I have heard it said that most people spend more time planning their vacations than they do their retirement. Maybe that is why I see too many people totally unprepared for the longest vacation of their life – that day, year or age that work life stops, often too abruptly, and retirement begins.
What about yourself? When was the last time you and your spouse completed a retirement fire drill where you clearly wrote down together your joint plans for retirement – the when, where and how? If it has been a while, or perhaps not ever, when will you do it? Studies abound showing that most Americans are not being realistic about their chances of a successful retirement hoping things will turn out okay. It has been said that “Hope is not a financial strategy.” As Tennessee Williams once wrote, “You can be young without money, but you can’t be old without it.” Unfortunately, I see this all too frequently in my practice as a retirement income specialist. Yet we all know that people don’t plan to fail, they just fail to plan.
Have a game plan
Planning for retirement is good but strategic. Advanced retirement planning is even better. You can and should start the process for your successful transition to retirement well before its actual commencement date. Think of it as a life timeline on which several ages tend to stand out. These would be ages 50, 59½, 65 and 70½.
For younger and middle aged health care practitioners, space does not permit me to elaborate on 50 preparations prior to age 50, except to say that all throughout your working life you need to be mindful that someday your accumulated assets may need to replace 75% to 100% of your income annually. The earlier you start toward that goal, the more successful you will be as compound returns favors those who start early. For example, a 30-year old who wants to make annual contributions to accumulate $1,000,000 by age 65, assuming an 8% compound rate of return, needs only contribute $5,568 per year, or a total of $195,000 of his own money. The rest comes from earnings. On the other hand, a 40-year old starting toward the same goal needs to save $13,116 annually of his own money, or $328,000 because of 10 years lost compound return.
If we assume a 4% withdrawal factor at retirement, and you expect to replace 75% of a $160,000 annual income (in addition to Social Security retirement benefits), or $120,000, you will need to accumulate $3,000,000 in invested assets to produce the $120,000 annual income needed. For a 30-year old, that is $16,704 required annual savings. For the 40-year old, it is $39,340 and just at the time when the children are looking at colleges.
If you haven’t started saving yet, when will you? Just remember that with compound returns, nothing happens early. It takes time for the returns to be meaningful. The above examples are hypothetical mathematical equations for illustrative purposes and not indicative of any particular investment or performance. The examples assume no transaction costs, taxes, management fees or other expenses, inflation or fluctuating principal. Past performance is no guarantee of future results.
Your timeline for retirement
Getting back to our life timeline for retirement and beyond, let’s look at each of the ages on the timeline and summarize the actions you may need to take or avoid regarding accumulated lifetime savings. Professionally, your plans for further growth and expansion of your solo practice or partnership may be occurring as well and you may be giving passing or perhaps serious notice to a possible future exit strategy. However, there are issues to consider about your personal assets as you have deemed them to support you and your family throughout the 20 or 30 years of retirement.
Age 50: You have hit another one of those milestone ages when it is not just another birthday – 21, 30, 40 and now 50. According to recent studies, only 6% of “powerboomers” feel confident and secure about their retirement (FRC:Engaging Powerboomers, 2007). In my professional experience, most have no idea what their standard of living should be when they retire as they cannot come close to detailing their normal monthly expenditures. Studies also show that among the many concerns boomers have about retirement, three stand out as consistent across all levels of wealth. They are:
- The corrosive and deleterious impact of inflation on retirement standard of living,
- The possibility of another extended market decline like from 2000 to 2002, early in retirement, thus decimating invested assets again, when earned income has stopped, and the portfolio of invested assets is all there is to provide retirement income security (or insecurity),
- The need to project a predictable and effective withdrawal rate from invested assets to secure a comfortable retirement income for life.
Inflation is everyday news as we are constantly reminded of it by the Federal Reserve’s battle to fight inflation by increasing or decreasing interest rates. The fear of a market downturn is real since we have not seen an extended market drop since the market turned around in October 2002, and since market drops are systemic and not exceptional.
