My earlier articles touching on retirement [Business Report, August 2020, July 2019, August 2018] provoked many requests for more “direction” regarding retirement planning. As I have pointed out before, each person or couple’s Plan is unique. Generic answers are never completely satisfying, but let me dispel some widely held beliefs or “myths" about retirement.
1. Retirement Goals are Personal, not Financial.
As Financial Planners, we our primary focus is on on finding the money to get there.
But successful retirement requires ample research into location (if moving), available amenities, costs of living, culture, weather, etc.; into changes in activities (hobbies, travel, bucket lists), social participation such as volunteer activities; and other potential lifestyle choices (fishing, golf, bridge).
My experience is that many retirees miss their work and after a month or two are bored. That leads to ‘mental fatigue’ which can blossom into a ‘mental fog.’ If the mind is not ready for a retired lifestyle (whatever that means to you) the body and mind will both deteriorate.
Some people are simply not suited for retirement; they need a new challenge that may include part-time work or mentoring through SCORE at the Small Business Association or even founding a new business.
The solution is to sample prospective retirement activities and venues while still working, in all seasons and with input from current residents. There is a lot to be said for living among peers with the same memories. My in-laws moved to a Florida community of fellow-Chicagoans and loved it.
2. Retirees spend less; retirement requires less income.
This may have been true in the 1950s. Not since. The truth is most retirees spend 10-20% more in their early retirement years in an attempt to do the things they had no time for when they were employed. Yes, 401(k) contributions and commuting costs are gone, but they are replaced by expenses of travel, eating out and leisure activities.
Also, if you were self-employed or enjoyed certain perks from your employer, you will now have to pay for business/personal vacation airfare and replace that company car. Those annual conventions and junkets to exotic locales are gone now and up to you.
While the early years may be more expensive, later years, when getting around is physically more difficult or just less desirable, expenses tend to become more predictable and curtailed.
Rather than plan for 70-80% of one’s pre-retirement cost of living, my experience recommends planning to maintain your current standard of living adjusted for inflation.
3. The classic 3-legged stool approach works.
Not anymore. For years, planners advocated the troika of retirement funding: Qualified Plan/Pension, Social Security, and Savings. As a three-legged stool, it was clear that each was to be of near-equal value to provide a “level” retirement income. However, employer-paid defined benefit pensions, that pay a percentage of annual earnings as a guaranteed lifetime income, have disappeared.
The substitution of 401(k) or 403(b) plans or IRAs is far less attractive and contributions are limited, especially for high earners and owners.
Social Security is no longer the robust replacer of a significant portion of your income. Still reliable, its viability remains in question. Claiming the most appropriate Social Security benefits, when, has become very complicated and requires dedicated software to choose.
Savings, basically private investment, is now where most of the emphasis must be placed. It is often vulnerable to market risk.
Investment needs the most attention to compensate for the shortfall of the first two “legs.” Depending on how late one starts to invest, the amounts required can be substantial. Whether index fund, mutual fund, stocks and bonds, or real estate, the non-qualified nest egg is pivotal.
We recommend dividing investments into “risky” and “safe” accounts so that a good portion has downside protection and is secure, allowing the remainder to embrace risk. We find it is more valuable to avoid losses than it is to chase after risky greater returns.
4. You should be debt-free at retirement.
Again, this harkens back to an earlier era. Despite bad emotional advice from infotainers Suzy Orman and Dave Ramsey, not all debt is bad.
For example, paying off your mortgage does not always make sense. Your house is an asset, but illiquid. Should you need money to pay bills for an operation or income due to disability, a paid-up house cannot easily free up needed cash, if at all. Bankers want assurance they will be repaid and that cash flow is sufficient: If you are partly incapacitated and not earning, you are not an acceptable risk.
However, if you had invested that money used to retire the mortgage in a “safe” account, it will be available. In short, cash is king; equity is seldom accessible.
Further, rates today are at an all-time low. What a terrific opportunity to lock in cheap access to capital! i.e., a 30-year mortgage. Also, remember that mortgage interest is subsidized; a 4.00% mortgage costs 3.00% in a 25% tax bracket.
(I acknowledge the reverse mortgage is a method of getting cash out of your home, but it carries high fees and takes time to get approved.)
5. Taxes will be less in retirement.
Current income tax rates are the lowest in 35 years with most of the tax burden borne by high earners. With rising national debt, exacerbated by the pandemic, federal tax collections must go up. If a new President is elected, higher rates are a given. States also need more money to maintain our crumbling infrastructure.
Yes, there is a higher standard deduction at age 65, but pensions, 401(k)s, are taxable and your former itemized deductions such as business expenses, charity, etc. are mostly no longer helpful. If you paid off your mortgage, that deduction is also gone.
An added tax is the shrinkage of the dollar: Inflation. You might opine that inflation today is very low, under 2%. That is the national rate, based on a basket of items a family of four might buy in a city. That is not the same as senior citizens’ purchases of food, fuel, vitamins and medicines – all of which have risen faster than the posted rate.
All planning must include income tax assumptions. We usually apply a 30% or higher effective rate in our calculations and then see what we can do to reduce exposure to it. We strongly endorse using the Roth 401(k) and/or a Roth IRA. Our “safe” accounts include robust tax-free retirement income and liquidity. Having two buckets from which to draw income gives our retiree control over her tax bracket. This can also be used to assure Social Security income is not taxed.
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This is the extent of our coverage of the 10 Myths until the next installment when we will resume with beliefs 6 through 10.5.
Had anyone else compiled this list, it might have been different. We are pleased to have helped hundreds retire financially secure with the flexibility to make alternate choices after retirement. If you want more, feel free to visit my website www.vancofinancial.com or call for a (virtual) appointment.