For financial planners, there is no typical client. While each individual or couple come in with common goals, everyone’s situation is different. Investors have their money saved in different places, and they’ve followed different advice along the way. Some have taken guidance from their accountants or 401(k) plan administrators, and others have been do-it-yourself investors.
Regardless of the path, we find almost every investor wants to know if they have enough to retire. And after that, what their allocation should be between fixed-income investments and growth investments. At 60, should an investor actually have 60% of his portfolio in bonds? General rules like this are almost always wrong. Imagine having 60% of your portfolio earning barely 3% while inflation is at 2.9%. You’d likely lose purchasing power within a few years.
Ideally, an investor should begin planning for retirement about 10 years prior, because there are some planning and tax saving opportunities that can be missed the longer they wait. The way we approach retirement is we first look at an investor’s retirement income sources, such as Social Security and pensions. We then consider what the investor’s desired after-tax spending will be in retirement. The difference between the two figures must come from the investor’s company-sponsored retirement plans, IRAs, annuities, or brokerage accounts.
We then apply our Ten Year Rule, where any money needed within the next 10 years for living expenses should be placed into fixed-income investments that mature when the money is needed. This creates a laddered bond portfolio that aims to match the cash flow created with the investor’s liquidity need. Laddered bonds can also help diversify the bond portfolio holdings.
For example, if you spend $50,000 in retirement and you have $25,000 coming from Social Security, you need $25,000 a year from your retirement savings. To cover 10 years of liquidity needs, your fixed-income allocation would be $250,000. The goal is to provide 10 years of uninterrupted income while the rest of an investors’ portfolio is invested in the stock market. While this is a very simplistic calculation, this is still a good starting point. Working with a financial adviser, an investor can apply specifics from their own situation, including assumptions on future tax brackets and inflation.
Working with an adviser 10 years prior to retirement can also help an investor plan for when they are forced to withdraw money from their retirement accounts at age 70½. Many investors save to tax deferred accounts for so long that assets have grown substantially, and at age 70½ when they must begin taking mandatory distributions, some investors can end up having more taxable income than they did in their working years. This can affect how Social Security benefits are taxed and can often bump an investor into a higher tax bracket.
While this is a “good problem” to have, no one enjoys paying more in taxes. By planning for your mandatory withdrawals 10 years prior to your retirement, you may be able to take advantage of making Roth conversions while your taxes are lower, or you may even consider switching retirement savings vehicles, by diverting funds into a Roth IRA or Roth 401(k) if they are available.
Many investors think they need the most help when they are saving for retirement; however, having experts to consult as you transition from the accumulation phase to the distribution phase is valuable as well.
If you have questions regarding your eventual retirement, the experts at Henssler Financial will be glad to help: