Many people look forward to retirement and the freedom it will offer them. But to truly enjoy life after work, you need to plan. Retirement planning isn’t just about the money, it’s also about the things that money can’t buy: Remaining engaged, active and fulfilled. Whether you are rapidly approaching retirement or still have many years ahead, now is the time to focus on getting your retirement plans on track so you can retire well.
Retirement is About More Than Money
People continue to underestimate the importance of planning for retirement, in terms of both finances and lifestyle. And the recent market disruptions have made many even more reluctant to look at the financial aspects of their retirement plans.
Complicating the planning process is the fact that the very concept of retirement has become more flexible than it used to be. Where once retirement was a time to hang up the career and start enjoying the fruits of your labors, many people are finding that the distinction between working and more traditional retirement pursuits has blurred. Technology allows many people to work whenever they like, wherever they choose. As a result, more people are choosing not to retire in a traditional sense.
But planning for retirement is crucial. To truly enjoy yourself, you need to articulate your retirement goals and work with your financial advisors to be sure your financial plan will provide the cash flow you need to achieve them.
Save for Retirement, Prioritize Your Goals
Saving for retirement in today’s economy is a whole new ballgame. These days, financial advisors are having a lot of heart-to-hearts with their clients. They are urging their clients to spend less, invest more, maximize company retirement plans and assess their current level of expenses. And they are asking clients to clearly define what they want their retirement to encompass, and which of their goals are most important.
“I think people need to truly define what their retirement will be like,” says Gregg Yaeger, director of financial consulting at Northern Trust. That means looking at everything from your basic living expenses to defining annual vacation allocations and charitable giving goals. When reviewing your goals, keep in mind the difference between lifestyle and quality of life. “Less money does not necessarily mean a poorer quality of life,” Yaeger says. It may simply mean changing your priorities.
Most people — even the affluent — are apt to feel more secure about retiring if they make some compromises in the short run. “I see people of all wealth levels cutting back, whether it’s taking less-luxurious vacations, reducing remodeling projects or waiting another year for a new car,” Yaeger says.
Some people have decided that maintaining their desired lifestyle in retirement may require continuing to save or working longer. Other people are becoming more comfortable with spending down their estates so they can fulfill their retirement goals. “Some of my clients say that whatever their kids will inherit is a windfall, so they are less concerned with complete estate preservation,” Yaeger says. “Others are so concerned about their children that they watch their own pennies.”
Creativity also can play a role in helping you meet your goals. If recent losses in your portfolio have you concerned about your ability to carry out your charitable giving plans, you may want to explore ways of providing support besides making direct gifts. For instance, you could name a charity as the beneficiary of an insurance policy, rather than making a cash gift. Or, if worries about short-term inflation have you rethinking gifts, you may want to consider establishing a charitable remainder trust (CRT). Not only can a CRT provide you with supplemental income during retirement, but the income tax deduction can be carried forward five years, which might serve to offset the effects of inflation, leaving more money in your wallet.
Consider Your Time Horizon
People today know they face a tricky balancing act in retirement. They’re concerned about how higher taxes, inflation and health care costs could affect their savings plans. But planning for the unknown can be daunting. To offset these worries, retirees should separate their short- from their long-term needs and look at each differently.
If you still have 10 years or more until retirement, you may be better served investing a portion of your portfolio in assets — like stocks — with a potential for higher long-term returns. And with stock prices down and the recovery apparently taking hold, many advisors are suggesting that now is a good time to start investing in equities again. Over the long term, stocks provide a good hedge against inflation. Over time, historically, equities have outperformed fixed income investments like bonds and CDs in virtually every case. “When creating your retirement plan, look at your life expectancy, what tax bracket you expect to be in and how much cash you’ll need each year to cover your expenses,” Yaeger says. This can help you determine the asset allocation best suited for your timeframe and risk tolerance.
Even if you are getting close to your desired retirement age, it can be helpful to separate your shorter-term needs — the cash flow you expect to need for the next five years — from your longer-term needs when looking at your retirement savings. After all, if you are retiring when you are relatively young or have a long life expectancy, you could be living off your retirement savings for 20 years or more. Focusing your entire investment approach on conservative strategies geared toward meeting your shorter-term needs may leave you coming up short in the long term. You may want to include more stocks, with their potential for higher returns, in the portion of your portfolio geared toward meeting your longer-term needs.
Conversely, if you are approaching retirement and have the majority of your portfolio invested in stocks, you may want to take a lower-risk approach for the portion you expect to cover your shorter-term cash flow needs. “Taking a certain percentage of an equity portfolio and liquidating for cash needs could be a good way to average out a portfolio,” Yaeger says.
Many people simply want a retirement plan that lets them sleep at night. Numerous triedand- true methods — a bond portfolio, a fixed annuity or even the laddered CD approach — still provide the security of fixed income while accruing interest. However, keep in mind that at about 4%, the rates of return on these investments are only half what they were in the 1990s. So people planning to live on income from their portfolio alone will have to set aside twice as much as someone would have needed 10 years ago to achieve the same income.
Special Roth IRA
Opportunity in 2010
If you have money in a traditional individual retirement account (IRA), you may want to consider converting at least a portion of that to a Roth IRA in 2010. That’s because, beginning in 2010, the income limitation on converting to a Roth IRA (in 2009, only individuals with less than $100,000 of modified adjusted gross income could make a conversion) has been lifted. And, if you convert your traditional IRA to a Roth in 2010, you can spread the resulting taxable income over two tax years (2011 and 2012). Keep in mind that you will be subject to the tax rates in those two years.
While both traditional and Roth IRAs offer tax-favored ways to put money aside for retirement and accumulate investment earnings without current taxation, the accounts do have some notable differences that may make a conversion worthwhile. Namely, qualified distributions from a Roth IRA are tax-free, while those from a traditional IRA are subject to income tax. An additional benefit that many affluent retirees find attractive is that a Roth IRA has no required minimum distributions during your lifetime, making it an attractive estate-planning vehicle.
However, while contributions to a traditional IRA may be tax-deductible, contributions to a Roth are not. For this reason, converting all or a portion of an existing traditional IRA to a Roth will trigger an income tax payment.
Depending on your tax situation and current financial situation, a Roth IRA conversion may be beneficial and help you achieve your retirement goals. Talk to your financial advisor to determine whether this opportunity is right for you.
Tax Implications of Retirement
When your savings need to stretch over two or three decades, figuring out the tax implications is half the battle. If you’ve crafted a plan that will leave you with $200,000 a year in income, do you know what you’ll owe next April? You could end up paying between $30,000 and $60,000, depending on a number of factors — a big difference for someone living off of savings alone.
To avoid surprises, be sure to have your financial advisor walk you through your plan from a tax perspective. For example, interest currently is taxed at a maximum rate of 35%, while qualified dividends are taxed at less than half that rate, and interest on municipal bonds isn’t taxable at all, although it may still be subject to the alternative minimum tax.
Taxes may even affect where you choose to live. As many people eye other locations in retirement — perhaps due to weather or family — they may want to consider state income tax rates, as well. While some states recently increased income tax rates targeting high-income filers, Florida and Texas have no state income tax at all, leaving more spending money for their residents.
Remember: Taxes, like the market, are subject to change, and you should revisit your retirement plan regularly. With so many uncertainties around us, a solid plan can go a long way toward preserving wealth in retirement and providing much-needed peace of mind, as well.