To plan for your retirement, look beyond online income calculators
We’ve all heard of the problems with relying on numbers: garbage in, garbage out; liars make figures, and figures lie; 87.2% of statistics are made up; And so on. Still, some people plan their retirement income by answering certain questions in an online calculator, reviewing the results, and checking the box indicating that their retirement planning is complete. They think they are good because the software says so.
Retirement income planning starts long before you calculate the numbers. You may know when you want to retire How many you wish to receive each month, and What you want to retire. But before you decide you’re ready to go, you need to consider some key planning variables: in particular, how you feel about returns, taxes, timing and risk. In other words, what do you expect to earn from your investments, how much of your income will be taxed, how many years will you need that income, and what could go wrong and change your goal of retirement income? Answering these questions not only helps you calculate whether you’ll have enough in retirement, but also makes it easier to develop strategies that will make your plans more realistic and secure.
So before calculating retirement income numbers, consider first grappling with the assumptions you’re using and what you think of them.
Once you start decumulating your retirement investment portfolio, you use a new set of assumptions. Of course, you always want to maximize your return while minimizing your risk. But your yield is not what appears on your brokerage statement – it is how much you pay yourself each month. And the risk is that you run out of money before you run out of oxygen. Also, since you’re decumulating your portfolio in order to maintain a standard of living in retirement, the return on your portfolio assets really needs to be viewed in terms of the spread – what’s the spread between what you’re earning on your assets and cost of living? Since you can’t invest to get out of an income shortfall in retirement, it makes sense to aim for an overall return on assets a few percentage points higher than the rise in inflation. Tactically, this leads to two approaches. If you are risk averse, lock in sources of income that you cannot survive, such as buying annuities. If you are risk tolerant, invest for a positive spread generated by a diversified portfolio of fixed assets and equities. Whichever route you take, have a backup plan in case inflation or bad markets unexpectedly eat away at your wealth.
Retirement income is an after-tax proposition. Retirees need to know how much they will have, in the hand, to be spent each month. The challenge is that retirement taxes are insidious. Pre-retirees assume that their earned income will disappear once they leave work, and with that, most of their taxes. The problem is that there are retirement-centric taxes lurking in the background, like Social Security’s tax torpedo and Medicare’s Monthly Income-Related Adjustment Amount (IRMAA). And for more affluent retirees, there’s net tax on investment income and federal estate and gift tax. Although it’s a maze of complications, there are four guiding principles that can help you figure out how you feel and handle tax planning:
– Although taxes are unavoidable, amount tax that a retiree pays is highly subject to planning. With ongoing tax management, you can legally reduce your taxes in retirement, often by a considerable amount.
– Your taxes will not be the same each year after retirement. There are age-based taxes such as Required Minimum Distributions (RMD), IRMAA, and Social Security Provisional Income Tax. Tax planning is not a one-size-fits-all strategy.
– Asset location – in other words where, not How? ‘Or’ What, your money is invested – has a dramatic effect on how much and when you pay taxes. Typically, retirement assets are found in taxable accounts (your after-tax investments), tax-deferred accounts (your IRAs and 401(k)), and/or tax-free accounts (primarily your Roth IRAs). Each month, your after-tax net retirement income will depend heavily on the account you draw on.
– Finally, the higher your net worth and income, the higher the proportion you are likely to pay in taxes. It is not just a function of higher marginal tax rates associated with increases in income. It also concerns taxes and surcharges for wealthy individuals. This includes so-called “precipice” taxes – such as the IRMAA or the gift tax – where an extra dollar leads to a tax increase of around 40%.
How long will you live in retirement? Web calculators often assume that you will retire at 65 and die at 90. Is this realistic in your case? First, define “retiring”. There is a trend towards phased retirement where the worker downsizes, continuing his job for several years for reduced earnings. This added wrinkle affects Social Security filing, tax strategies, and health insurance decisions. Second, for married couples, the calculation of retirement income changes significantly. Not only are you dealing with two life expectancies, but there are also bizarre tax and benefit rules regarding the death of the first spouse.
In today’s environment where employers primarily offer defined contribution plans such as 401(k) plans, a key timing challenge is that your retirement income payments may not match your life expectancy – your income can stop before you do. Americans have far fewer sources of guaranteed lifetime income than in the past. They have Social Security and, if they’re lucky, a defined benefit pension plan. Otherwise, most retirees turn to their 401(k)s and investments for systematic income withdrawals. This means that the individual, not the employer, bears both the risk of investing the 401(k) product and matching their withdrawals to life expectancy.
For many retirees, major sources of income will be periodic. Examples include installment payments from the sale of a business, life insurance cash value withdrawals, reverse mortgage payments, deferred compensation arrangements, and other income streams that are terminated. You need to prepare for a time when some of your sources of income will stop but you will still be alive.
When you retire, the risk remains. But like a snowflake, no retiree has the same risk profile. That’s why a standardized retirement income calculator can’t get you there. Before you lock in your plan, ask yourself what risks you’ll face in retirement and which ones are particularly relevant to you. It may be helpful to divide common retirement risks into groups:
– Survive your Resources is obvious, but its causes are not. Beyond living longer than expected, other culprits can be inflation and spending more than is sustainable.
– Risks related to aging can be misleading. Rising health care costs are clearly a monetary risk, but there are also expenses associated with frailty and long-term care. Sometimes it’s the little things that can break a budget – meal preparation, financial assistance, making your home wheelchair accessible. Everything adds up. And with aging also comes the particularly frightening proposition of elder abuse.
– Investment risks are always a concern, but the sequence of return risks is particular to retirement planning. The problem here is when you retire. The risk is that your portfolio will experience lower returns just as you retire and start to dip into your assets. Let’s say you retired a year ago. You may have withdrawn 4% from your 401(k) for retirement income, but your underlying assets may have shrunk by 20% due to the current poor stock market. When this happens early in retirement, there is little opportunity to recoup those losses; Remember that your portfolio is intentionally decumulated to meet your retirement income needs.
– Occupational and family risks are specific to each retiree. With work, issues may include forced early retirement, loss of employability during phased retirement, or employer insolvency. With family, the big issue is often the loss of a spouse, but there is also the risk of unexpected family responsibilities like raising a grandchild. These family risks are not only difficult emotionally, but also financially.
Retirement risks do not lend themselves to easy analysis. For example, who can predict variables such as the Social Security system running out of money or increasing health insurance premiums? Although retirement planning software can do incredible things in calculating income and creating investment and tax strategies, there is no algorithm that can accurately quantify your retirement risks and predict what you will be facing. think.
Before doing the numbers
Retirement income planning needs to be put into context. You are blessed with choices in how you approach creating your standard of living during your golden years. You have a say in investment, tax planning and risk management. You can look ahead and assess your prospects, prospects and opportunities. The challenge, however, is that much of this problem must be solved before the numbers can be calculated. Ask yourself the tough questions, guess the best assumptions to use, then work your magic with retirement income software.