As we are thick in the middle of the warmer summer months, my French bulldog, Max, is getting lots more exercise – mostly because we can finally play (what seem like) endless games of fetch after work. And for the most part, I enjoy repeatedly tossing him the ball, over and over, especially after a long day at work. In my world of finance, a world that specializes in building sound financial and retirement systems, things can move at light-speed. Ol’ Max does not know it but he is kind of a therapy session for me, reflecting on the day, its accomplishments, its challenges.
About a week or so ago, I noticed that no matter what direction I toss the ball, Max tracks it closely and adjusts his course to retrieve it. He really wants his ball and he’s smart enough to realize that if he keeps running in his original direction, he probably won’t catch it. Max adjusts his course to give him the highest probability of success.
This reminds me of something I encounter on a regular basis with folks who are trying to build their financial and retirement systems. After diligently saving for years in preparation for retirement, I often find that folks experience a unique transition in their financial lifestyle that is unlike any other time in their lives. Focusing on the savings side of retirement can make us feel somewhat anxious or unsure when it comes time to start taking income, unless you can adjust your mentality to match this new phase of your life.
You see, many retirees are reluctant to spend down savings, approaching retirement with the perspective that they’ll try living off interest as much as possible. Which is pretty unlikely in today’s economic environment, unless you have accumulated significant wealth. Running out of wealth in retirement is an existential fear for about half of Americans, according to AARP, and according to me.
You know, I never believed that adage, “You can’t teach an old dog new tricks.” You absolutely can. You have to motivate the old dog properly. Usually with a food treat, but sometimes a belly rub or an ear scratch will do. Or perhaps a favorite ball. The same rule applies to investors, even if they’re acting like the old dog. Hopefully, without the belly rubs.
Folks, it’s one thing to save for retirement. But here, most of our focus has been on saving rather than putting our assets to work. Adjusting your money mentality is key to navigating that transition successfully. So, it is essential to acknowledge this transition up front: You’re going from a period of wealth accumulation, working, saving, and growing investments; to wealth distribution, when you put the assets you’ve accumulated to use.
When it comes to distribution, don’t depend on rote formulas like the 4% Rule, the famous rule of thumb that states you should withdraw 4% of your savings each year to avoid running out of money in retirement. General rules of thumb rarely apply to specific investor situations and aren’t the same as a retirement income strategy.
The first step is to have a budget to work with. Budgeting is something you’ve probably (hopefully) done your entire life, but even here, it requires a different mindset. Because you’re working with a finite resource – the wealth you’ve accumulated. And now you must manage that effectively to provide you and your spouse with the income you need throughout retirement.
Understand all of your monthly expenses in retirement. Consider the cost of leisure activities and other activities you plan to pursue in retirement. Account for any big-ticket purchases you plan to make. And health care costs must be accounted for, of course. It’s estimated that a 65-year-old couple retiring this year will need approximately $285,000 to pay for medical expenses through retirement, according to a study by Fidelity. Make sure to factor inflation, “the experts” recommend at 2-3% per year. I suggest 4-5%.
Budgeting in retirement can change things enough that you need a new mentality to approach it. You have an opportunity to take a hard look at the expenses you’ll be carrying into retirement. Now’s the time to see if you can make adjustments to those expenses to better suit this new time in your life, such as paying off mortgage debt and other loans, or downsizing homes as adult children move away.
Once you understand what your expenses will look like, it’s a time to do an inventory of your post-retirement income sources, including retirement assets. Social Security plays an important role here for many of us. But it also plays a finite one. For the average earner, Social Security benefits replace about 40% of wages. Many retirees can continue to support the same lifestyle they had pre-retirement on about 80% of their income, which leaves a significant gap.
And that’s where your retirement savings and investments become critical. So, make sure to account for employer 401(k) and 403(b) plans, IRAs, and your Health Savings Account (HSA), if applicable. Annuities, real estate holdings, and stock-based compensation should also be considered. Understand what you have to work with and how and when to appropriately take distributions from these accounts to minimize your tax burden.
You’ll want to also understand how the distribution of these assets may affect your tax bracket in retirement. Withdrawals from traditional IRAs and 401(k)s are treated as ordinary income, while qualified Roth IRA distributions are tax-free. You may need to factor capital gains taxes if you’re counting on the sale of taxable investments to help fund your retirement. Also factor in the effect of Required Minimum Distributions from your retirement savings accounts on both your income and your tax status.
Investment risk tolerance is another area that requires a different money mentality in retirement. As you approach and enter retirement, it’s a good idea to reassess your appetite for risk. When you’re younger and still working, it’s easier to bounce back from market volatility. But over time, one’s investment strategy and one’s corresponding appetite for risk will likely change, focusing more on capital preservation, or the risk of loss. The savings you have will need to last you, so trying to squeeze out every last gain without understanding the risk associated with it, well, may not be the most prudent.
Finding a distribution method that suits your goals and your risk tolerance is crucial, and here’s where the advice of an investment advisor can pay dividends. There are a number of distribution strategies you can use, and your advisor can help you determine which one works best for you.
Adjusting your course – and your money and investment mentality – isn’t impossible or even hard. But it does require some discipline and a fundamental change in how you view your assets. But once you realize that you need to make a change to enjoy the retirement you envision, you are half-way there. You can now take steps to create the predictable income you need, while adjusting for inflation and protecting from significant market risk. You’ll have the tools you need to pivot from the wealth accumulation to distribution stage of your financial lifecycle. Like Max, you always want to position yourself to achieve the highest probability of success.
Be vigilant and stay alert, because you deserve more.
Have a great week!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC
Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at email@example.com.
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