Retirement Plan Checklist

Does your plan include these 10 factors?

Investing in Prescott AZ

In retirement planning, most of the emphasis is placed on accumulating the largest retirement portfolio possible.  This Retirement Plan Checklist will help you identify the missing parts of your retirement plan.

However there’s a lot more involved in creating a comprehensive retirement plan.

I’ve put together a list of the 10 most important components in a retirement plan. Each of these 10 will have a major impact on your lifestyle in retirement.

This list is designed to help you look beyond building a large retirement portfolio. It’s designed to focus on the many divergent, yet interconnected, factors that will affect your life – and your finances – throughout your retirement.

By knowing what these factors are, you can develop plans for each of them. So that you’ll be ready no matter what happens.

If you’re already retired, it’s not too late. You can dramatically improve your retirement finances by revising your plan to include these rules.

  1. Plan for Longevity – Think Decades not Years. When planning for retirement it’s important to look beyond the first few years. People are now living for decades after retiring, and you’ll need to be prepared to cover a longer life span. For example, if you plan to retire at age 65, you should plan to be able to support yourself for at least another 30 years – people living to be 95 is no longer uncommon. Since women generally live longer than men, you might want to consider planning out through age 100. That’s 30 plus years!

Even if you don’t think you will live that long, maybe because people in your family historically haven’t, you must still be financially prepared for the possibility.

From an investment standpoint that means you will need to continue to have some growth in your portfolio. The growth assets will enable you to make sure the assets you have in your 60’s will last well into your 90’s.

  1. Your Social Security Benefits

When it comes to Social Security, many people cling to the outdated notion that you simply wait until you turn 65, file for benefits, then start collecting them for the rest of your life. While that is still possible, there is actually an entire set of strategies designed to maximize your Social Security benefits.

The strategy is mostly about timing when to collect those benefits. The timing of your benefits will have a major impact on how much you will receive.

For starters, 65 is no longer the standard retirement age. The Social Security Administration has been gradually increasing what it calls full retirement age, or FRA. That’s the age at which you will receive your full Social Security benefit.

For people born between 1943 and January 1, 1955, the FRA is 66. If you were born between January 2, 1955 and December 31, 1959, it will be 66 plus an additional two months for each year you are born after 1954. If you were born after December 31, 1959, it’s 67.

If you retire at any time before your FRA your benefits will be reduced proportionately. For example, while you can begin collecting benefits at age 62, the amount you’ll receive will be limited to no more than 70% of the benefit you would receive if you waited until you reached your FRA.

Conversely, if you delay collecting benefits until after your FRA, your monthly benefit will increase about 8% per year. If you delay collecting benefits until you reach age 70, you can increase your monthly benefit significantly. (IMPORTANT: there is no additional benefit for delaying past age 70).

This is why the timing of when to collect your Social Security benefits is so important. If you’re able to continue working past age 62, or even past your FRA, you will receive a larger income as a result of the delay.

Spousal benefits: Social Security benefits for a spouse carry two options. The lower earning spouse can either collect benefits based on their own work history, or he or she can collect 50% of the benefit paid to the higher earning spouse. The advantage here is the lower earning spouse will automatically collect the higher of the two calculations, as long as the higher earning spouse has already begun collecting benefits.

As a general rule, Social Security benefits are roughly equal to 40% of the pre-retirement income of a middle-income worker. Since monthly benefits are capped, that percentage will be lower for higher income people.

The point to consider here is if Social Security will provide 40% of your income, then you will need to be prepared to have other sources providing the remaining 60%.

  1. Shifting Your Portfolio Away From Growth

At retirement, you will need to implement a shift in your overall investment strategy.

Since you’ll be at the point where you’ll begin to withdraw income from your retirement portfolio, you will no longer have the benefit of many years to ride out a major decline in the stock market. This means you must make a fundamental change in the way your assets are invested. Your asset allocation must change from purely growth-oriented investments, to assets that emphasize income and capital preservation.

As you get older, the percentage of your portfolio optimized to generate income must increase. In retirement you need a definitive outcome, monthly income that is not dependent on the market’s performance. You can no longer ride out the averages like you did when you were working and could allow the average returns over time to work in your favor. Averages no longer work, as the income you must take puts additional pressure on the assets. See our article here about Sequence of Returns Risk. Where exactly you should invest your money for income and capital preservation is a topic all its own…

  1. Specific Income Generating Investments

Fortunately, there are a lot of options in this area.

Bank Investments: These can include certificates of deposit (CDs) and money market funds. Neither pays much in the way of interest, given today’s low interest rate environment, but both offer absolute safety of principal. The FDIC insures your total deposits at any one institution up to $250,000.

US Treasury Securities: You can directly invest in US Treasury securities through Treasury Direct, the US Treasury‘s investment portal. There you will find a variety of interesting fixed income investment opportunities, including bonds, notes, bills, and E/EE Bonds. They can be purchased in denominations for as little as $25, and carry virtually no risk of principal if held to maturity. Treasury inflation protected securities (TIPS), and I Bonds not only pay interest, but also make annual adjustments to principal based on the Consumer Price Index (CPI). That’s interest income, plus inflation protection.

