With average life spans becoming longer and longer each decade, it is important to plan for your retirement years, including your older years. When my father was born, on average men only lived into their 50s and 60s. Now, 70s and 80s is considered normal and living into your late 80s and even 90s is much more common place.
This fact will put an additional burden on your retirement savings, especially in the older years, and planning for this is more important than ever before. So, why wait until your retirement years to actually retire? If during your career “working years” you maximize your savings going into your retirement/investment accounts you may be able to retire earlier than you thought, before you are even old enough to collect pensions or Social Security.
The challenge is knowing how to manage your money so it provides a stream of income once you retire. This includes figuring out how to withdrawal income from your investment accounts to support yourself and others during the “early retirement” years before pensions and Social Security kicks in, yet maintain some growth so you’re able to have income during your older retirement years. Here are the keys to making your plan work for you.
PLAN THE AMOUNT YOU WILL NEED
Planning from the start, you’ll need to determine how much income you will need immediately and then potentially for the next 40 years. It is important to plan for the early retirement years as well as the long time frame, usually 90 years for men and 92 years for women is a good rule of thumb. Before planning can proceed it is especially important for couples to get a handle on what they actually spend and what they truly need to spend in the years ahead. Each individual or couple will be different but this figure is best worked out by looking at fixed and variable monthly expenses then annualized expenses to come up with a reasonable and workable amount. Whether the number is $50,000 or $150,000 per year, determining what it is and sticking to it is going to be the key to planning for your portfolio to last 40 years.
PROPER ASSET ALLOCATION
Getting the mix of assets right is important. Back in the days when interest rates where at more historical norms, a retiree would begin reallocating their investment accounts toward fixed income securities such as bonds to reduce risk, gain safety and enjoy a healthy income stream. However, in today’s low interest rate environment, it is not as easy to find good yields in bonds and retirees are going to need to leave a much higher percentage of assets in dividend stocks and high growth equities. It is also suggested that every couple have a minimum of five years of living allowance for an emergency cushion. Most economic cycles last about 5 years so this is a good rule of thumb, even though after the 2008-2010 recession there was a fairly quick recovery, thanks to Federal Reserve intervention, this can’t be counted on so an emergency cushion is a very important part of the plan.
Getting the asset allocation planning right is also important because of inflation. Inflation will eat away at the value of your savings. Stocks offer the best potential for fighting inflation over the long term. Many people believe that retirement means you need to invest everything in low-returning money market accounts or certificates of deposit at the bank. While these investments do offer low risk to principal, you should also consider the risk that your assets will not keep pace with inflation. Although past performance is no guarantee of future results, stocks have historically outpaced inflation by the widest margin and have provided the strongest returns over the long term. So you should consider keeping a portion of your portfolio invested in stocks and stock mutual funds throughout your retirement years so you don’t run out of funds early. Maybe even 30-50% of your assets should be spread among large, medium and small cap stocks including international growth stocks to stay ahead of inflation and keep the fund growing into the “out” years. Think high value companies with good dividends. The remaining funds should be in stable high quality bonds and other fixed income securities, avoiding high yield bonds with similar risk levels to equities.
SMART WITHDRAWALS
It is also a good idea to create a smart withdrawal plan. This plan will generally include withdrawing funds from taxable accounts first, allowing any tax-deferred accounts to continue to grow throughout your early retirement years. There are rules about when you can start making withdrawals from tax-deferred accounts (age 59 without a penalty) and you must start withdrawing funds from tax-deferred accounts generally by the time you are 70 1/2 years old. Be sure and check with your retirement account specialist for the details on these rules.
A good rule of thumb to determine how much to withdrawal, used by many experts to make sure that a couple doesn’t run out of funds, is about 3 to 4 percent annually. This is generally considered a safe range for annual withdrawals which allow for inflation and some continued growth in your investment accounts throughout your retirement years. However, this is just a rule of thumb and each individual and couple’s circumstances are unique and need to be taken into consideration. There are no guarantees and you need to be somewhat flexible to account for market swings and unexpected needs.
For example, a high withdrawal rate combined with a market downturn may put a couple who is spending a lot in the beginning years at risk of running out of money in the “out” years.
BOTTOM LINE:
Planning for retirement early is the most important step. Understanding what you need and when you will need it, how to allocate your funds properly to allow the market to keep working for you to meet your needs in the near term and the long term, and when/how to withdrawal your funds is critical to retirement success. Always check with your accountant, financial advisor or retirement professional for specific planning in your circumstances. Remember: Save Early, Allocate Properly and Withdrawal Smartly.