Click this link for access to a free Family Wealth Education Institute class on advanced estate planning and estate tax control/elimination personally taught by Dr. Camarda & “Super Board-Certified Tax Lawyer” John Crawford.
Retirement income planning – the critical path you can’t afford to miss
Like a critical life-saving operation where every move must be perfect and every minute counts, crafting and maintaining a retirement plan entails some of the most important decisions you will ever make. It should go without saying that what we do toward or past the end of our earning years has a grave finality to it, since we typically won’t be able to make more money to replace that lost to poor decisions, nor have the time to forgo withdrawals and wait on a couple of market cycles to make up lost ground. Getting retirement planning right can give us all the income we need for a satisfying lifestyle, with adequate reserves against the risks of higher health care costs and long term care, and to leave a nice inheritance to the people or causes that we care about. Getting it wrong can yield a life of misery and even a shortened one if we can’t afford to pay for the drugs, operations, and other care we may need. This guide could alert you to danger areas that you or your other advisors have overlooked, and brighten your future. If so, I am happy to have helped you and your family.
There are two big dangers in retirement planning that don’t seem to get much media play, so I want to emphasis them before getting into the “traps.”
The first is so-called “longevity risk,” the risk of living longer than expected or assets can support. Lifespans have gone way up – far past your parents’ – and it is likely medical technology will give those that can afford it another quantum leap soon. The risk of running out of money has never been more acute, and the conservative approach is to consider a much longer life expectancy than may seem reasonable to you.
The second is cognitive risk, the irritating truth that our brains just don’t function as well as we age. “Old timer’s disease” does not necessarily mean Alzheimer’s or other forms of dementia. Cognitive declines occur even as part of the healthy aging process, which is probably not good for financial and investment decision making. Recent studies have shown a steady decline in financial decisions quality after 65 or so, perversely with an increase in financial decisions making confidence! In other words, older folks can have rock-solid confidence in poor decisions, and stubbornly cling to them even as they go sliding down the ladder. I can’t think of a better reason for retirees to seek out quality advisors, and take their advice! (For ideas on how to separate the “good” advisors from the others, read my report 8 Big Mistakes to Avoid in Choosing a Financial Advisor – this really open your eyes on how the financial industry works, and can give you solid touchpoints to guide your critical decisions).
Retirement Trap #1 - Setting unrealistic expectations
The nature of human thinking seems to sometimes guide us to the land of make believe. Some us can’t help believing, say, that $1,000,000 (a million dollars!) should be more than enough to provide $100,000 in inflation-adjusted after tax spending income, even if we begin at 60 and have a realistic joint life expectancy to age 90, making for a 30 year payout period! Sadly, the steady near-guaranteed average return to make this true is about 14%, which in nearly every imaginable scenario is hopelessly optimistic – those that believe in such numbers are almost sure to crash and burn.
We see this kind of wishful thinking pretty common in our practice, especially for those who don’t have baseline retirement income flooring (we will discuss flooring in a bit) like from pensions or other sources to give them a concrete budget anchor point to ground their thinking.
In many cases, pie-in-the-sky expectations are a recipe for disaster. Retirees risk blowing through their money, and winding up dependant on children or government programs at a time when they will have no ability to do anything about it! As a reality check, the prognosis for government assistance is not good as we get deeper into the 21st century (already nearly 1/5th over!), with lots of gloom and doom for Social Security, Medicare, and other programs, forecasts that have festered for 50 years or more, with no political gumption to solve the problem even back when it seemed solvable.
The flipside danger to not having a clear retirement income plan is a kind of spending paralysis that afflicts some people, whose unrealistic expectations trick them into believing they don’t have enough money, instead of plenty for whatever they want. Not sure of a safe spending rate, they spend far too little and live far too poorly, and so undermine the retirement lifestyle they have saved their whole lives for.
Retirement Trap #2 - Not tax planning
As I have written extensively about for years (see my 9 Biggest Tax Mistakes and How to Avoid Them report – call 800-262-1083 to get your copy), poor tax planning is probably the biggest impediment to wealth accumulation facing most Americans. This goes double in retirement, when every penny can become more precious.
Many assets have different tax treatments (capital gains vs. ordinary income, expedited and heightened taxation of mutual funds vs. ETF’s, max-bracket and additional excise tax exposure in annuities and IRA’s, max-bracket on interest vs. lower rate on dividends, etc.) and it is very common to see the wrong types of investments in the wrong sort of accounts, such as stocks and other capital gains assets in IRA’s, which can double or more the effective tax rate. Paying attention to lining up account type and asset type tax treatment has been called asset location planning, but is often overlooked by investors and their advisors. But asset location and withdrawal location planning can make a huge difference, with net annual return potential said to be over 3% or more a year ((https://corporate1.morningstar.com/uploadedFiles/US/AlphaBetaandNowGamma.pdf)). On a million dollar nestegg, that could be over $30,000 more a year to spend! Other mistakes include not harvesting capital losses to offset taxable gains, not planning other income around Social Security tax issues, ballooning the amount in Social Security benefits forgone due to higher taxation, and so on.