Annuities: These are investment contracts purchased through an insurance company. They come in a variety of forms, and can be established to provide an income for either a specific period of time, or even for your entire lifetime. Annuities can be the perfect addition to your overall retirement plan if you are not covered by a traditional pension plan for your employer. An annuity can provide an income arrangement very similar to that of a pension.

You can even convert funds from an IRA or 401(k) to an annuity. This is an excellent way to add a guaranteed income stream to your retirement plan. Remember, since your contributions and investment earnings were tax-deferred, income distributions will be taxed at ordinary income tax rates upon distribution.

There are various types of annuities:

  • Fixed Annuities: These annuities are a lot like bank CD’s. They typically allow you to withdraw interest income without paying penalties. There are no fees on fixed rate annuities, although they usually do have a surrender charge in the event that you withdraw more than an amount specified in the contract, or if you terminate the agreement early. Fixed Indexed Annuities (or FIA). This are like fixed rate annuities, but with an investment provision. You set up a certain term, as well as a minimum interest rate. But an FIA also allows you to link your investment to the stock market, which allows you to earn an even higher rate of return. And not only can you participate in stock market index gains (typically the S&P 500 index), but you’ll also be protected from any losses to your principal investment. This is a way to participate in both income and growth with your investment.
  • Annuity with a guaranteed lifetime withdrawal benefit (GLWB). This is a rider that you can attach to any type of annuity. It will provide you with an income that will last for the rest of your life, and allow minimum withdrawals without having to annuitize is the contract. Note: this could be a FIA (mentioned above) or a variable annuity (I am not particularly fond of variable annuities) These lifetime income riders are a powerful addition to an already strong tool in retirement. They allow you to create another guaranteed income source that is not dependent on the performance of the markets for insuring your income needs are met. When combined with income form Social Security and perhaps an employer pension, these income benefits go a long way to providing peace of mind in retirement.

You might also consider adding an investment type life insurance policy to your investment mix. Such policies allow you to accumulate cash value in the policy on a tax-deferred basis, much like defined contribution plans. They can be an excellent addition to your retirement portfolio mix if you routinely max out your retirement plan contributions.

  1. Creating a Housing Plan

Since housing is typically the largest single expense in most households, it should be considered carefully in light of your overall retirement plan. At a minimum, you should plan to pay off your mortgage and own your home free and clear by the time you retire.

That will keep the cost of your current home to an absolute minimum. It will also provide you with an unencumbered major asset at your disposal at some point after you retire.

You may also want to consider the possibility of changing your housing situation entirely.

There are several reasons why this may be either necessary or desirable:

  • Downsizing to a smaller, less expensive home to reduce basic living expenses.
  • Moving to an area that has a more favorable climate or preferred recreational amenities.
  • Moving to an area where the general cost of living is lower.
  • Living in a location with a high WALK SCORE to reduce the need to drive.
  • Moving to a state with lower income or property tax rates or special rates for retirees.
  • Moving to be closer to your adult children and grandchildren.
  • Moving into a home that will require less repair and maintenance on your part.
  • You may want to free up some of the equity in your home to put into income producing investments.
  • You may decide that your current home is simply too large for a retired person or couple.
  • You may even consider renting for a time, while you decide exactly where and how you want to live.

Complicating your considerations is the fact you may also want to have a second home in a specific location. That may also motivate you to think about downsizing your primary residence in order to make room in your budget for the second home.

Fortunately, if you do plan to sell your home, and you have a considerable amount of equity, the IRS allows you to exclude up to $250,000 on the gain on the sale of your primary residence from taxation. For married couples filing joint, the exclusion is $500,000.

  1. Never Ignore Inflation!

It’s important to understand inflation doesn’t stop when you retire. And since you can fully expect to live another 30 years after you retire, you will have to adjust your financial situation for rising prices.

As a general rule, you should assume inflation will continue at about 3% per year. That’s about what inflation has averaged over the past 30 years. That means general price levels will roughly double in about 19 years after you retire. You’ll have to prepare your retirement portfolio and your income for that outcome.

Fortunately, Social Security benefits are indexed to inflation, so those payments will rise as well throughout your retirement. Recently however, the increases have been very small and are likely to remain small, so that even as they rise, they aren’t likely to keep up with the general rate of inflation as the Social Security Administration seeks to limit payouts and the government tries to reduce so called “entitlement” spending. However, your retirement portfolio will have to grow in order to keep pace with inflation, and that will require you to have some of your assets invested in growth-oriented assets. Investments like stocks, commodities, and real estate. Yes, this means risk.

One way to reduce this risk is by using Fixed Indexed Annuities as discussed in #4 above.

  1. Income Taxes – They May Not Be As Low As You Think

When planning for retirement, you should consider the very real possibility that you will be in a higher income tax bracket than you are right now. There are several reasons for this:

  • Your income is higher in retirement, due to your having multiple income sources, and/or
  • Required Minimum Distributions on qualified assets.
  • Fewer write-offs and deductions since home is likely paid for and kids are no longer dependents.
  • Income tax rates increase by the time you retire.

