Q: When should I retire? How much income will I need? How much can I afford to spend from my investments each year in retirement?
A: These are all terrific questions.
Unfortunately, the answers aren’t always the same. Managing money in retirement involves decisions about withdrawal rates, asset allocation and a host of other factors that will impact your lifestyle and how long your assets will last. Following are some straightforward answers to commonly asked questions about planning for income needs in retirement.
Asked and answered: Key questions about retirement income planning
When should I begin thinking about tapping my retirement assets, and how should I go about doing so?
The answer to this question depends on when you expect to retire. Assuming you expect to retire between the ages of 62 and 67, you may want to begin the planning process in your mid- to late 50s. A series of meetings with a financial advisor may help you make important decisions, such as how your portfolio should be invested, when you can afford to retire and how much you will be able to withdraw annually for living expenses. If you anticipate retiring earlier than 62 or working later than 67, you may need to alter your plans accordingly.
How much annual income am I likely to need?
While studies indicate that many people are likely to need between 60-80 percent of their final working year’s income to maintain their lifestyle after retiring, low-income and wealthy retirees may need closer to 90 percent. Because of the declining availability of traditional pensions and increasing financial stresses on Social Security, future retirees may have to rely more on income generated by personal investments than today’s retirees. Whether or not you own your home entering retirement will also have an impact on these percentages.
How much can I afford to withdraw from my assets for annual living expenses?
As you age, your financial affairs won’t remain static: Changes in inflation, investment returns, your desired lifestyle and your life expectancy are important contributing factors. You may want to err on the side of caution and choose an annual withdrawal rate somewhat below 4-5 percent. Of course, this depends on how much you have in your overall portfolio and how much you will need on a regular basis. The best way to target a withdrawal rate is to meet one-on-one with a qualified financial advisor and review your personal situation.
When planning portfolio withdrawals, is there a preferred strategy for which accounts to tap first?
You may want to consider tapping taxable accounts first to maintain the tax benefits of your tax-deferred retirement accounts. If your expected dividends and interest payments from taxable accounts are not enough to meet your cash-flow needs, you may want to consider liquidating certain assets. Selling losing positions in taxable accounts may allow you to offset current or future gains for tax purposes. Also, to maintain your target asset allocation, consider whether you should liquidate a portion of an asset class that may have become overweighted (i.e., exceeded your intended allocation).1 Another potential strategy may be to consider withdrawing assets from tax-deferred accounts to which nondeductible contributions have been made, such as after-tax contributions to a 401(k) plan.
In some cases however, tapping your tax-deferred accounts first may also make sense. If you maintain a traditional IRA, or a 401(k), 403(b) or 457 plan, in most cases you must begin required minimum distributions (RMDs) after age 70-1/2. The amount of the annual distribution is determined by your life expectancy and, potentially, the life expectancy of a beneficiary. RMDs don’t apply to Roth IRAs. By tapping these accounts sooner, you may lower your RMDs in the future, potentially providing for lower taxes in future retirement years.
Are there other ways of getting income from investments besides liquidating assets?
One such strategy that uses fixed-income investments is bond laddering.2 A bond ladder is a portfolio of bonds with maturity dates that are evenly staggered so that a constant proportion of the bonds can potentially be redeemed at par value each year. As a portfolio-management strategy, bond laddering potentially may help you maintain a relatively consistent stream of income while limiting your exposure to risk.
When crafting a retirement portfolio, you need to make sure it generates enough growth to prevent running out of money during your later years. To facilitate this goal, you may want to maintain an investment mix that has the potential to earn returns that exceed the rate of inflation. Dividing your portfolio among stocks, bonds and cash investments may provide adequate exposure to some growth potential while also helping to protect against market setbacks.3
As you can see, there is really no one-size-fits-all answer for retirement-income planning. That’s why you should meet with a qualified professional who can help evaluate your specific situation. What may make sense for your friends, neighbors and/or coworkers may not be the best strategy for you. And the sooner you begin your planning, the more comfortable and better prepared you will ultimately be.
Jeremy Gussick is a financial advisor with LPL Financial, the nation’s largest independent broker-dealer.* Jeremy specializes in the financial planning needs of the LGBT community and was recently named a 2012 FIVE STAR Wealth Manager by Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, including the Delaware Valley Legacy Fund, the Greater Philadelphia Professional Network and the Independence Business Alliance. OutMoney appears monthly. If you have a question for Jeremy, you can contact him at [email protected]. LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
*As reported by Financial Planning magazine, 1996-2012, based on total revenues. **Award details can be found at www.fivestarprofessional.com.
1Asset allocation does not assure a profit or protect against a loss.
2Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
3Investing in stocks involves risks, including loss of principal.
There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The purchase of certain securities may be required to effect some of the strategies. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. This article was prepared with the assistance of S&P Capital IQ Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or me, if you have any questions.
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