Study after study has shown that a 4% withdrawal rate from your retirement portfolio, combined with a healthy allocation to equity asset classes, makes for a reasonable probability of a successful and secure retirement standard of living of 30 years or more. So these fears are real and need to be addressed realistically as you develop your game plan for retirement, beginning at least no later than age 50. Be aware the projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results.
A question you will need to ask yourself – and answer – at this early stage in the pre-retirement planning process is whether legacy planning is important as an overall financial goal. In other words, should the quality and quantity of your own retirement standard of living be affected (i.e., diminished) by your desire to leave significant assets to your children and grandchildren? Or is your retirement motto to die broke? If not, then you need to factor in some amount of invested assets that will have to be retained throughout your lifetime and that of your spouse. The bottom line is that it certainly will require more accumulated assets to fund your own retirement if the use of some of those assets themselves (not necessarily the income derived from those assets) is off-limits to you.
By age 50, you need to grapple with this significant personal issue with potential financial overtones. From my experience with pre-retirement clients, I would advise you to make sure you and your spouse are on the same page regarding legacy planning with retirement assets as a lack of communication or simple disconnect here may cause relationship problems later on.
Here are some additional items to review at age 50:
- What assets are you earmarking for your retirement income standard of living? IRAs, pension plans, etc. are easy. But what about your vacation home? Your office building? The value of your practice? What plan do you have to convert these and other non-portfolio assets to cash/investments for the production of retirement income? Will you sell or lease? What timetable have you established to maximize value received?
- Are you maxing out your retirement plan contributions, including the “catch-up” amount that begins at age 50? For 401(k)s the maximum contribution is $15,500, plus $5,000 for the catchup. Other plans have different limits-check with your advisor. Do you have outside consulting income not counted under your employer’s 401(k) or pension plan? Have you established a retirement plan, like a SEP-IRA, for that side income? As college tuitions decrease, then disappear, are you substituting additional retirement savings for those terminating expenditures, or are you rewarding yourself now by spending freely on depreciating consumables that have zero value for your retirement standard of living? To replace 75% or more of your income at retirement, you will need to save more than 15% of your income (typical limit in qualified plans). If you don’t save enough for your retirement, who will?
- Have you checked the beneficiary designations on all of your qualified plan assets to make sure they reflect your current estate wishes and the needs of your family? Have you perhaps disinherited a child not included under a prior designation? Have you redone your wills/trusts and perhaps forgotten to coordinate your retirement plan beneficiaries with those revised estate planning documents? What if you have remarried, and you wish to leave your 401(k) or other pension plan assets to the children of your first marriage? Have you made sure your second (third, etc.) spouse has waived his or her ERISA spousal rights under your plans? If not, you may unintentionally disinherit all of your children from those assets as your current spouse exerts his or her rights to those assets under ERISA. Please double-check this one, as being wrong can have financially tragic consequences for your family.
- Do you still have a frozen-Keogh account around, or perhaps a money purchase, single participant profit-sharing plan? Most of these have long since been abandoned but the accounts may still be alive and invested. If the assets in your account exceed $100,000 have you filed the annual 5500 forms as required, and have you amended your plan documents as needed, under recent pension laws? If not, you may need to revisit these plans to clean them up. Many of these plans did not permit non-spouse beneficiaries to avoid immediate taxes at your death (and your spouse’s death). Work with your retirement specialist to determine the best place to move these frozen assets.
- Are you unable to contribute any amount to a traditional or Roth IRA because you participate in your employer’s retirement plan and your single or joint adjusted gross income is too high? You may have received a big break from the Pension Protection Act of 2006. Beginning in 2010, traditional and non-deductible IRAs can be converted to a Roth IRA without regard to your adjusted gross income (currently forbidden for adjusted gross incomes more than $100,000). You can have a non-deductible IRA regardless of your level of income. You could contribute the maximum annual amount to a non-deductible (after-tax) IRA ($4,000 in 2007, but $5,000 if you are age 50 or older), then convert the non-deductible IRA to a Roth IRA in 2010. You would pay tax on the gain at that time, but then all future gain would be tax-free based on current Roth IRA laws and holding requirements (later of 5 years or to age 59½). Check with your tax advisor or financial planner to see how this new wrinkle in the Roth IRA laws can benefit you.
