The Short Answer is it depends...
Retiring later and phasing in retirement are becoming more common every decade. Funding a retirement takes some planning in advance. Now don’t beat yourself over the head. There are a few reasons this outcome is becoming prevalent. People are living longer. In the 1970s and prior, most workers retired earlier but only enjoyed their retirement for another 10 to 15 years. Work, Retire and Die was the plan. Retirees of those days also had a company pension and Social Security that would replace most of their working income. By the 1980s modern medicine and general health awareness took hold and gave people a longer life expectancy. Life Insurers started using new tables to reflect this new standard for Americans. Employers started to replace their sponsored pension plans for Employee contribution plans using the well-known 401k model where the Employer is only responsible for a matching contribution and the Employee is expected to fund most of their own retirement. Investment returns have been significantly lower for employees during this century. I know my retirement statements are not as fun to look at compared with what I received in the mail during the 1980s and 90s. Social Security used to largely make up the difference between the company pension and the lifestyle income of those retirees. Today, people must fund a much longer retirement with fewer outside resources. It might not be the perfect storm, but it is a storm.
To answer the question of when to retire the worker must know a few things. Let’s start with a realistic budget. In this budget, I highly recommend using real expenses and adding them up rather than using a formula based on a percentage of pre-retirement income. These formulas running from 60 to 80% are acceptable to use as a cross-checking tool but let’s dive into what it really costs to retire. You know your fixed costs for housing, transportation, and your basic needs so I’m going to throw in the variables and give you some ideas on how it may play out over a 30-year retirement.
Inflation has been the elephant in the room for the last couple of years. Prior to that, there wasn’t much discussion about rising prices other than Healthcare and Education. Having seen inflation approach double digits during the summer of 2022 the recent reports of moderating inflation back to mid-single digits are encouraging but there are a couple of things to consider. First, one doesn’t know from these recent reports reflect a trend of moderate inflation. Secondly, even if the inflation rate is going down, we would still have moderate inflation on top of a year of high inflation. That means everyday things like food prices are still high and not expected to go down in the near term.
Taxes have been historically low on the federal front and a bit above average for many states. Currently, seven states have no income tax at all. The reason I bring up taxes is the expectation that taxes will be increased. Continuing deficit spending and high federal debt levels may prompt legislators to take this approach at some point. For now, the political environment is tax-friendly, but it is a must-watch item.
Long Term Care Costs can be Devastating
The costs associated with Long Term Care can be devastating to the retiree’s finances. These costs can total several thousand dollars or more per month. This presents a difficult obstacle for planning. As Baby Boomer's ages continue to rise so will the use of this care. Until very recently, Long Term Care costs have risen significantly higher than the rate of inflation. As inflation moderates over time, one can expect these costs to outpace inflation again. Long Term Care costs include traditional nursing home costs, home health care costs, and adult day care. Around half of these costs are paid for by Medicaid, a government plan for the indigent. The rest are either self-funded or covered by private insurance. Medicare does not cover the cost of Long-Term Care. It only provides minimal coverage for a brief post-inpatient hospital need for care. Medicare does have coverage for skilled in-home care. It is intended for skilled care coverage and not for a care plan that is primarily custodial in nature. Custodial is basic needs for bathing, dressing, eating, and transference. The guidelines are on this link. Medicare Home Health Care Coverage.
There are a few different ways to at least partially fund these costs. Properly structured Private insurance, while pricey, is one of the more comprehensive ways to cover this. Buying a policy in one’s late 50s to early 60s is advisable if going with one of these plans. Applying for a policy after that, premiums become prohibitive. These policies generally accept applicants based on their current health so a person, age 60 is more likely to be accepted than a 70-year-old. Bear in mind these policies are health insurance policies and, in most cases, premiums are nonrefundable if an insured never needs care covered by the policy.
One alternative to the health insurance policy is buying a life insurance policy with a living benefit. One of these Living Benefits is based on long-term care needs. Generally, this will pay a percentage of the death benefit based on age and health history at the time of applying for a policy. This way, one’s family is assured to at least recover the premium paid less any benefits paid. Unlike the regular premium health insurance policies these contracts require a large up-front financial commitment from the insured. The funds deposited are intended to stay in the life insurance policy for the life of the insured to maximize the benefit. Early withdrawal can be done but at a reduced amount compared to keeping the policy until death.
