A common question we hear at HCM is “How do I retire? I’ve never done it before!” Well, we’re here to help. This blog will talk you through the basics of planning for retirement, how to be financially prepared for retirement, and when a good age to retire might be. The best retirement plan is the one that is personalized to your individual retirement desires and needs; with hard work, diligent saving, and our guidance, we can put you in a good position to realize that.
Planning for your future retirement
It’s easy to procrastinate on retirement planning – it can feel so far away, and there are so many other pressing concerns in life. By virtue of compounding, the earlier you start, the better off you’ll be. Step one is to know what you’re aiming for: do you know how much you’ll need in retirement? If you do, you’re doing better than most; only 40% of Americans have calculated what they’ll need to save for retirement. If you haven’t, a quick way to “guesstimate” it is to assume you’ll need 80% of your current income in retirement (so multiply your current income by 0.8), subtract out the amount you expect to receive from social security and any pensions you might have, and that’s what you’ll need to make up with savings and investments. Assuming a 4% withdrawal rate, multiply that total by 25 and you’ve got a ballpark estimate of your savings goal. Of course, if your post retirement plans include a lake house or exotic travel, you will need to set a higher target.
Now that you’ve identified your savings goal, what do you do with it? If you’re on track or exceeding it, well done. If you need to catch up, check out our blog on making up shortfalls in retirement. Now, to complicate the analysis you need to consider how your retirement income will be taxed? Remember that $1,000,000 in a 401(k) plan will be substantially less after taxes are paid on your distributions. How will your Required Minimum Distributions (RMDs) be taxed later in life? Also, it’s important to map out your retirement income timeline and build an appropriate safety net to help protect your nest egg in the event of turbulent markets.
Of course, there’s more to retirement than savings. How do you want to live in retirement? Do you want to stay where you are or see the world? How important is being close to family? Are there hobbies you’ve always wanted to cultivate? Do those require you to live in a certain area or spend large sums of money? In our many years of helping people design retirement income plans, HCM has found it makes for a much happier retirement if you to retire to something rather than simply retiring from something. What are you retiring to?
What does an ideal retirement portfolio look like?
As is true with most things in life, retirement portfolios must be balanced between competing interests: in this case, stability and growth. Lean too hard on the growth side and market volatility or sequence risk may cause problems. However, if you weight your portfolio too heavily in the opposite direction, clinging too heavily to stable returns from things like bonds, you risk losing purchasing power to inflation, robbing you of financial security. So how do you navigate these treacherous waters?
At HCM, we do it with careful investing, actively managing your portfolio based on your age, expected date of retirement, risk tolerance, and other relevant factors, and relying on dividend growth stocks to provide a dependable source of income in retirement. In general, during your accumulation years (when you’re still making money and investing for retirement), your portfolio may be tilted toward a more aggressive stance; given a long enough time frame, the market usually provides a 10% return to investors. You’ll want some bonds in your portfolio, for balance, but as long as you don’t plan on living off your investments for a while, volatility shouldn’t be a problem, and sequence risk only applies when you start withdrawing assets. As you move closer to retirement, you may want to shift your investments to be a bit more conservative. Although the market returns 10% on average, roughly a third of years have had negative returns. The market has experienced negative volatility of 30-40% five separate times.(not including the coronavirus volatility). We can’t know when the next big dip will be, so we may begin to reduce exposure to market volatility by shifting a portion of the portfolio to fixed income assets and other alternative investments. The specifics vary with market conditions, but this will get you most of the way there.