- Will your plans for retirement be stymied if you become disabled and can’t make contributions to your qualified retirement plan, like your 401(k)? You probably did not know that only a few insurance carriers now offer coverage to insure continuing deposits to a retirement plan trust for your benefit if you get totally disabled. Further, this coverage can be implemented in addition to your regular personal disability insurance plus perhaps your practice overhead coverage. In other words, if you have bumped up against the limits for obtaining disability benefits, you still may qualify for this retirement plan disability coverage. Check with your broker or financial planner.
- Age 50 is not too early to look into insurance to offset the potential financial ravages of long-term care. According to Wilmington, Del. financial planner Brent C. Fuchs, CFP, CLU, ChFC, of Lincoln Financial Advisors Corp., “Assets you may have accumulated for your retirement could get devastated by a long-term care (LTC) bout with Alzheimer’s disease, for example. Have you measured how 3, 5 or 10 years of expensive care for you or your spouse might decimate your carefully-crafted retirement standard of living?” Long-term coverage is fairly inexpensive at age 50 compared with the asset pool it creates as a substitute for using your retirement savings. Fuchs added, “In many cases you can pay up the long-term care insurance during your working years so premiums can stop when you retire.” Further, those in C-corps can deduct the premiums and not include them as income, so Uncle Sam will subsidize this important retirement protection. Will you check it out?
- Is your asset allocation mix still geared for growth? Or are you going conservative because you fear losing principal to market volatility like perhaps you did during the prolonged market decline from 2000 to 2002? If the latter, you need to be careful that you haven’t simply exchanged one level of risk for another. Maybe you have eliminated market risk and business risk from your portfolio by abandoning equities, but in their place you may have introduced purchasing power or inflation risks to your portfolio. As an example, if you are earning 4% on bonds, and inflation is 3%, your real rate of return is a measly 1%. In taxable accounts, the bonds are first subject to income taxes whether you take the interest or accumulate it. Your 4% may first be reduced by 30% for taxes, leaving only 2.8% which is then-again reduced by 3% for inflation. Your net real rate of return is negative so you are losing purchasing power every day. Bonds alone are not the answer. Stay focused on the your joint life expectancy and maintain a healthy allocation in equities to potentially keep ahead of long-term inflation.
- Financial planner Randall Clark, CFP of Lincoln Financial Advisors Corp. in Dallas, suggests that in preparing for retirement you give thought to allocating your resources among the various retirement and non-qualified account types which will diversify your tax burden at retirement. He advises clients that putting all their money in a traditional IRA or 401(k) is risky. He added that one could end up a tax prisoner in retirement. To the extent you can allocate retirement savings to items that produce totally or, partially tax-free income or tax favored income from a return of principal, like Roth IRAs and Roth 401(k) (if available), tax-free bonds, tax-favored annuity income payments, etc. you can, as Clark summarizes,“…help minimize the tax bite in later life.” (Wall Street Journal “Encore: A Special Report,” Dec. 11, 2006).
- Above all, you need to be seriously thinking about a plausible and reasonable answer to the following question – when am I planning to retire? When is my spouse planning to retire? If you can’t pin down a specific age or date, work with a couple different planning scenarios and set of dates. Begin to imagine and to visualize when, where and how your retirement will occur. If you don’t, how can you plan? And if you can’t plan properly, are you increasing your chances for retirement failure where your assets die before you do?