There are also annuity-based benefit plans that also have long-term care benefits available. One buys a single premium annuity. Like the living benefit plan, one can expect a sizeable premium as one’s coverage for care limit is based on this deposit and the investment return over time. While there is not a tax-free death benefit as in the Life Insurance option, the annuity owner will retain rights to the contract value less any surrender charges, if any. And like the life insurance policy, one expects at least the return of their premium less benefits paid.
For many, Health Insurance costs rise at retirement. Most group insurance policies terminate when a covered employee retires. If retiring before age 65 when Medicare begins, premiums will be high. If retiring before you’re eligible for Medicare, you will only have to be saddled with the higher premiums until the first day of the month you turn 65. It’s easy to see how Healthcare costs may become one of the biggest budget items on your list.
IRA Rollover or Not?
For many, if not most American retirees, their Company Retirement Plan is the largest pool of money in their portfolio. Inside a typical plan, there are a handful of different costs. The plan itself has bookkeeping and other administration costs. Most often these are paid for by the employees. There are also investment costs associated with the fund choices you have made. These costs can vary widely depending on the money management firm that invests the money. Most funds in these plans are actively managed, meaning there is a manager buying and selling investments on behalf of the fund. When the manager buys or sells an investment inside the fund, there are usually trading costs. Over the course of the year, these costs can add up and be a significant part of what you pay. There often is an advisory fee for the financial advisory firm that helped set up the plan. One could search the internet to find most of these fees in the latest Form 5500 filing, but this is an area where a competent advisor can help you ascertain these costs. Once these annual percentage costs are tallied one can decide if they are better off to roll the account to their own IRA. More often than not, the Rollover option becomes attractive due to the costs inside the retirement plan. Most plans allow for an early rollover option called In-Service Distribution. An employee must be 59 ½ years old to qualify for this option. It is a way to roll over to an IRA account, without taxes, an amount equal to the employee’s contributions and the investment earnings attributable to those contributions. Only one Distribution can be done from a plan and still qualify as an In-Service Distribution. The plan’s customer service department will have the information needed to know how much money can be rolled and the required paperwork, if any. Many plans can do this online or over the phone. This is another area where most people use an advisor.
With regard to investments, costs do matter. One can shave off thousands of dollars per year just by doing some very simple research. Most of this data is declared in mutual fund prospectuses, fact sheets, or on free independent software available online. Most people skip this step and concentrate on past performance. Measuring performance can be tricky. With changing market conditions there is no assurance that your favorite performing fund will repeat its past success. Often, last year’s winners turn out to be next year’s under-performers. How the management company achieved its performance is most telling. Companies that perform well with a repeatable process and not using trendy tactics are more likely to repeat their excellent performance. I know this doesn’t tell you much about what funds to pick and that’s why many people choose index funds and low-cost structured funds. These funds tend to have lower management expenses and don’t do a lot of trading in any given year. With a low trading frequency as measured by Portfolio Turnover, trading costs tend to be lower than funds with higher turnover rates. Our cost analysis helps people receive a more accurate estimate of total investment costs than the fund fact sheets fund companies disburse.
The Sequence of Returns Can Affect Your Plan for Income
Timing withdrawals from one’s portfolio can be a crap shoot. I have this side-by-side chart where two couples with the same sized portfolios, same average annual returns, and same annual withdrawal rates, and both couples had wildly different results. One couple nearly doubled their money after returns and the other couple was penniless. How could this be? The only difference is what is referred to as a sequence of returns. Simply put, this is how the market performed in terms of good years, bad years, and the order in which these returns were experienced. The couple that experienced the good years at the beginning of their retirement had a good outcome. The couple that had bad market returns at the beginning of their retirement had disastrous results. How can we protect ourselves from this? This comes back to budgeting. If one has some sizable cash reserves and short-term fixed-income investments outside of their stock market holdings there should be available cash for withdrawals during an extended market downturn. If one is cutting it close every month and must make withdrawals from their investment portfolio, this would serve as a red flag. The popularized 4% withdrawal rate may work well but some management on your part is still advised. If your portfolio experiences a 20% downturn and you do you’re your 4% withdrawal, you would experience a decline of roughly a fourth of your portfolio. If this scenario were to repeat the following year you could be a candidate for portfolio failure. Having a portion of your portfolio in low-volatility assets should give you a pool from which to withdraw upon. This will be a significantly larger piece of the pie compared to your working years. It's best to take a lower-risk approach as you approach retirement. Without proper risk reduction, a large market downturn in your final working years could force you to delay your retirement for a long time. A competent advisor will have the tools and expertise to guide you through challenging markets.
Please feel free to contact us if you have any retirement related questions.