By Jeffrey C. Simon, CFP®
RBC Wealth Management
As we continue to live longer and are more active, retirement is changing and is different than for previous generations. You may now have to fund upwards of a 30-year retirement. This will take financial planning prowess as you juggle the effects of inflation, distributions, taxes, asset allocation and expenditures. Are you up to the task?
The amount you'll need each year to maintain your desired standard of living is the most critical variable to identify in the retirement planning process. No rule of thumb will suffice. If you are like many baby boomers, your spending will not drop significantly at retirement. In the beginning, you'll be fulfilling the many dreams you postponed during your career and child-rearing years. Later on, the cost of health care will become a significant factor in determining your income needs.
Longevity is perhaps the greatest challenge for boomer retirement planning. Half the population will outlive their life expectancy. A frequent misunderstanding about mortality age is the statistical increase in mortality age that occurs when calculating joint mortality. A male age 65 has a 50 percent chance of living to age 82. A female age 65 has a 50 percent chance of living to 85, but as a couple, they have a 50 percent chance of one of them living to age 92. A worker retiring early at age 55 may need to generate at least 40 years of retirement income. This is the basis for the new definition of long-range planning.
The increased longevity that boomers can expect contributes to the serious risk of inflation, which is the long-term tendency for money to lose purchasing power. This has two negative effects on retirement income planning. It increases the future costs of goods and services that retirees must buy and it potentially erodes the value of their savings and investments set aside to meet those expenses. In prior generations, inflation was not such a worry, since retirees were not expected to live much beyond five or 10 years past age 65. When the Social Security retirement age of 65 was enacted in 1935, the average mortality age for a man was 64.
Explore any and all sources of guaranteed income available when retirement begins. Social Security, pensions and any other income sources must be quantified as to how much, from what source and for how long. Pay careful attention to whether benefits index with inflation or continue to a surviving spouse, since survivor planning is an important part of retirement income planning. This is where wealth management planning tools are needed to project future values and income streams from various types of assets. Retirement accounts will generate less spendable income than investment accounts, because of the taxes due on distributions from retirement plans. Be cautious about considering your primary residence as an investment asset. Be ZIP-code flexible when making your retirement plans. Many areas have low to no income tax and there can be significant differences in the cost of housing and health care.
Health insurance, disability insurance, life insurance and long-term care insurance should also be evaluated. These policies can be expensive and they may not be necessary if you have significant assets. However, they can provide an important safety net in the absence of such assets. For professionals like attorneys, litigation is a very real risk to your retirement assets and professional liability insurance is a must. Divorce is another land mine that can blow up even the best retirement plans, but to date there is no insurance policy available to reduce this risk.
The double whammy of longevity and inflation creates an asset allocation dilemma for boomers. The old adage of subtracting a person's age from 100 to obtain the optimal percentage of equities just doesn't hold for a five-decade retirement portfolio. Invest too conservatively and your money may not grow enough to last your lifetime considering the erosion of long-term inflation. Invest too aggressively and you run the increasing risk of outright capital loss without adding significant years to your plan under average market conditions. Designing a portfolio retirement income is different than designing a portfolio during the accumulation phase.
You can set up regular portfolio transfers to your bank account to enable you to manage your income just as you did when paychecks were funding your expenses. This tends to dampen overspending by imposing some discipline on the withdrawal process.
The withdrawal rate is the one variable over which you have the most control — not your mortality, not your health, not your investment returns, not inflation — just your withdrawal rate. Being realistic about what you can spend and keeping a sufficient contingency reserve fund will ease the pressure that withdrawals put on retirement portfolios.
The challenges facing boomer retirees are significant, but not insurmountable with some realistic and prudent planning.
You will need to consider what you own, what you owe, what you will make and where it will go to develop a workable retirement income plan.
Jeffrey Simon's website is jeffreysimon.com. He works at RBC Wealth Management, a division of RBC Capital Markets LLC, member NYSE/FINRA/SIPC.