retirement savings if people aren’t prepared.
Rising (or falling) interest rates:
Some investments, like bonds, are heavily influenced by changing interest rates. If you are relying on income streams tied to interest rates and interest rates fall, then you may find it difficult to secure the same level of income when you need to replace maturing securities.
You should conduct a review of your expenses at least once a year—or if a material change in circumstance like a health problem requires you to.
How You Save Impacts How You Can Spend
The type of accounts you use to save can have big impacts on your retirement income strategy. This is because various retirement savings accounts have different tax implications. Depending on your time horizon, cash flow needs and other factors impacting your tax situation, you may want to consider adjusting your strategy to better align with your retirement income goals.
Required Minimum Distributions (RMDs)
RMDs are another factor to consider with IRAs. Past the age of 73 (70 ½ if you reach 70 ½ before January 1, 2020), people are required to withdraw a minimum percentage from their IRA annually. Failure to withdraw a RMD, failure to withdraw the full amount, or failure to withdraw the RMD by the applicable deadline, will result in the amount not withdrawn to be taxed at 50%. RMD’s on Roth IRAs aren’t required until the death of the account owner.
This is an important factor to consider as it may have implications on what accounts you use to generate your income. Again, there are many complexities around both how these RMDs are calculated and what accounts they apply to, which can make it beneficial to work with both a professional tax advisor and money manager capable of guiding you through them.
Choose the Right Asset Allocation
Similar to how different account types can impact retirement income, the types of investments you hold can impact your funds during retirement because they each have their own benefits and risks. We believe your asset allocation (mix of stocks, bonds, cash and other securities) is one of the most important choices an investor can make. Having the right asset allocation may ultimately make the difference between having the income you need to serve your retirement goals and running out when you need it most.
Bonds Have Risks, Too
Perhaps more significantly, if you’re a long-term investor, holding too much of your portfolio in bonds can leave you at risk for not having enough growth to reach your long-term goals. While they can be very useful for generating income, they may be less useful in helping your investment portfolio keep pace with rising costs of living.