Retirement Trap #3 - Ignoring home equity
As you have no doubt heard for decades, home ownership is the biggest investment many Americans make. Unfortunately, real estate is fairly rigid and illiquid, and most people go to their deaths never unlocking this sometimes very large pool of resources that otherwise could have lifted their income, lifestyle, and safety margin.
This can be really huge for you. While there are many ways to skin this cat, the three most basic are:
- Sell your home and find somewhere cost-effective to rent. If you can live with moving, the numbers may work so well that your spendable income jumps dramatically. You would also save on taxes, repairs, and breaking your back to keep the place up. This also makes eventual transition to an extended care facility smoother if it becomes necessary.
- If you love your house and won’t consider moving, you may want to use a home equity line of credit, with which you are no doubt familiar already. Downsides are interest rate risk (these are usually not fixed rate so when rates go up your costs do too), tightened rules post-2008 which may make these loan products harder to get and live with, and foreclosure risk – they may actually expect you to pay the money back sooner than is convenient, and if you (or your heirs) don’t the house is toast.
- Reverse mortgages still have a pretty bad hangover reputation, but actually have evolved into fairly good products. While too complicated for me to get into here, the main points are you don’t have to pay the money back during your lifetime, you can’t be forced to move, and come payoff time if the house can’t be sold for what is owed, the government, not your heirs, eat it. While I personally think this is bad tax policy for the country, I think it is very good for you and you should jump on it if this sort of program works for you in boosting income, converting home equity into assets to invest elsewhere or pay off other pesky debt, or just set up a line of credit safety margin facility for you.
Retirement Trap #4 - Poor Social Security claiming choices
Social Security claiming decisions – when and how you take your benefits – can be one of the most bewildering and error-prone choices retirees make, and once done, there is usually no going back to fix mistakes. Since the old “file and suspend” “loophole” has been closed, I won’t give you indigestion telling you about it, but hats off to those readers who had the foresight and good advice to grab the “free money” before the door closed, in some cases producing hundreds of thousands of dollars in additional benefits. A big mistake for many remains taking benefits too early – as soon as available, or not before reaching full retirement age, or even later depending on your fact pattern. If you expect to live a normal life expectancy, you may be leaving lots of money on the table since total payouts to you could be much less than waiting, and getting a bigger check even for a shorter period of years. Not coordinating with your spouse’s claiming strategy is another potentially costly pitfall, as are divorcees not claiming benefits, and not carefully planning job income around Social Security tax traps. Another mistake we see is not checking for errors in the Social Security credit record – it is not uncommon to see government mistakes on past earnings that slash benefits unless corrected. Finding errors and fixing them is not as hard as it sounds, and if you take us up on the free Portfolio Stress Test I’ll tell you about later, we will show you how. If you get the Portfolio Stress Test done, we can also do a detailed Social Security claiming strategy analysis to help guide you toward the best decisions in your personal circumstances, and try to get ahead of this complex, error-prone area.
Retirement Trap #5 - Not building an income floor
By income floor I mean a baseline, dependable or guaranteed, paycheck-style income like from a pension, Social Security, or the right kind of annuity (and there are so many wrong kinds of annuities that are abusively sold that you should consider reading my report The Unvarnished Truth about Annuities before keeping any annuities you now have, or writing any checks for new ones – ask for one if you have the Portfolio Stress Test done). The floor can also come from bond ladders*, dependable rental property, or other steady sources that you can count on. It can also come from a cash or very conservative investment pool or “bucket” that is intended to be methodically consumed to provide regular paycheck-like payments.
Unless you have a floor, you are at risk of pulling funds out of variable assets like the stock market or mutual funds in the wrong amounts or at the wrong times, exacerbating the odds of running out of money or underfunding your retirement lifestyle. If instead you have a steady income stream to meet life’s basic expenses, you have more control over “extras” spending decisions, and a better chance of smoothing consumption and having your money last and provide a satisfying lifestyle regardless of how long you live.
Building a floor requires some careful thought – typically you want to convert some growth assets into flooring security, which inevitably involves tradeoffs. You give up the home run for the single, but both aspects are important. Convert too much to dependable income flooring, and you limit the growth you may need to offset higher costs later in life, slowly choking as income covers less and less lifestyle cost, and hurt the opportunity to pass money on to your heirs. But if you don’t convert enough, you may be forced to sell growth assets at losses at the worst possible time, perhaps dangerously thwarting your wealth trajectory, and setting yourself up to run out of money before you run out of life.
