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Social Security
Remember to include Social Security payments in your overall strategy as they can supplement your income and might influence how much you withdraw. Additionally, your monthly retirement income can have an impact on how your Social Security benefits are taxed if you “give yourself a raise” and move into a high tax bracket.
Sequence of returns risk
Sequence of returns risk happens when the order and timing of investment returns cause you to withdraw too much too soon early in retirement, making it difficult for your portfolio to rebound, if at all.
“A lot of people who are doing it on their own have the tendency to underestimate what they’re spending and overestimate what their returns are going to be,” says Barrow, referring to sequence of returns risk. “You can dig yourself into a hole really quickly, which then means you’ve got to either go into the next decade taking out a lot less or you’re going to run out of money.”
Retirement modeling
Barrow also recommends using a financial advisor to help you determine the right withdrawal strategy at any given time. Many advisors have modeling software that allows you to review and compare withdrawal strategies and find the best fit.
Tax‑efficient approaches for retirement income
Along with the right income and withdrawal strategy, there are other tax-efficient approaches for your income in retirement. You’ll want to stay in the lowest tax bracket you can to keep your tax liability minimal.
- Be mindful of income bumps: Remember that any income bump can put you into a higher tax bracket, increase your Medicare premiums and make a higher percentage of your Social Security benefits taxable.
- Minimize your RMD tax burden: While RMDs are taxed as ordinary income, they could push you into a higher tax bracket. To mitigate the risk of moving into a higher tax bracket, you could proactively withdraw from those funds earlier, lowering the balance of the account—and potential RMD—each year.
- Employ tax strategies: Whitney recommends two tax strategies that are often employed by high-net-worth individuals to minimize tax liabilities: charitable giving and tax-loss harvesting. By donating cash, property or investments through charitable giving, you can deduct up to 60% of your adjusted gross income from your taxable income. Additionally, you can offset capital gains on taxable investment accounts through tax-loss harvesting. This involves selling assets for less than what you paid, which is counted as a loss.
- Convert to a Roth account: By moving money from a tax-deferred account into a tax-free account, you remove RMDs and allow the money to continue to grow in the Roth account tax-free. While you won’t have to pay taxes on the funds when you—or your heirs—withdraw them in the future, the IRS views the money you convert to a Roth account as income for that tax year, so you’ll need to pay taxes on the amount you convert. According to Whitney, converting to a Roth account during market downturns and low-income years could be advantageous as you’ll likely convert a smaller amount of money.
Managing risk and longevity in your retirement plan
A good retirement strategy guards against outliving your savings by managing risk. According to Mangaliman and Whitney, a few potential risks include:
- Inflation: By investing in appreciating assets, which can outperform the market when inflation is high, you might be able to gain income that adjusts for inflation. Such assets include real estate, Treasury inflation-protected securities (TIPS), commodities and gold.
- Market volatility: When you have time to grow your money, a down market isn’t so bad and you can even buy at a discount, says Mangaliman. “But in retirement, a down market [becomes problematic] because you’re not buying at a discount anymore. You’re selling at a loss.”
To manage this risk, build a diverse portfolio and rebalance it as your retirement date gets closer, being a little less aggressive and a little more conservative. “You can’t just let it be all risk because the consistency of your return is much more important than the actual percentage of return,” says Whitney.
It’s also important to refrain from panic-selling your investments when the market turns. To help you prepare for volatility, have your advisor run different scenarios, like market dips, recessions or large purchases, to stress-test your portfolio and project how a down market or large financial need can affect it, so you can feel more in control if it happens.
- Healthcare costs: During your career, your employer typically pays a portion of your healthcare coverage. But if you retire before age 65—when you’re eligible for Medicare—you’ll need to pay your full premium on your own. According to the Kaiser Family Foundation, the average healthcare premiums for a 40-year-old in the U.S. range from $456 to $625 per month, though they can surpass $1,000 in some areas of the country. Older adults and couples can expect to pay even more.
You’ll want to strategize how you’ll pay for or mitigate expenses if you need to bridge the gap between employer-sponsored healthcare and Medicare. This might include going on a spouse’s plan if they’re still working, maximizing contributions to a health savings account (HSA) and focusing on preventative health. Once you’re eligible for Medicare, learn about your program options, use your HSA, consider supplemental insurance and work your monthly premiums, deductibles and prescription costs into your budget.
- Long-term care: The Federal Long Term Care Insurance Program found that the national average cost for a semiprivate room in a nursing home is $112,420 per year and $66,132 per year to stay at an assisted living facility. You might think you’ll never need long-term care, but your retirement strategy needs to factor it in regardless. According to the Department of Health and Human Services, 56% of Americans reaching age 65 will need some type of long-term care services during their lifetime. Long-term care insurance can help offset costs, while a dedicated savings account, HSA or home equity loan can help pay the difference.
FAQ
When should I start planning my retirement strategy?
“You should start planning your retirement strategy the day you start earning a paycheck,” says Barrow. “The earlier you start, the more successful you’re likely to be and the less work you’ll have to do later to reach your goals.”
Starting as early as possible gives your money time to grow with compound interest and allows you plenty of meetings with your financial advisor to tweak your plan. “Once a year, sit down with your planner [to go over] how much you should be saving this year and how it should be allocated,” says Barrow.
How can I optimize Social Security claiming strategically?
The longer you wait to collect Social Security, the higher your monthly benefit will be and the more protection you have against running out of retirement income if you live longer than expected. For example, if you start getting benefits at 66, you’ll get 100% of your retirement benefit. However, if you wait until age 70, you’ll receive 132% of your retirement benefit.
Delaying Social Security might not make sense for those who need financial security, want more spending flexibility, are reluctant to draw down their assets or have a shorter life expectancy. It’s important to weigh the benefits and disadvantages in your situation to choose when to claim Social Security.
How do taxes affect my retirement withdrawals?
If your retirement withdrawals are taxed, that lowers the net amount you receive, so you want to plan for that difference between the gross (pre-tax) and net (post-tax) amount.
“People say, ‘I think I’m going to need $5,000 in income.’ Well, is that net? Is that gross?” says Mangaliman. “That’s net. You want that amount hitting your account every month. So you’re going to need to plan for more than $5,000 a month because you have to factor in your taxes. That can have a huge drag on your portfolio if you don’t time it out correctly.”
Should I consult a financial advisor to retire strategically?
While some people might be able to build a strategy on their own, Whitney worries about where they might get safe information, real education and the tools necessary to do it correctly. He also sees the value in having third-party assistance because advisors can have an outside perspective and offer non-biased insights into your financial behaviors as well as what you’ll need in retirement.
According to Mangaliman, a reliable retirement advisor will help you coordinate everything from income and the most tax-efficient way to withdraw it to when to start collecting Social Security. When choosing a financial advisor, he recommends working with someone who is an experienced, fiduciary retirement advisor, who has the right credentials and a successful track record of working with clients who have similar needs.
Both Mangaliman and Whitney recommend using a financial advisor who specializes in retirement instead of one who focuses more on holistic financial planning and wealth management for all stages of life. Barrow also recommends broadening your scope and working with a tax advisor and estate planner to feel even more comfortable and confident in retirement.