Filling Your Retirement Buckets
by A. Andrew Raub
When it comes to planning for retirement, the biggest issue facing Americans today is the possibility of outliving their retirement income. Retirement is part of the “American dream” for most—it represents a reward after years of hard work. In your mind, retirement may mean lazy days of golf or fishing with friends, travel and adventure with family, giggles and gift-giving with grandchildren, sipping iced tea on your front porch, a new consulting career, or philanthropic work with non-profits. Whatever your mind’s eye holds for retirement, it’s going to take some money to achieve it. After all, retirement means quitting your job or working drastically reduced hours. What will you live off of? And will it last as long as you do?
As we take a high-level look at this complex problem of adequately planning for retirement, it’s important to note that the possibility of outliving retirement income is increasing for a variety of reasons. One of the biggest contributors to the problem is that Americans are living longer than ever, which means that we need more reserves than ever to finance a retirement that might last 30 years. With more and more people facing retirement in the next several years, let’s look at how to maximize your income potential and then look at how long it will last.
Maximizing Income Potential
As you accumulate money for retirement, you can put your money in three basic buckets that will work together to fund your retirement one day: 1) Qualified plans, 2) Non-qualified savings and investments, and 3) Social Security.
The simple explanation is that the more you put into these buckets, the more they’ll give back to you one day. But let’s delve a little deeper and look at each bucket individually as it relates to retirement spending.
Qualified Plans
If you’ve heard the term “qualified plan” thrown around but can never remember what it means, you are not alone. The term really applies to any type of plan or account that was created by government laws and therefore has some government stipulations on what you can and cannot do with it. Qualified plans include but are not limited to traditional IRA’s, pensions, profit sharing, 401(k) and 403(b)’s, and Roth IRA’s.
With the exception of the Roth, the contributions to qualified accounts have typically not been taxed. This means that once you remove money from under the umbrella of a qualified account, it will be taxed. The Roth is a bit different in that your contributions are in after-tax dollars, so a Roth grows tax-free and is distributed tax-free.
With tax qualified plans, there are regulations on how much and when you can contribute and withdraw. Withdrawal regulations come into play most notably with what we call Required Minimum Distributions (RMD). At age 70½, the law requires you to begin taking these distributions. Every year you are required to withdraw a minimum percentage from the total of all accounts. This withdrawal can come from one account or from all accounts, so long as the total percentage is met. The percentage starts at about 3.6 percent and increases each year. If you withdraw less than the required amount, you will be charged a penalty tax of 50 percent of the under-withdrawn amount. The RMD is designed to slowly deplete your accounts through age 120 or so. Basically, the IRS wants to receive their tax on these previously untaxed accounts and the RMD is a way to force that.
Non-Qualified Savings and Investments
As you might have guessed after reading about qualified plans, if an investment is “non-qualified” that means it was not created by government laws, has generally not been sheltered from tax, and is now subject to ongoing income tax and capital gains taxes. Some of the types of savings and investments that fall into the “non-qualified” category are bank accounts, mutual funds, stocks and bonds, real estate, and inheritance.
Since these accounts have little or no restrictions, you can contribute or buy as much as you want and also take out or sell as much as you please.
Social Security
The best estimates say that Social Security will still be a factor for retirement spending for about the next 30 years. After that, I would advise people to plan for retirement as if Social Security will not be there. If it is, great—but don’t bank on it.
In the mean time, Social Security is still a major player in financing retirement today. When you plan your monthly income for your retirement, you will want to remember four things about Social Security benefits.
You may take benefits as early as age 62.
Monthly payouts are smaller when taken early and larger if you wait.
If you continue working before your full retirement age, your earnings may offset your benefits.
Spouses qualify for benefits.
In July’s newsletter I addressed each of these Social Security issues in more detail, so I won’t delve into it again. The point is that, for now, Social Security is one of the main avenues of income for many in retirement but you need to know what the rules of the game are before you begin withdrawing.
Will My Money Last?
After you’ve accumulated your assets for retirement into the three buckets we just talked about, now you are faced with the issue of making your income last through retirement. Of course, this is no small task. Keep in mind that retirement distribution planning is one of the most complicated and written about topics in financial planning, so my discussions here are very general in nature.
As a general rule, when you retire, it is recommended that you limit your initial withdrawal to between 4 and 5 percent of your portfolio’s value. Then adjust the dollar amount annually for inflation. Research shows that 4 to 5 percent provides the most reasonable estimate that your savings will last at least 30 years. Of course you aren’t locked into a fixed withdrawal rate in real life, so you can make adjustments as your investments fluctuate. Spend a little more when you have a few good years, and reduce your spending when your portfolio performs poorly. By making adjustments along the way, you will find that making your money last becomes a little bit easier and a whole lot friendlier.
Four Guidelines for Retirement Income
When it’s time to begin tapping your portfolio for retirement, I have four guidelines to consider for retirement spending and investing.
- Use income investments to produce income and growth investments to offset inflation and grow your portfolio.
- Manage your tax bracket by spending non-qualified assets before qualified assets if possible.
- Don’t forget to take Required Minimum Distributions into account to avoid being penalized.
- Outline your goals for retirement and match your investments to those goals.
These four simple guidelines will help you plan for the months and years ahead so you can maximize your portfolio and your retirement.
Rather than guessing at future income potential, we use a variety of planning tools to develop and monitor individualized retirement distribution plans for our clients so they can have Peace of Mind. If you are interested in more information, please give us a call.