As in so many things, balance is the key. Unfortunately for retirement planning, getting a clear picture on what balance looks like can be complicated and confusing, both to investors and to many advisors. Probably in no other area can quality financial planning software, in the hands of a skilled and objective practitioner, be more valuable in averting disaster. If you have us do the free Stress Test, ask us about how we help people map out retirement income strategies.
*beware that buying bonds (and income annuities) during periods of low interest rates (like now!) comes with lots of purchasing power risk – so be careful!
Retirement Trap #6 - Taking too little– or too much – risk
Akin to not building a floor, not having right the risk recipe right can really derail a happy retirement. Of course, when we say risk, we mean prudent, diversified risk in volatile assets like stocks, not speculative risk taking (to help determine what you may be doing now, sign up for our free Portfolio Stress Test – details below). It is unavoidable that risk and volatility are the most certain paths to growth! Do not forget this. These are the kinds of investments that swing up and down in value (sometimes frighteningly so) but generally can be expected to appreciate nicely over the long term if you have a sound plan and stick to it.
Take too much risk (which we see quite often) and you may be forced to sell at losses just to cover your monthly expenses, perhaps to never make it up, and run out of money. Don’t take enough, and your risk seeing your spending power slowly choked off as cost of living increases outstrip your “fixed income.” Our free Portfolio Stress Test can really offer valuable insight on this topic, while you still have time, perhaps before the next bear market forces your hand.
Retirement Trap #7 - Not planning for health and LTC costs
For many retirees, lifestyle change and enhanced health care costs are inevitable. Your personal health and genetic data (and your spouse’s) can shed a lot of light on what’s in store for you, but in the end you never know. Typically, retirement progresses slowly from an active recreation and travel phases, into a more sedentarily one, with higher health and prescription costs, and possibly with home health care, home modification, long term care, and nursing home care later in life.
Budgeting for this can be extremely complex, frustrating, and uncertain, but the alternative – ignoring likely changes and just assuming the money will work out – can be disastrous. This is another area where quality software (and be careful to distinguish this from sales pitch software designed to drive commission sales) in the hands of someone who knows what they’re doing and cares about doing a good job can really make a difference.
Retirement Trap #8 – Succumbing to a “Depression Age” mentality
Chances are good that you were touched by the Great Depression, either living through it or hearing lots about it from loved ones. Odds are also quite good that the Great Recession of 2008 scared the pants off of you, and reinforced any tendencies toward “Depression Age” thinking. This works hard in influencing folks to take less risk than they need – perversely increasing the risk of running out by taking steps they think will help avoid it! We see many, many investors that are influenced by this kind of mindset – the fear of running out – who on the other hand may spend far less than they probably safely can. This is a shame, especially if you want and can afford a richer lifestyle, but are being held back by heighted fears of burning through your resources. This can be a bright spot in my otherwise pretty gloomy report, and another area where a sound retirement income plan generated by a quality financial planning analysis can be worth its weight in gold. I hope this is true for you, and hope we can help you get the information that may justify a higher sustainable retirement lifestyle for you and your family! If you have us do the free Stress Test, ask about our Portfolio Income Load Estimator and other tools.
Retirement Trap #9 - Poor investment planning and product choices
This is probably the biggest problem area we consistently see in retirement planning, and one of the biggest dangers to retirees’ happily-ever-afters. Many investors’ portfolios are riddled with high hidden costs and fees, and take far more risk than the investors – and probably even their advisors – seem to appreciate. This is especially true where annuities are used, but also quite a problem for stock, bond, and mutual fund/ETF investors. Much of the problem may rest with the relationship many investors have with their advisors, many of whom – probably the majority – are not generally required to put clients’ interests before their own. According to an extensive government (GAO) study this is not widely know even among very astute investors, who can rely on investments salespeople as fiduciary advisors when this is not really the case. The problem is compounded by the disclosure rules, which satisfy legal disclaimer requirements, but rely on documents like prospectuses which are so complicated that may investors may feel overwhelmed and avoid reading them to get information on risks, costs and other concern areas. In many cases an investor may wind up owned a basket of investment products selected more to satisfy the compensation needs of the advisor than the investors’ retirement funding needs. When risks and costs go up, retirement income security can really go down, with unfortunate or disastrous consequences. This is another area that our free Portfolio Stress Test can help clarify, and provide suggestions that may help you reduce portfolio costs and risks, and more closely align your portfolio with your retirement income needs – perhaps while there’s still time to right your boat and get through retirement comfortably.