The stocks we do stay invested in during distribution years are overwhelmingly dividend growth stocks. These are stocks that pay dividends that have grown historically for several years. Why? It’s our philosophy that for income to be secure it must be in cash, dependable, diversified, and growing faster than inflation. Dividends are in cash – they represent a direct payment to you, the shareholder, on a quarterly basis. Ditto with dependable – you can practically set your watch to when you’ll be receiving the income. Diversification is key – knowing the average dividend per sector allows us to diversify to balance returns versus stability. Going strong in one sector can realize big short-term gains, but it leaves you open to a possible negative swing if bad news breaks out in that sector. By diversifying, our plan protects you from such an event taking out all your savings. Finally, ensuring the dividends paid by the companies you’re invested in grow faster than inflation is an art we’ve practiced for 30 years. A carefully selected portfolio of dividend paying stocks has the potential to handily outpace inflation over time. But, over some short time frames, inflation did outpace dividend growth. By employing a fine-grain analysis and choosing stocks that have shown dividend growth for several years, we aim to outperform the “average” return and help provide our clients with real peace of mind to enjoy financial security in retirement.
Tips for becoming financially prepared for retirement
Congratulations! You’ve worked hard, saved well, and made smart decisions. Now it’s time to reap the rewards. How do you do it? If you haven’t already done so, it’s good to build up a safety net of reserves that, when paired with your predictable income from sources such as Social Security, dividends, interest and pensions, could cover your spending needs for about 5 years. Next, it’s important to create a retirement budget including long-term tax projections. What are your necessities (base needs in HCM lingo), what are the luxuries (lifestyle needs) you want to purchase, and how will you pay for them? Once you’ve worked out a budget, write it down and make sure to revisit it at least annually to see if adjustments are needed.
In thinking about your retirement spending plans, you will need to decide if you want/need to work in retirement. An encore career can be a great way to stay busy and bring in some money. You’ll have to gauge your aspirations and income to see if part-time work is a fun hobby or a financial necessity for your life, post-retirement.
There are some more specific questions that need to be answered: for example, assuming you have a 401(k), do you roll it over to an IRA, keep it with your former employer, or cash it out? Should you convert any retirement assets into Roth accounts? How will you manage your taxes to ensure optimal financial security? If you’re not sure, don’t worry; our team can walk you through this process.
Also, it’s important to understand your health options and important deadlines. For example, when you do turn 65, you’ll want to sign up for Medicare promptly. You could even do it three months before your birthday, if you’d like. But, if you wait too long, you’ll pay a lifetime penalty. It is also important to develop a plan for how you will pay for long-term care expenses if they come up. Consider your health, your family history, and what you would want to happen should you fall ill when making this choice. The solutions most people consider involve some combination of long-term care insurance, self-insurance, family assistance, and home equity.
At what age do you plan to retire?
You may have just planned to work until you got tired of it and then called it quits, but as most things in the financial planning world, it can pay dividends to be strategic. Too often people are forced into retiring prematurely because they are a caregiver for a family member, they have health concerns of their own, or they face an early termination at work. In any of these cases, it’s very helpful to have mapped out your income streams (investments, social security, pension, etc.) as well as when you’re going to be able to access them in advance. Some types of accounts have penalties if you make withdrawals from them too early, and others have incentives for delaying withdrawals.
A big variable in when you choose to retire is when you plan on collecting social security. You can access it as early as 62, but you gain an 8% bonus for every year you abstain until you’re 70. Also, it’s important to evaluate your and your family’s health: how long have your relatives lived, and do you expect to live about the same number of years? Also, will you be able to maintain your health insurance when you retire, or do you need to wait for Medicare? How do your benefits stack up against your spouse’s and is there a strategic benefit in claiming one benefit early and deferring the other? Do you qualify for another person’s benefits (such as survivor’s benefits), or do other people qualify for benefits on your record? These are all important questions to answer before determining when you should begin to take your social security benefits. HCM has special tools to help you with this decision.
As with most complex decisions in life, it’s best to have a plan. That plan should cover the technical, tax, risk management and investing side of retirement as well as the social side of retirement. Also, you can’t neglect your health, both in terms of selecting whether or how much, if any long-term care insurance you’d like to carry as well as when you choose to finally retire. At HCM Wealth Advisors, we’re here to help walk you this process so that you can make well informed decisions to benefit you and your family.