During your working years (or what we call the “accumulation phase” of life), you’re earning a paycheck, saving for the future, and building your assets.
During retirement (or the “distribution phase”), everything changes. You’re no longer earning a paycheck or saving for the future because that future is now your present.
You’ll be tasked with the challenge of withdrawing from your savings—but having your savings grow at the same time. You’ll also have to think about your finances in new, unfamiliar ways. Here are nine major considerations to take into account as you enter into retirement.
1. Your Income and Investments Will Become Intertwined
Before retirement, your income and investments, for the most part, were separate. However, for anyone on the doorstep of retirement, income and investments become very intertwined. In fact, at this stage your investments will now need to provide a big part of your income going forward.
Other forms of income, like social security and pensions, also come into play; however, we know that where you can have the most impact on your retirement income, for good or for bad, is how you go about converting your savings into a growing stream of income.
2. Asset Allocation
Asset allocation is making disciplined, well-educated decisions about what percentage of your assets you’ll divide between stocks, bonds, and cash. Academic and real-world studies prove time and time again that this decision drives 94% of investor results.
As you near your retirement transition, you will need to revisit your asset allocation to find the right percentage of stocks and bonds that will help you create a growing stream of income, thereby allowing you to reach your goals. Being disciplined around this decision throughout your retirement journey is critical, only revisiting your decision in conjunction with major life events.
3. Critical Portfolio Maintenance
Many investors set an asset allocation target, but have no outlined process for maintaining that allocation over time. As a result, they end up with a significantly different level of risk than they initially signed up for—and in some cases, a lack of diversification. This breakdown in a portfolio’s structure can ultimately compromise an investor’s life goals.
Over time, due to normal market movements, your allocation drifts from its target. It is critical to have a disciplined process around bringing these targets back into alignment.
4. Withdrawal Risk
In retirement, most people are unaware of what is referred to as “withdrawal risk,” which comes into the picture when you have to take money out of your portfolio, whether to supplement your income or take Required Minimum Distributions. If you do that when the market goes down, you’re forced to sell securities at a loss, thereby locking in those losses. The data tells us that getting back to even is virtually impossible.
Therefore, having a plan in place that will help you manage withdrawal risk becomes key to a successful retirement.
5. Inflation Risk and Your Unique 3 Numbers
Before you retire, you should understand your unique 3 numbers.
- 1st: knowing how much your lifestyle is going to cost you on an annual basis.
- 2nd: how the cost of that lifestyle will grow over the next 30+ years.
- 3rd: how much you will need before taxes in order to support that lifestyle.
People are often surprised that, due to inflation, the cost of their lifestyle will double and sometimes triple over the course of their retirement. Failing to have a plan for growing your income can lead you to consistently going into principal and undermine your wealth’s longevity.
6. Longevity Risk
Longevity risk is exactly what it sounds like: living longer than expected. Along with an extended advanced age comes the increased probability of ever-rising healthcare expenses.
In the past, retirement lasted only a decade or two. Now, people are living longer, and retirement tends to last between twenty-five and forty years. Retirees have to take into account that their retirement investments and income will have to span three-plus decades—a much longer timeframe than previous retirement planning may have indicated.
7. Increasing Healthcare Costs
The current data shows that as a retiree gets older, there is a high likelihood of healthcare costs becoming a larger and larger percentage of their annual expenses. These healthcare costs rise at a dramatically faster rate than the average cost of inflation. Currently, healthcare costs are rising by an average of 8-11% annually.
What we often see during the later years of retirement is that people are spending less on lifestyle costs; however, they are spending more on healthcare costs.
8. Tax Risks
There’s a perception that you’ll be in a lower tax bracket in retirement than you’re in during your working years. For a while, that may be true. But what we see for people who’ve done a great job saving for retirement is that by the time they reach their early 70s, they could be in an equivalent tax bracket. By their late 70s, we see many who are in a higher tax bracket.
Therefore, how you go about withdrawing from your savings will have a large impact on the amount of taxes you pay in retirement.
9. A Plan that Inspires Confidence
During your accumulation years, financial planning is important, but there’s more time to adjust and correct errors. During retirement, there’s less time to course correct. Unfortunately, we’ve seen hundreds of prospective clients enter their retirement years without a plan. As a result, they lack the confidence and clarity they need to truly enjoy retirement.
If you’re entering the transition to retirement, you’re moving into a period of tremendous change, with a lot of critical decision points in front of you. The plan you set now will act as a guide and ensure that, on the other side, you’re able to enjoy the life you’ve worked hard for.
This article was adapted from the book Income for Life by S. Joseph DiSalvo, ChFC, AIF and Marie L. Madarasz, AIF.
Joseph DiSalvo, ChFC, AIF and Marie L. Madarasz, AIF of Quest Capital & Risk Management, Inc. are experts in Retirement Income Planning, who have used a proven process for more than two decades to help clients achieve sustained success and lifelong prosperity.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.