Many Americans face major decisions as they age and consider retirement.
One of the most challenging ones is retirement income planning, or making a plan to coordinate all of your decisions to ensure you have enough income to pay the bills and be prepared for uncertainty.
Financial planners and retirees have always attempted to calculate how much income a retired couple or individual can “comfortably” count on to pay their bills and maintain a calculable retirement income projection.
For many investors, the “4 Percent Rule” has helped both financial planners and retirees guestimate an investor’s portfolio withdrawal rate.
Your life expectancy typically plays an important role in determining if your chosen withdrawal rate is going to be sustainable. Retirees who live longer, or retire early, will need their portfolios to last a longer period of time and should expect medical costs and other expenses to typically increase.
What is the “4 Percent Rule?”
The 4 Percent Rule for retirement is merely a guideline that financial professionals and retirees have used as a rule of thumb to help make retirement withdrawal calculations. The big question today is, in a low interest rate environment, is this rule still relevant?
Prior to answering that, it’s important to remember that even, at best, the 4 Percent Rule is only a rule of thumb; it’s not a law! Each and every retiree’s plan could be slightly or greatly different.
When interest rates were higher, this 4 Percent Rule might have been a good starting point because it tried to keep withdrawal rates reasonable. It also took into account that inflation will make things increase in cost as the year progresses. Having a starting point can be healthy, but it is not a replacement for creating a specific plan for your success!
9 Considerations for Retirement Income Planning
You May Not Want to Convert All of Your Savings to Fixed Income or CDs
Even when you are at a retirement age and are starting to take withdrawals from your investments, it is still important to consider keeping a diversified portfolio.
One of the reasons the 4 Percent Rule actually helped, was the assumption that if your portfolio could grow by an average of 6 or 7% or more – then by withdrawing only 4% you still saw modest growth.
Understanding that interest rates are currently low on fixed income investments and that your rates of return will fluctuate make it essential to revisit your portfolio allocations periodically.
Resist the Desire to Overspend During Good Years
Market cycles could produce healthier returns during a good year. However, it is important that you do not view these better years as an opportunity to splurge.
It is very easy to think, “I don’t want to limit myself to a 4% withdrawal, I can afford 10%,” during a good year. Investors and high-income earners who maintain discipline and self-control are more likely to achieve a better long-term result.
Stay the Course During Bad Years
Many investors benefit from setting up a “reservoir” for funding their withdrawals and bill payments during retirement.
Market cycles are susceptible to bad times and those might be inopportune times to panic over income. Your personal plan needs to have a strategy in place for downturns. This is why we discuss risk tolerance as well as immediate needs with our clients. Investments are not meant to be handled on an emotional basis and therefore some advanced planning is required.
Cut Back Whenever Possible
Even if you plan for a “comfortable” retirement with a 3% or 4% withdrawal rate, whenever possible consider staying below that rate.
Even though you are retired and should be enjoying your life, maintaining financial prudence is still a wise decision. Savers find that it can be useful to be ahead when it comes to planning for all retirement stages.
Remember to Consider Taxes
When calculating your retirement withdrawals, you should always consider using the least taxing methods available to you.
Coordinating the tax ramifications of where to take your distributions from can prove to be invaluable. Remember that when you withdraw money from your retirement plans, you should first consider the tax impact. For example, money withdrawn from many traditional IRAs and company 401k plans can be subject to taxes.
Make the Most of Income Dips
Perhaps in the year after you retire, with no paycheck coming in, you drop to the 15% bracket or you have medical expenses or charitable deductions that reduce your taxable income briefly before you bump back up to a higher bracket.
Tapping pretax accounts in low-tax years may enable you to pay less in taxes on future withdrawals. These are strategies we can discuss with your financial advisor.
Social Security Decisions and Income
Social Security income is complex but is something that all retirees need to consider when crafting their retirement income plans.
The Social Security program allows you to begin receiving benefits the month after you reach age 62, or to wait until your full retirement age, or even later. The longer you wait, the fewer checks you'll receive. But the checks will be bigger if you wait (up to age 70), so a delay will produce a greater total benefit if you live long enough.
The decision about when to start taking your benefits is partly a gamble on how long you're going to live and partly a matter of economic circumstances and personal preferences.
Learn more about how our Social Security planning services can help you prepare for a comfortable retirement.
Remember to Consider Required Minimum Distributions (RMDs)
Retirees must start making required minimum distributions (RMDs) by age 70½. With a large retirement account, that income could push you into a higher tax bracket. This is another area of consideration that you should address in your retirement plan.
Roth IRA Conversions
Some investors benefit from converting to Roth IRAs during retirement.
This conversion can be done on a partial or full basis, but it is complicated and needs to be well planned. It will create immediate tax considerations and has its own set of complex rules.
Prior to making any Roth IRA conversion decisions, it is important to talk to a qualified tax planner to determine the tax consequences. A poorly designed conversion plan can be very costly.
Plan for a Comfortable Retirement with Chatterton & Associates
The primary purpose of retirement income planning is to maximize your use of retirement and savings accounts. Trying to create and manage your retirement income by yourself can be challenging. Having the right professional helping you along the way can greatly streamline this process and alleviate any pitfalls or challenges that may arise. You should always seek out the advice of a qualified tax planner and financial advisor who both can work with you to make sure that your plan is properly implemented on your specific terms.
At Chatterton & Associates, we house financial planners, tax planners, and estate attorneys to help our clients analyze their financial situation and carry out a plan that meets their unique needs and goals.
This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer or financial professional. You should discuss any tax or legal matters with the appropriate professional.
© Academy of Preferred Financial Advisors, 2017.