Whether I am speaking with a family member, client, or prospect, I often encounter a similar question – ‘How do I know if I'm ready to retire from a financial perspective?’ The answer I give is very common for me – it depends 😊. All joking aside, the outcome of this potential decision does depend on the lifestyle you intend to live throughout your retirement years. I typically will use an example of clients who retire comfortably with $250,000 of portfolio assets – living a great life, and clients who retire as multi-millionaires who could be at risk of running out of money if they maintain their current spending levels. Some of this also has to do with where their income is coming from, and by not by not previously devising a plan to efficiently take withdrawals from their retirement / investment accounts or determining the appropriate timing of Social Security. There also should be some planning around the inevitable big ticket expenses – vacations, car purchases, boat purchase, etc.
The common theme here is having an understanding of the lifestyle you’d like to live, and how you can best utilize the funds you have accumulated to fund this desired lifestyle. Furthermore, I try to remind clients that retirement can last 20, 30 or even 40+ years depending on the age they retire at, and of course, how long they live. So, in conjunction with their lifestyle and income plan, a well thought out investment plan needs to be developed and implemented in order to comfortably sustain their lifestyle in the longer term.
What does retirement look like from a number’s perspective? How about from a life planning perspective?
With that said, in my opinion there is a lot more that goes into the retirement decision than simply understanding how much you can withdraw from your portfolio using the ‘4% portfolio withdrawal rule’; as many articles will tell you. When I sit down with clients to discuss this transition to the next phase of life, I often challenge them to consider what they will do once they stop working in their current role. Said differently, where are they retiring ‘to’? Some clients have had this planned out for years and they know exactly how much they want to travel, where they want to live, what big purchases they want to make, if / when they will work part-time – the list can go on as long as you’d like. While the vast majority of clients have not given this much thought as their energy has been consumed by their working career over the last 30-40 years. This may seem like a silly place to begin, but I do find that the answer to this question drives a lot of the assumptions we make in our analysis surrounding income, expenses, and the investments.
From here, we work to put together assumptions surrounding their income and expenses – accounting for Social Security income, pension benefits (if applicable), level of portfolio assets and cash, general living expenses, desired level of travel each year, future car purchases, home maintenance expenses, etc. We also make conservative assumptions for inflation and investment returns to ensure some level of breathing room in a worst-case type scenario. As we all know the stock market will not increase every single year…there will be bouts of volatility, and when planning is done properly these periods of market volatility can be opportunities. So, once we run the initial projection and confirm that it is feasible to retire at their desired age, I again challenge clients to go beyond the numbers. Typically, our conversation heads in this direction as clients refer to a ‘minimum’ standard of living in retirement, when in reality I want them to think about what is comfortable and ideal, not just the minimum amount of expenses needed to survive. I find that clients have been so accustomed to saving for 40+ years into their 401k and living off their salary, that it can be quite scary to consider taking withdrawals from their assets as a replacement for this mostly guaranteed salary.
Here I tell clients to understand that the projection we put together is not their ‘plan’, - their plan is how they will spend their time, who they will spend it with, and what will they spending their time doing – volunteer work, travel part-time work, etc. – their assets are simply the mechanism to fund the plan. Again, going beyond the numbers truly assists clients in finding their ultimate purpose outside of their working, which in turn, informs us where the income needs to come from to fund their plan.
Social Security Timing / Withdrawal Strategy
Furthermore, once we confirm the client is in good shape to retire from a financial perspective and life planning perspective, we quickly shift are focus to the income / distribution plan with a focus on tax efficiency. I could probably write hundreds of pages on the many withdrawal strategies out there, but for simplicity, I will cover this on high level.
In the initial analysis we put together, we typically start by assuming a client collects Social Security at their Full Retirement Age (FRA), but when we drill down on their income plan the timing may change depending on upcoming expenses, the clients projected marginal tax bracket, and where their assets are positioned from a tax perspective. For example, let’s say a client has a ROTH IRA, pre-tax 401k, and a good amount of cash in the bank. Let’s also say this client was maxing out the pre-tax contributions to the 401k plan for the last 10 years while they were in the 24% marginal tax bracket. The client was receiving a 24% marginal ‘tax break’ on these contributions when they went, with the understanding that taxes would be due upon withdrawal. The taxes owed on the withdrawal depend on the tax bracket the client is in at the time of the withdrawal.
So, where we choose to take this income from depends on the client’s tax bracket. If the client is married and needs $65,000/year to live, we could choose to hold off on taking Social Security and begin to withdraw monies from the pre-tax 401k plan and keep the client in the 12% marginal tax bracket. As a result, the client made the contributions while in the 24% marginal bracket and is withdrawing a portion of these contributions while they are in the 12% (under current tax laws), not a bad deal. Always on consult with your tax advisor. Doing so could also help reduce the amount the client will need to take out at their Required Minimum Distribution (RMD) age and could also allow them to pay less tax on these monies than if they waited until their RMD, which could put them right back into the 24% marginal bracket. If that is the case, the tax burden was simply put on hold until years later.
As you can see, a lot planning went into this simple example of withdrawing $65,000/year for living expenses. Moreover, the distribution plan is different for every client depending on age, tax brackets, anticipated expanses, and their health (longevity).
Moreover, a good amount of time also needs to be dedicated to the development of the asset allocation plan, to ensure it lines up with the distribution plan. Aside from owning a diversified portfolio positioned to grow, and support client’s lifestyle throughout their retirement years, the portfolio needs to have a bucket built in to hold future withdrawals. My rule of them is to hold at least two years of future income needs in something stable – i.e. money market fund, short term bond, CD, etc. Not investment advice. By planning out a few years ahead of time, we can take comfort in knowing the client is going to have their income needs satisfied even if we experience a volatile stock market. This is also why it is very important to monitor the portfolio and rebalance over time in order to take advantage of opportunities to refill the income bucket.
In essence, there is a lot to think about here, not only within the portfolio management piece of the pie, but within the entire decision to ‘retire’ and transition to this next phase of life. For many, this next phase is an exciting period filled with travel, relaxation, and spending time with friends and family, but for others it can be very stressful and scary – especially if they do not yet know how they want to spend their time.
To wrap up, some topics that I did not cover today can also add to the stress and uncertainty surrounding this decision if they are not understood and planned for – a premature death, plan for long term care, estate planning, legacy planning, etc. However, while these areas are extremely important and certainly need to be covered, I find that once we determine a client’s ‘plan’ of how they wish to spend their time – it becomes that much easier to take action in these areas.
If you found this helpful or if you have additional questions regarding your retirement planning, please feel free to connect with me through the contact info below.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give tax or legal advice.