This will require some type of income tax diversification planning on your part. Two ways to do this through your retirement portfolio include:

  • Don’t put all of your investable dollars into a qualified plan such as a 401(k0 or IRA. Withdrawals from non- qualified accounts will be more tax friendly, since neither the contributions nor the investment earnings were tax-sheltered in any way.
  • Invest in a Roth If you are at least 59 ½ and have had the plan for a minimum of five years, both the contributions and investment income can be withdrawn free from income taxes.

Taking those two steps won’t shield all of your investment income from taxes in retirement, but they will cut down on exactly how much is subject to tax.

Fortunately, you will have a built-in tax break with your Social Security benefits. Many taxpayers won’t have to pay any tax at all on their Social Security benefits. But if you are single, and have taxable income of at least $25,000, or married filing joint with a taxable income of $32,000 or more, up to 85% of your Social Security benefits will be taxable.

  1. Making Your Distributions Last a Lifetime

After spending your working life accumulating a large retirement portfolio, the job in retirement will shift to creating a distribution plan that will provide you with an income for the rest of your life.

There are different ways to do this. Perhaps the most common method discussed is the safe withdrawal rate. The theory says that if you withdraw no more than 4% of your retirement portfolio in any given year, your portfolio will never deplete. In theory, this works. The problem is that it does not recognize the impact of investment market declines. It also disregards years in which you have negative investment returns, or even returns that failed to cover your withdrawals. In a worst-case scenario, you could be withdrawing 4% each year of a declining investment base. Recent studies by well-respected retirement experts have essentially debunked this methodology. In fact using today’s interest rates and market volatility, they have placed the “safe” withdrawal rate at around 2.8%. Imagine a retirement portfolio of one million dollars; the safe withdrawal would be just $28,000 dollars. If this were a qualified plan like an IRA or 401(k) this amount would then be taxable. Not much lifestyle for a million dollar portfolio, wouldn’t you agree?

So while you can consider the safe withdrawal rate as a general guideline, you may need to make adjustments in the strategy on an annual basis. For example, in years when the market is in decline, you might not want to make withdrawals at all. In such years, you might want to have non-retirement assets that you can draw from to make up the difference. Working with an experienced and competent retirement income planner can help dramatically in this area. There are many tools at their disposal designed to create income and reduce risk.

  1. Health Care – The Retirement X Factor

Statistically at least, healthcare costs become even more significant as we age. Even with Medicare, senior citizens are never completely insulated from the high and rising cost of healthcare. And since they tend to be more frequent users of the healthcare system, they are more exposed to these costs. So how do you prepare for healthcare costs in your overall retirement plan?

  • Make good health a priority in your life – start now, even if you are not close to retirement age. As the saying goes, an ounce of prevention is worth a pound of cure. Start those prevention efforts now.
  • Sign up for Medicare as soon as you turn 65.
  • Add a private Medicare supplement plan to your basic Medicare plan. Medicare doesn’t cover everything, and the supplement will generally pay for what Medicare doesn’t.
  • Add a Medicare prescription drug plan to greatly reduce the costs of most prescriptions.
  • Make sure you have an emergency fund – apart from your retirement portfolio – available for those years in which uncovered medical expenses are particularly high.
  • Plan to maintain a life insurance policy on each spouse for the rest of your lives. The death of one spouse, following a long medical event, often devastates the finances of the surviving spouse. Life insurance proceeds can replenish those funds.

It’s impossible to know ahead of time exactly what your medical costs will be in retirement. But that’s exactly why you should have a plan – with multiple options – in place for when the need arises.

  1. Planning For Long-Term Care

One downside to living longer is the likelihood of needing either assisted living or long-term custodial care. Assisted living alone typically costs in the range of $40,000 per year, but a nursing home stay can easily cost $80,000 per year, and even more in high cost locations.

Importantly, Medicare does not cover long-term residency in either an assisted living facility or a nursing home. And while Medicaid will cover these costs, they will only do so after you have exhausted all of your financial resources. If one spouse is in a facility, and the other isn’t, this can leave the healthy spouse is an extremely difficult financial position.

Long-term care insurance is more necessary as people live longer. A long-term-care insurance policy is much less expensive if you buy it well before you retire, and while you’re still healthy. The longer you wait, the more expensive it will be.
There are different long-term care policies, with different provisions. For example, a policy that will cover a very long-term stay in custodial care facility will be very expensive. Plans that limit coverage to two or three years are much more affordable. Most plans also have a per day expense cap, that may or may not be sufficient to cover the actual cost of care.

But even if a long-term-care policy doesn’t cover 100% of the cost of the facility, it’s still a great help if it covers most of it.

Building up your retirement portfolio, is the obvious first and best step in creating your retirement plan. While you’re doing that, spend some time considering all of the other retirement issues, and what you can do right now to be prepared when the time comes.