Can I Retire With What I Have? Understanding the Risks and Steps to Determine Your Readiness
One of the most common questions asked by clients of all ages is, "Can I retire with what I have?" It's a crucial question that requires careful consideration and analysis. The decision to stop working and transition into retirement is a significant milestone in life, and it's important to understand the risks associated with this next phase. In this blog post, we will explore some of the key risks to consider and outline steps to help you determine if you have enough to retire.
Risks to Consider Before Retirement
Longevity Risk:
With advances in medicine and improved living conditions, people are living longer than ever before. While this is undoubtedly a positive development, it also means that you need to plan for a longer retirement. Outliving your savings can be a significant concern, as it can lead to financial hardships later in life. It's essential to factor in the possibility of a longer life expectancy and ensure that you have an adequate financial buffer to sustain yourself throughout retirement.
Sequence of Return Risk:
This risk refers to the potential impact of market fluctuations on your retirement savings. If you retire and experience a significant market downturn early on, it can significantly affect the longevity of your savings. If you rely heavily on your retirement savings for income, a poor sequence of returns can deplete your portfolio faster than expected. Developing a strategy to mitigate this risk, such as diversifying your investments or adjusting your withdrawal strategy, can help safeguard your retirement experience.
Inflation:
Inflation is a critical factor to consider when planning for retirement. Recent market conditions have demonstrated how inflation can erode the purchasing power of your savings. It's important to anticipate the rising cost of living during retirement over many years. If your projected costs increase at a faster rate than the average inflation rate, you may face a shortfall or a decline in the satisfaction you expected from your retirement income. Accounting for inflation and incorporating it into your retirement budget is crucial for long-term financial security.
Medical Expenses:
One often overlooked aspect of retirement planning is healthcare costs. Medical and long-term care expenses can be significant burdens during retirement. The average annual cost of a nursing home is around $75,000, and most individuals spend about three years in such facilities. To ensure financial stability, it's prudent to allocate a substantial amount for healthcare expenses in your projected budget. This includes accounting for premiums for Medicare and setting aside funds for any potential emergencies. Neglecting to factor in medical expenses can lead to financial stress and potential hardships later in life.
Steps to Determine if You Have Enough to Retire
Change Your Mindset:
Transitioning from saving to spending your hard-earned assets can be psychologically challenging. It's important to shift your mindset and understand that depleting your savings is part of the retirement process. Having a well-thought-out plan in place can provide the peace of mind necessary to stay dedicated to your retirement strategy.
Analyze Your Current Cash Flow and Balance Sheet:
Understanding your current financial situation is crucial in determining your retirement readiness. Conduct a thorough analysis of your cash flow, identifying where you stand today and where you will be in the future. This analysis will help you identify areas where you can potentially reduce expenses or identify expenses that will decrease or disappear upon retirement, such as savings contributions.
Build a Projected Retirement Period Budget:
Once you retire, you no longer need to allocate funds for savings. The general rule of thumb is that you will spend around 80% of your pre-retirement expenses due to the elimination of retirement contributions. Creating a projected retirement budget allows you to forecast your expenses, accounting for inflation and increasing costs over the years. Be cautious of creating a spending estimate that is too low just to fit your plan. Spending too much during retirement because you weren’t conservative enough with your projected budget can be devastating to your retirement plan.
Review All Sources of Income:
Retirement income comes from various sources, including savings, pensions, annuities, Social Security, and potentially other investments. It's essential to review and understand how much income you will receive from each source. This will help you align your expenses with your income and ensure that you can sustain your desired lifestyle during retirement.
Create a Withdrawal Strategy:
Developing a sound withdrawal strategy is crucial to maximize your retirement income and minimize tax implications. A commonly recommended approach is to spend your taxable assets first, followed by tax-deferred assets, and finally, after-tax assets.
Taxable Assets: These include checking accounts, savings accounts, and brokerage accounts. It's beneficial to keep at least three years of expenses in cash or low-risk investments to mitigate sequence of return risk. Spending taxable assets first allows tax-deferred and after-tax assets to continue growing. Additionally, since taxable assets are not subject to income tax, you may have an opportunity to convert some of your tax-deferred assets into after-tax assets.
Tax-Deferred Assets: These include traditional IRAs, 401(k) plans, annuities, and pensions. Withdrawals from these accounts are subject to income tax. By spending down your tax-deferred assets after depleting taxable assets, you can manage your income to potentially keep more of what you spend. It's important to control your income at this stage to avoid being pushed into higher tax brackets.
After-Tax Assets: After-tax accounts, such as Roth IRAs and Roth 401(k) holdings, should be spent last. These accounts offer several benefits, including no mandatory withdrawals (required minimum distributions - RMDs) and potential estate planning advantages. Since after-tax accounts have already been taxed, your beneficiaries can inherit them without incurring additional tax liabilities.
Optional Step. Tax Relocation:
Depending on your circumstances, it may be advantageous to consider adjusting the tax location of some of your assets. Moving more assets to after-tax accounts, such as a Roth IRA, can help control the amount of your required minimum distributions (RMDs) and potentially prevent higher tax obligations. However, this step isn't necessary for everyone, and it's crucial to work with a qualified financial professional to determine if it aligns with your overall retirement plan.
Review Annually:
It's important to remember that retirement planning is not a one-time task. I am constantly telling my clients that the plans that I build with them will be wrong at some point. This is because as your goals, financial situation, and the economic environment change, so does inputs of your plan. Regularly reassessing and adjusting your retirement strategy ensures that it remains on track to fund your retirement and mitigate as many risks as possible.
Conclusion:
Determining if you have enough to retire requires careful consideration of various factors and risks. It's essential to understand the risks associated with retirement, such as longevity risk, sequence of return risk, inflation, and medical expenses. By following the steps outlined in this blog post, including changing your mindset, analyzing your current financial situation, creating a projected retirement budget, reviewing all sources of income, and developing a withdrawal strategy, you can gain confidence in your retirement readiness. Remember to seek professional advice and regularly review your plan to adapt to changing circumstances and maximize your chances of a financially secure retirement.
Fiduciary Mission:
At Integritas Financial(IF), we are committed to providing fee-only, fiduciary financial planning services that are tailored to the unique needs of young professionals, particularly millennials. IF works with you to develop customized financial plans that address key areas such as estate planning, trusts and wills, retirement, workplace benefits, education funding, student debt, and buying a house.
IF believes in transparent, client-focused service that puts your financial goals at the center of everything we do. As a fiduciary firm, IF is dedicated to acting in your best interests, and we never sell products that charge commissions to clients.
IF’s goal is to help you achieve a stable and prosperous financial future by providing comprehensive financial planning services that are tailored to your individual needs. Whether you're just starting out in your career or you're already well-established, IF can help you navigate the complexities of financial planning and create a roadmap for success.