For many folks, the New Year means resolutions to improve in the coming year. Being a finance guy, I naturally gravitate towards financial steps we can take to get us closer to a successful retirement. After all, we all get a clean slate for the year – right?
Well, folks – not everyone. Unfortunately, many of us are starting the New Year with some financial baggage in the form of credit card bills. Christmas spending can easily get out of control, even for those who had a defined budget in mind. In fact, the National Retail Federation found that in 2021, consumers will have spent an average of $997.73 on gifts and other holiday items — which is quite a pretty penny when you consider that the median weekly salary in the U.S. in 2021 is $1,001 before taxes₁.
Though it seems to be common sense to avoid landing in debt over holiday sprees, it’s easy to see how even the most organized shoppers can underestimate just how shockingly expensive decking the halls can be. At the Cutter household, we did a pretty good job of sticking to our Christmas budget – well, Jill and I did. Maeve, Phoebe and Sophie actually ended up spending way more than they planned. I think that’s mostly because they got a little distracted and “gifted themselves” a few times.
But you know, overspending at Christmas doesn’t always mean that we pay for it all year long. With a few extra bucks redirected towards credit card bills, these can usually be paid off in just a few months. But you know, this issue makes me think about ways that we tend to overspend in other areas of our lives, too – and especially once we retire. You see, once you retire you don’t have the freedom to go crazy with your wallet and still expect your money to support your retirement. You aren’t earning an income any longer, so sticking with a budget becomes crucial.
Yet we’re seeing some alarming trends regarding retiree spending these days and this has the potential to derail your ability to sustain your retirement lifestyle. According to Katherine Roy, managing director and chief retirement strategist at J.P. Morgan Asset Management, retiree income-replacement needs have risen from 80% to 92% from 2016 to 2019, among those earning $70,000 per year before retirement₂. She notes that, “There’s not as large a drop-off [as there used to be] between pre-retirement spending and comparable lifestyle post-retirement.”
So just what’s causing this creep in retirement spending? Well, it isn’t inflation because the figures cited by Roy are all inflation-adjusted. It used to be that people would spend less in retirement because they’d paid off their mortgages, say, or their transportation costs had gone down. But that trend is fading and there’s not as large a drop-off for pre-retirees making $70,000 and their comparable lifestyle post-retirement.
One of the most powerful levers that a retiree has is to spend less or to adapt their spending so that they’re not drawing on a portfolio that could be struggling, depending on what’s happening in the market. So, aside from making – and sticking to – your budget, what can you do to manage your spending in retirement to a level that lets you experience retirement without losing sleep at night? Let’s look at a few options.
We should start with reviewing the amount in your 401k (or other employer retirement plan). Roy’s research found that many folks – 42% of them – still have assets in 401(k) plans three years after retirement. What are the implications?
Well, for starters, a 401k plan typically has far fewer investment choices than you’d have if you rolled your money into an IRA account. And the options within the 401k usually are not designed for downside risk mitigation to help preserve capital in times of market stress. Plan fees are often high, and Plan sponsors typically don’t offer any investment advice or guidance on your investments.
From a tax perspective, the 401k is a ticking-time bomb just waiting to go off. These are tax-deferred assets, which means they’ll be fully taxable when you withdraw them in retirement. If you need to pull out more money from these accounts to pay those taxes, it’s more likely that your Social Security benefits will be subject to taxes and also, longer term, increasingly likely that they’ll trigger Medicare surcharges.
Another reason to scrutinize your taxes in retirement is President Biden’s proposal to increase taxes for many. Some investment options may seem appealing until you understand their tax implications, and it often makes sense to have your financial advisor and CPA working together on your tax situation.
For example, if you’re heavily concentrated in tax-deferred accounts, you may want to diversify your holdings by different tax treatment. You could convert some of those assets into a Roth IRA, or a Roth 401(k) if your employer offers it. This allows you to pay the taxes on any funds converted now – at today’s known tax rate – instead in the future when tax rates are likely to be higher. Qualified withdrawals from the Roth in retirement are then tax-free.
You might also consider investing in long-term equities in those accounts to potentially benefit from capital gains treatment. You want to build in options for greater control and flexibility so that a change in the tax code doesn’t significantly impact you.
Be sure to consider inflation’s effects on your money as well . . . especially now. Historically, the stock market has been the best place to help keep up with inflation, but that comes with added risks that a retire may want to stomach. Ideally you’ll want to maintain some growth exposure as you near and enter retirement, but only after you have a solid downside risk mitigation strategy in place to ensure a market drop doesn’t derail your finances.
At the end of the day, we should think of retirement as a long-term position and not short-term investing. Want to set yourself up for a greater chance of success in retirement? Start the year out right by not only paying off those Christmas bills, but reviewing your retirement spending plan and make adjustments as needed.
And as always – be vigilant and stay alert, because you deserve more!
Have a great week and a Happy New Year.
Jeff Cutter offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at firstname.lastname@example.org.Insurance products, including annuities, are offered through Cutterinsure, Inc., (MA insurance license #2080572). Cutter Financial Group and Cutterinsure are affiliated and under common control but offer services separately. Members of Cutter Financial Group’s management receive revenue directly from Cutterinsure. Any compensation received is separate from and does not offset regular advisory fees. Cutter Financial Group does not charge advisory fees on any insurance products. We do not offer tax or legal advice. Always consult with qualified tax/legal professionals regarding your own situation. Investing in securities involves risk, including possible loss of principal. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. This article is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Market data and other cited or linked-to content in this article is based on generally available information and is believed to be reliable. Please contact us to request a free copy of Cutter Financial’s Form ADV 2A and applicable Form ADV 2Bs. 1. https://tinyurl.com/2p8p55dm 2. https://tinyurl.com/2p8t4b7v