Retirement is just as much a leap of faith as any other significant life change. No matter how much you prepare, you will only really understand all the implications when you start your new life. That's one reason we believe that a good retirement plan is flexible enough to efficiently encompass changes in your life as you adjust to your new situation.
How do we get to maximum flexibility? It starts with thinking through retirement risks and leaving yourself a safety net for unexpected changes. The more your plan is set up to accommodate predictable events or situations, the greater your ability to adjust to the unpredictable.
Making Sure You Don’t Outlive Your Money
The biggest concern for retirees is making sure they don’t outlive their money. The Social Security Administration reports that the average life expectancy for a man reaching age 65 in 2023 is just over 84 years, and for a woman, it is almost 87 years. A twenty-year retirement is a norm now, and for many people, it can be a decade or more longer than that.
Expenses in retirement are often high during the early, active years. In the middle years of retirement, expenses may drop. But longer life expectancy often means increased expenses in the last years of retirement to pay for health care. Returning to our 65-year-old couple above, Fidelity estimates that healthcare expenses may be approximately $315,000 throughout their retirement – over and above Medicare.
How do you mitigate this longevity risk? It comes down to three things:
- Keep a careful eye on expenses and update budgets regularly
- Optimize your social security benefits by timing when you start
- Invest with a bucket strategy for both your short-term and long-term needs. This allows you to keep capital growing for long-term needs and to ensure you have what you need in the short term without liquidating investments at a loss
Keeping an Eye on Inflation – But Not Too Close
The high levels of inflation we've seen in the last couple of years are hitting everyone's wallet. But taking a longer view, over the previous 50 years to 2021, inflation has averaged about 3.28% annually. The stated goal of the Federal Reserve is for inflation to remain around 2% annually, and we are obviously a lot higher than that.
Building an income strategy around today's high inflation could result in taking too much income out of your plan in the early years. It's a good idea to go beyond the statistics and consider how inflation affects you. Realize that your personal experience with inflation will be different from the reported numbers, good or bad. Social Security is indexed to inflation, so some income will keep pace. Retirees also may have a smaller outlay on things impacted by inflation than people still in their working years.
Include a modest assumption for inflation in your income planning, and for temporary spikes, some remedial budget-cutting is probably enough to keep you on track.
Paying Attention to Your Taxes
You’ll be in a lower tax bracket in retirement, right? Well, maybe. You may not have the same deductions as when you were working, and once you hit 73, required minimum distributions (RMDs) turn your tax-advantaged savings in 401(k)s and IRAs into big chunks of taxable income. If your income gets too high, you may end up paying a tax on Medicare through the IRMAA, which kicks in at higher income levels.
You don't have to give up control of your income if you plan ahead. You can deploy several tax strategies, particularly in the early years of retirement. One example is a Roth conversion. The key is to take a multi-year planning approach. The goal is to even out income streams to keep taxes as low as possible.
The Bottom Line
Retirement changes your mindset from being a saver to essentially a spender as you begin to live on the nest egg you accumulated. You won't have income from work, but you will have more freedom. For many retirees, the newfound freedom opens new doors, but also new speed bumps. By planning for the expected and unexpected, leaving a safety net, and managing your taxes, you can mitigate some of the biggest retirement risks.
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