In the next installment of Common Questions, we tackle the topic of retirement spending. Retirement income planning is a complex topic with many moving parts from understanding income sources to asset allocation strategies to income tax ramifications. Below we try to address several of the most commonly asked questions.
1. How much should retirees withdraw annually and from which accounts should they draw income first?
The seminal study done in the 1990s around sustainable withdrawal rates during your retirement years suggested a 4% withdrawal rate, adjusted for inflation annually. However, that study was done when interest rates were much higher. Therefore, many financial planners and retirement income specialists today believe that the actual sustainable withdrawal rate today is closer to 3%. This is likely to be true with both stock and bond markets near historical highs.
Which accounts clients draw from should be carefully orchestrated based on the client’s income needs and their income tax situation. Different buckets of money such as IRAs, Roth IRA’s, annuities, or nonqualified investment accounts all have different tax ramifications as funds are withdrawn. Careful planning and coordination can help avoid paying unnecessary income tax liability. Remember, if you do not have an income tax plan as part of your retirement income strategy, you may be paying more tax than needed.
2. What's the best strategy to ensure that retirement funds last?
First and foremost, you need to understand your retirement income needs and how much you plan to spend on basic living expenses, healthcare costs, as well as aspirational travel and lifestyle goals throughout your retirement years
Secondly, you need to understand the sources of retirement income available to you. For most retirees, this includes ongoing paychecks from Social Security or, for a much smaller percentage of the population today, defined benefit pension plans. Beyond this, most retirees rely on withdrawals from savings, IRAs, and 401(k) plan assets that they accumulated during their working years.
Finally, some retirees have passive income from things such as rental real estate, or active income from continuing to work or consult on a part-time basis during their retirement years.
You need to understand whether your projected retirement income sources are sufficient to meet your family’s unique retirement income needs. These income goals need to be adjusted for inflation, which is now running at a higher level than we have seen in nearly 30 years. Remember, at a 3% inflation rate costs would nearly double over a 20-year retirement lifespan
3. What are the worst money moves for retirees, contrary to popular belief?
One of the common mistakes we help retirees correct is having an asset allocation that is not structured to produce an inflation adjusted income over a 20-to-30-year retirement horizon. Many retirees get too conservative too quickly, which does not allow for growth of their asset base or income over such a long period of time.
The second mistake we see retirees make is to not understand sequence of return risk. This is the risk that markets go through a period of sharp declines and negative returns in the early years of retirement. Having done this for more than 30 years, I can tell you that the two groups of retirees that struggled the most were the ones that retired when markets had melted up towards all-time highs.
The first includes those who retired in ’99-’00 just as the dot.com/9-11 bubble burst, leading to a two-year, 47% decline in the stock market. The second group retired in ‘07-‘08, right before the subprime market crisis and the failure of AIG/Lehman Brothers caused the stock market to drop more than 50%.
With markets near all-time highs again today, it would make sense for those nearing retirement to make certain that they had enough cash and short-term liquidity to make it through their first 2 to 3 years of retirement. By doing so, they will help mitigate the risk that short term market volatility or periods of dislocation do not derail their retirement income goals and lifestyle plans.
You should remember that these are general guidelines. The specific details of your situation could vary greatly and probably warrant discussion with your advisor at Impel Wealth Management. We stand ready to help you and your family.
Our team will continue to identify common themes and questions as we meet with you. However, if you have a particular topic that you would like us to address in the series, please let us know. We want to make certain that we are helping you with the issues you confront. It is part of our service and the value proposition we strive to provide as we continue “Moving Life Forward”.