This age has been burned into our psyche because it is the first normal age after which we can withdraw monies from our traditional IRAs, SEPs, SIMPLEs, etc. without the imposition of the 10% penalty. But there are other items of interest that can impact your retirement planning at this age, such as:
- Many company and hospital 401(k) plans and profit sharing plans permit early in-service withdrawals beginning as early as age 59½ or 60. What about yours? Your spouse’s plan? You can check this provision in the summary plan description the plan must provide each year. There may be reasons why you would want to remove assets from your 401(k) to invest personally in your own IRA, such as poor or limited investment choices, avoidance of plan-imposed restrictions, opportunity for Roth conversions (beginning in 2010, the $100,000 adjusted gross income restriction has been removed from Roth conversions), greater estate planning flexibility, avoidance of the qualified joint survivor annuity requirement that your plan may impose, opportunity to use restricted beneficiary designation for certain spendthrift, undisciplined or special interest heirs, etc. Removing assets from your 401(k) may have certain appeal to you and your plan may allow that.
- On the other hand, assets you have rolled into your qualified plan at work from prior employer plans are generally always available to be rolled out to a traditional IRA, for example, but check the summary plan description to make sure.
- While your plan may allow for early in-service withdrawals, there may be other reasons to retain assets in the 401(k) plan including lower plan maintenance expenses, better investment choices, as well as the significant creditor protection afforded ERISA qualified plans. This is a big deal. Recent federal law changes have extended $1,000,000 of creditor protection to IRAs under certain circumstances (bankruptcy) but the possibility may still exist whereby IRA assets could lose creditor protection in certain states, maybe yours. ERISA assets receive absolute creditor protection, so keeping qualified plan assets in an ERISA plan may be an overriding factor. Remember that solo-401(k)s and owner-only Keogh plans, which do not include common law employees beyond just spouses, receive no ERISA creditor protection.
- If you have not defined your retirement alternatives by now, age 59½ ought to be a red flag to do it as soon as possible. In my experience, the earlier you formulate the details of your life in retirement – and here I don’t just mean money – the easier your transition will be from work to retirement. Waiting too long to plan can cause you to remain defined by what you do rather than who you are, and the early years of retirement may be psychologically rocky. Make the effort now to determine what retirement means to you and your spouse.
- Revisit your asset allocation strategy to slowly begin the process of converting assets to the allocation you wish to maintain in retirement based on your personal experience with risk tolerance, or “loss aversion” and time horizon. Your time horizon is not necessarily to the day you retire. It is to you and your spouse’s normal life expectancy, which may be 20 or 30 years. If you have been at 100% stocks, or 80% stocks/20% fixed income, you could dial down equities a bit (but gradually) to reduce risk and volatility without losing some of the upside of equities in your retirement portfolio.
- If you believe the equities have peaked and you are concerned about downside possibilities, then consider the various ways to lock in the growth from your equity assets by converting those assets to guaranteed income for life, especially if you are retiring now or soon. Immediate annuities can convert invested assets to a non-qualified personal pension-like guaranteed income, but you lose control of the money. The new breed of variable annuities with a lifetime income guarantee riders – to insure against longevity risk – may suit your investment temperament better at this time. With these products, you are buying downside protection for your retirement income while staying invested to capture upside equity growth. Another positive is that these income guarantees riders can be purchased within the variable annuity without giving up control of the assets. For these reasons, consider checking out these products now at age 59½, or at least for later on.
In the second and final part of the series (December 1st), I will examine ages 65 and 70½ on the life timeline. If you send me an e-mail request, I will send a copy of the brochure “Improving Retirement Readiness – Laying the Groundwork for a Financially Secure Retirement.”
For more information:
- Kenneth W. Rudzinski is a registered representative of the Lincoln National Advisors Corp. Securities and advisory services offered through Lincoln Financial Advisors Corp., a broker/dealer (member SPIC), and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. He is located at: 2036 Foulk Rd., Ste. 104, Wilmington, DE 19810; (866) 529-1320; fax (302) 529-1324; or e-mail Kenneth.Rudzinski@lfg.com.
- Lincoln Financial Advisors Corp., or its representatives, do not give tax or legal advice. The information in this article is from sources deemed reliable. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.