This article will attempt to provide some basic information related to retirement planning. The Fidelity website has a lot of good information, diverse investment options, and was the 401(k) provider of a former employer, so it is used is most examples. This article is not an endorsement of an service company or investment option. Do your own research, make a plan, and follow it.
Retirement
Ah, retirement… Now what? Did you not read the earlier sections? You need to figure out what to do in retirement yourself … unless you are referring to investing. As discussed earlier, you may want to reduce the risk in your portfolio as you approach retirement. If you do not have enough money, you need to make a choice.
- Maintain or increase the risk to try to grow enough to retire how you want
- Reduce the risk as planned and live at a lower standard of living
- Find a legal partial alternate source of income. (Just to be clear, legal partial NOT Partial legal)
- Wait to retire and accumulate more retirement savings
This is a decision that only you can make. The first choice might allow you to live as you want and retire when you want because the market increased or require you to push retirement back another five years because the market decreased. The second one might mean drinking less soda for a small deviation or preventing you from completing your bucket list for a large deviation. Depending on the source of income, the third one might not be a loss. You might enjoy camp hosting at a state park or working with kids part-time at a community center. The fourth one … well … no one really wants to talk about the elephant in the room, but it might be the safest option.
What to Invest in While Retired
Your retirement investment strategy is pretty much the same as your working strategy. The differences are that you should have more money for more diversity and a different asset allocation. The list below is configured to the 60/40 retirement portfolio discussed in the savings section as the most successful asset allocation for retirement. If you need higher returns in retirement, you can accept the higher risk and adjust the percentages to be 70/30, 80/20 or 90/10. A common investor opinion is to keep the specialty/speculative fund to no more than 2%-5% of your portfolio. If you want a truly “fun gambling” type of speculative investment in individual stocks, create a separate account and allocate a small monthly stipend to “gamble” with. You should never gamble with your retirement savings.
The Fidelity Fund Portfolios page has sample diversified portfolios, but they are managed funds instead of index funds. The current returns are better than the index funds. Sometimes the managed funds out perform index funds in good years and fall behind in bad years. Some are doing well because of the fund manager, and when that person retires, you might need to move your money. From a previous employee 401(k), I know that Fidelity has at least some good managed funds. Feel free to use the funds suggested by the sample portfolios. I would expect them to be reasonable proven investments. The list below is an alternative using index funds.
- 10% of two large cap index funds
- 10% of each small cap index mutual fund
- 2% of one speculative or specialty fund (expect higher fees)
- 9% of each international large blend index fund
- 10% of three bond index funds
- 10% of one short term fund
This asset allocation uses 11 funds, so there should be reasonable diversity in your investments. On this day, the 10 year performance would be about 6.3%. These are not all the same funds or percentages that I used. Growth funds tend to outperform value funds over time, so it might be better to weight the growth funds at 12% – 15% and value at 8% – 5%. Feel free to research and select your own investment provider and specific funds, but these also appear to be reasonable options. The performance of every Fidelity bond index fund is not spectacular, so you may find it worthwhile to pay higher fees for a managed bond fund. Using managed bond funds with lower quality bonds can raise the 10 year return to more than 7% at the expense of higher annual fees and higher risk.
If your speculative/specialty fund under performs for 3-5 years in a row, you may want to change the investment. I chose healthcare as my speculative investment. It has not done as well as my other equity investments, but it has moved laterally to them. This has reduced the volatility of my portfolio, and it has not lost money.
Where to Invest While Retired
If you read the previous installment, you have already invested in various tax advantaged accounts. You may have them spread across multiple employer plans and investment providers. The same as changing jobs, you should consider rolling over your old employer plan to an IRA. You should also consider consolidating to one investment provider and one bank. Read the Retirement Savings: Where to Invest While Working about rolling over from one retirement account to another retirement account. It is important to avoid a taxable event when consolidating your retirement accounts. Being taxed on some of your retirement money in a single year might mean that you pay 2x-4x more taxes than you should in retirement. Using the sample 20 year with $3.4 million saved for retirement at 68 years old, taxes on all their retirement savings in one year would mean paying 10x more taxes than they should in their entire retirement. It also means living at 50% – 60% of their working salary instead of the planned 90%. Talk to investment professionals and use direct rollovers.
Pensions, Annuities, and RMDs, Oh My!
Pensions
Pensions and annuities serve the similar goal of providing you with guaranteed income at retirement. Pensions are a savings and investment product that is, at least partly, funded by your employer. When you retire, you need to decide how the pension should pay out. The common options are:
- Single Life – This option pays until the beneficiary dies and ends. Selection this might leave your partner with insufficient income, but it should have the highest monthly payments. If you are married, some states require a spousal waiver to select the single life option.
- Joint and Survivor – This option pays until the beneficiary and spouse die. The original amount paid is normally less than the single life option. You should be able to select the survivor payments to be roughly 50%-100% of the original payment. In addition to being a lower monthly amount than single life, a higher monthly survivor payment results in an even lower original monthly payment.
- Period Certain – This option is similar to the first two, but it allows payments to a third person, if you and your spouse die before a specified number of years.
- Lump Sum – This option is for rolling the funds into an IRA for the beneficiary to manage the growth and distribution of funds.
FINRA has decent article on Selecting Retirement Payout Methods that is worth reading. Pensions can provide an income stream for life, but it might not keep up with inflation. You will need to spend less from your IRAs to account for this in your retirement. You will need to decide which option is right for you and your spouse. Usually, two people cost 50% – 75% more than one person. This means that two thirds of the benefit for the survivor is often enough. If the survivor has a pension too, 50% may be sufficient.
