Living in Retirement - Variables to Consider
Similar to the principles of investing, there are several principles and guidelines to living in retirement successfully and with the most confidence possible. One must first establish a retirement plan that maps out income and expenses anticipating a number of different outcomes. As daunting as this can seem, it does not need to be - an integral facet of a successful long term retirement plan is the understanding that reality will at times deviate from the plan. If we accept this possibility, we can better anticipate these deviations in a plan, which in turn may present a higher likelihood for a plan to work in the long run. Retirement, similar to one’s working career, can be subdivided into different phases. Each phase has different characteristics as an individual navigates through retirement.
A dependable retirement plan anticipates the likelihood that one will live for a long time in retirement. Per the Social Security Administration, a least one member of a sixty-five year old couple has a 9 in 10 chance at living beyond the age of 80. [1] With this in mind the strategies with respect to investment allocation and the timing at which Social Security is claimed may be adjusted in comparison to past models’ rules of thumb as out life expectancy continues to rise. Retirees may need to depend on their investments at a minimum preserving principal, if not growing, for a number of years after the date of retirement, with the hopes of their assets keeping pace with inflation.
In relation to Social Security, “benefits are calculated based on your 35 best earning years. You are eligible for 100% of your benefit at your Full Retirement Age (FRA). Individuals born in 1954 and earlier have an FRA of 66. Claiming at 62 will permanently reduce your benefit by as much as 25%. Waiting to claim after FRA gives you an 8% increase each year in your benefit amount for a maximum of 124% or more.” [2] When determining the best age to claim Social Security, the benefits of waiting can be revealed in using a benefits calculator. In most scenarios, delaying for as long as possible is the best course of action - but a decision to wait must be weighed against current and future cash flow needs, as well as one’s overall health and expected medical expenses through time.
As we age, and as we progress through retirement phases, a retiree must be cognizant of increasing healthcare costs. Data released by the Employee Benefit Research Institute estimates that “out-of-pocket costs for an average 65-year-old retiree on traditional Medicare are projected to more than triple from around $5,300 this year [2020] to over $17,000 by age 95”. [3] The inflation rate of healthcare has historically outpaced US inflation as well. The long term average healthcare inflation is 5.26%, versus the average long term US inflation rate of 3.21%. [4] Therefore not only are healthcare costs becoming more expensive compared to average inflation, retirees need more healthcare services to begin with. Healthcare is an undeniable variable in retirement, and a proper retirement plan prepares for this with ample margin for error in expense projections.
Long term care is a facet of living in retirement that some may overlook. It can be difficult to accept this reality, but some day-to-day tasks may not be feasible at later stages of retirement. Long term care encompasses a number of services that health insurance will not. This coverage includes day-to-day activities such as dressing and bathing. The advantage of a long term care policy is protection of one’s nest egg. Without long term care insurance, long term care services are oftentimes prohibitively expensive. A recent Genworth study revealed that the median cost of a long term care facility is nearly $90,000 annually. [5]
Regularly rebalancing investment portfolios can prove to be beneficial throughout retirement, it is important to align risk and liquidity with one’s current retirement phase and outlook. Another practice that is commonly overlooked is a Roth conversion. At times it may be advantageous from a tax perspective to convert an IRA into a Roth IRA, so that future potential gains are tax free at withdrawal. A Roth conversion would mean paying taxes on the withdrawal amount at the year of distribution as regular income, but in the long run this may prove to be a valuable strategy so that taxes are front-loaded and grow without tax implication when the Roth account is liquidated.
Regarding withdrawal rates, many adhere to the “4% rule”, wherein a retiree withdraws 4% of their assets annually for expenses, and no more. The formula was developed in 1994 by William Bengen, a financial advisor. In 2021 and beyond, 4% is not always a cut-and-dry rate for each retiree, if it ever was. Interest rates have decreased since Bengen initially arrived at 4%, and Bengen himself stated that 4% is not likely an appropriate percentage withdrawal to follow now. He argues the average retiree should withdraw somewhere along the lines of 4.5% of their assets annually, while others argue that the figure should be lower, at 2.4%. [6] The 4% rule is still a widely accepted principle of retirement, but in reality a retiree and their plan should never rely on heuristics to ensure a successful retirement. Developing a more ironclad plan requires more legwork at its outset and through the duration of one’s retirement, as expenses and priorities change through time. The argument that a 4% withdrawal rate should remain static throughout an individual’s retirement and in all retirees’ respective scenarios is unjustifiable in many scenarios.
This synopsis addresses a handful of common oversights in retirement planning and variables worth considering, but it is crucial to understand that each retiree’s or prospective retiree’s scenario is different. The central theme worth noting is that a retirement plan must be flexible and durable enough to endure surprises along the way, and an adequate retirement plan anticipates the possibility of surprise with each input, which should translate to a wide margin of safety built into models that project each aspect of life in retirement.
Disclosures & Sources:
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often neutered for investments in emerging markets. Asset allocation does not ensure a profit or protect against a loss.
Investing in mutual funds involves risk, including possible loss of principal. Find value will fluctuate with market conditions and it may not achieve its investment objective.
Stock investing includes risks, including fluctuating prices and loss of principal. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect principal.
The economic forecasts set forth in this material may not em develop as predicted and there can be no guarantee that strategies promoted will be successful.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
The Financial Consultants at Vintage Wealth Advisors are registered representatives with, and securities offered through, LPL Financial, Member FINRA/SIPC. Investment advice and financial planning offered through Financial Advocates Investment Management, DBA Vintage Wealth Advisors, a registered investment advisor. Financial Advocates Investment Management, Vintage Wealth Advisors, and LPL Financial are separate entities.
Social Security Administration, Period Life Table, published 2019
JP Morgan Asset Management, Principles for Successful Retirement, Copyright 2021 JP Morgan Chase & Co.
Employee Benefit Research Institute, January 2020 Consumer Expenditure Study, JP Morgan Analysis
YCharts - Indicators, US Health Care Inflation Rate, Graph , YCharts - Indicators, US Inflation Rate, Graph
Genworth Financial, Inc - Long Term Care Costs Averages