Annuities
Annuities are an insurance product where you hand over a pile of money and the insurance company pays you a certain monthly amount for the rest of your life. I am not very familiar with them beyond the fact that I believe they are, generally, not in your best interest. An annuity is basically a bet that you will live longer than the insurance company estimates. If you read the life insurance section, you might remember that insurance companies are better at math than you, and (on average) they always win. If you have a long lived family, you might win that bet.
For example, I was told that an certain annuity was top tier, best of the best. It is guaranteed to always return at least 4%. I asked what the catch was. I was guaranteed there was no catch. I pointed out that the company would not stay in business with that model. I was told, *grumble* *grumble* well, they cap the maximum annual return at 15%… As it turns out, the stock market has good years about 2x as often as bad years. Do you want to guess who is better at math than you and wins all the time, on average?
If you are not capable of managing your spending, not capable of investing safely, or terrified that the market will crash for your retirement, then you may consider putting all or part of your money in an annuity. If you are not happy with the annuity, you may not be able to get your money back out, so research and select carefully. Keep in mind:
- Annuities are a product designed to make insurance companies money. Your lifetime income stream is secondary to their making money
- Almost any feature/rider you add will make the insurance company more money, no matter how good it sounds
- Money used to buy an annuity is kept by the insurance company when you die. There may be some annuities that pay out that amount when you die, but you pay for this with a smaller monthly benefit amount
- If the annuity provider goes bankrupt, you might only be entitled to about $100,000 back
- You should use an unbiased third party for research because every annuity provider says “Our annuity is the best!”
- The insurance company is better at math than you and always wins, on average
RMDs
Most, if not all, tax deferred retirement accounts have required minimum distributions (RMDs) starting at age 72 or 73. (Remember that the only two certainties in life are death and taxes.) The government wants to make sure it receives taxes on that money. The annual RMD equals:
Amount in the Account at the Start of the Year
_________________________________________________
Number of Years of Life Left
The number of years of life left is a statistical calculation that you look up in a table provided by the IRS. The company that manages your tax deferred IRA will often report the value to you at the end of last year or beginning of the current year.
If you do not withdraw at least a RMD, you pay a 50% excise tax on the amount of the RMD you did not take out. When you do not take your RMD, you usually lose, unless your combined state and federal tax for the year exceeds 50%. If you are in a state that does not tax retirement distributions, you usually lose even more. (The SECURE 2.0 Act may drop the excise tax to 25% or even 10%, if corrected within two years. If this is correct, there may be special cases where it is cheaper to pay the excise tax and correct for it another year.)
RMDs are not entirely bad because you usually pay less taxes by taking your money out in substantially equal amounts over a long time. If the government made you pay taxes on the entire account when you died, your heirs might be paying 40% – 50% taxes on the total instead of 10% – 25% taxes on distributions. With a few exceptions (e.g, spouse), the current laws require your heirs to take the money out of the account and pay taxes over a 10 year period after they inherit.
Taxes
Taxes are something to keep an eye on. It can be useful to sell off part of a fund with gains when you sell off a fund with losses. Remember that you can only claim $3000 in capital losses in a year. It is to your advantage to plan ahead to cancel gains and losses.
If you have transactions on the same fund within 30 days, the wash sale rules can prevent you from claiming losses. Be careful when rebalancing to avoid wash sales. I usually wait at least 32 days to rebalance to avoid this issue. I only rebalance if one of the investments is about 3-5% out of balance.
Depending on your income versus healthcare situation, you may be able to leverage the current laws to your advantage. If you sell investments at the beginning of this year for this year’s expenses and the end of this year for next year’s expenses, you may be able to get your income low enough next year to get discounts on market place health insurance or even other assistance. You will have to evaluate your tax situation to determine whether it is worth it. You do not want to pay $20,000 in taxes to save $10,000 on health insurance.
Hunkering Down
If the economy transitions into a recession or there is a large long term market decline, it is in your best interest to reduce spending. The closer the decline is to the start of your retirement the more important it is to prevent excessive drain on your retirement savings. If you have enough retirement savings that you live at a very low percentage, you may be able to ignore the decline. If your [(Income Percent) + (Inflation Percent)] is greater than or equal to your (Average Annual Return), you should definitely consider cutting back the withdrawals from your retirement savings. If you have other income to supplement your retirement, this may reduce the impact of the market decline.
Summary
If you want to be financially secure and retire comfortably, these are some of the key points to remember.
- Do:
- Improve your financial health
- Buy term life insurance to protect people you care about that depend on you
- Pay off expensive junk debt
- Build up a 3 to 6 month emergency fund
- Automatically invest for retirement
- Remove emotion from your retirement investing
- Setup automatically monthly/paycheck deposits
- Use asset allocation in your portfolio
- Target an average rate of return for your retirement timeline
- Invest in mutual funds
- Prefer high returns and low fees or index mutual funds
- Make retirement saving a priority and
- Pay yourself first
- Invest most of your pay increases in retirement savings
- Use time to your advantage
- Invest what you can as young as you can
- Invest with higher risk when young, and reduce risk as you age
- Let your money work for you
- Save and invest for large purchases instead of using credit cards or loans
- Reduce your taxes now or in retirement with a Traditional and Roth IRA or your employer retirement plan.
- Take advantage of matching employer contributions to your 401(k), 403(b), etc.
- Plan appropriately for early retirement
- Plan to stay in slightly more aggressively investments in retirement
- Plan to live off a smaller percentage of your retirement savings
- Plan to have enough money invested in individual accounts to pay for retirement from your early retirement age until 59 1/2
- Protect yourself from market declines near retirement age
- Improve your financial health
- Do not:
- Generate more junk debt
- Sacrifice retirement savings for short term luxuries
- Wait to start investing for retirement
- Try to time the market to increase your rate of return
- Invest in managed mutual funds, when possible
Next: Terms and Appendix