With the U.S. stock market roughly doubling in value over the last three years, many people are thinking of retiring. If 2022 is your year to quit your day job and toss away the alarm clock, here are six things to think about before you hand in that resignation.
Distribution Rate: Because you’ll be living off your money when retired, you need to pick a distribution rate from your portfolio. If you haven’t done so, it’s worthwhile to read up on how you estimate your distribution rate and what constitutes a reasonable assumption. The research firm Morningstar recently published an update on the topic, you can find it here.
In a nutshell, the rule of thumb in financial services has been 4%. Recently, however, some researchers are advocating distribution rates closer to 3% because of the persistently low interest rates. It’s unclear how this will play out, but you can likely still use 4% so long as you take a flexible approach.
Budget. Once you know how much you can take out of your portfolio each year, you really need to understand your living expenses. Before retiring, it’s important to construct a detailed budget of your annual spending. While most people know the basics, like their mortgage, auto and utility costs, they often don’t have a good sense of their one-off and discretionary spending. Things like household purchases, vacations, clothing, hobbies, out-of-pocket medical costs, real estate taxes, gifts, veterinary bills, and the list goes on. Our suggestion is to analyze what you have spent over the last two years, then bump your estimates by 20%.
Taxes. It’s important to understand the taxes you’ll owe once retired. The distribution rate mentioned above is pre-tax. It will be reduced by whatever taxes you need to pay on your investments and the distributions from retirement accounts. For instance, if you distribute 4% and your tax rate is 25%, you will only be living on 3%. There are a number of online calculators you can use to estimate your taxes, but you need to really focus on the details. If this isn’t your cup of tea, then hire an accountant to provide you with some tax projections. It’s important to know these numbers.
Social Security. You’ll need to make some decisions regarding Social Security. As you may know, you can claim as early as 62 or wait until age 70. What’s right for you depends on your career earnings history, your spouse’s history if you are married, and your income needs going forward. In general, if you can wait, it’s often a good idea because the benefit increases each year you wait. But, if for instance, you can’t make your numbers work at a 4% distribution and Social Security would help fill the gap, it may make sense to claim early instead of eating into too much of your retirement portfolio.
This is an area where you should spend time researching and talking to someone at Social Security to get your actual numbers. One problem today is that the Social Security offices have been closed to visitors for almost two years and it’s reported that about half of all calls to Social Security are never answered. So, start early on this one. If this sounds like too much, you can seek the help of a fee-only financial planner, but be sure they have the skills necessary to analyze Social Security claiming options. If you’d like to speak to a qualified advisor at Beacon Pointe, click here.
Medicare. While Medicare coverage is considered by most as quite good, it’s getting more expensive and more complex to manage. There is Part A (hospital), Part B (physician), Part D (drug), supplemental plans, co-pays, and deductibles. While there is generally no premium for Part A coverage, premiums for Part B vary by your income. They can be as low as $170 a month or as high as $578 a month per person. By the way, the base Part B premium increased almost 15% for 2022. There are also premiums for the supplemental plans, Part D plans, and then potentially sizeable deductibles, particularly in the prescription drug area.
Confused? There is something called the State Health Insurance Assistance Program that is available to help with Medicare decisions. You can find it by visiting ShipHelp.org
Bad Markets. On top of all this, you also need an investment strategy for when the financial markets can become volatile. It happens every so often and the declines can be devastating and potentially long lasting. A typical retirement may last up to 30 years. If you go back in history, at least once (and often more than that) in any 30-year time frame, the market has experienced a decline approaching 50%.
Usually, it takes years for markets to recover. The decline in 2020 was unusual in that it was so short-lived. But prudence requires that you plan on bear markets lasting for at least five years. For instance, during the 2008 financial crisis, it took the market about five years to recover its prior highs. That means at a minimum you should have a source of distributions that is outside of the stock market and adequate to meet your living expenses for that five-year cycle.
If all this sounds like a lot of work, it is. And that’s the point. You don’t want to head into retirement without being fully prepared. It’s a great privilege to retire, but it also comes with serious challenges. Many people retire without fully considering all the parts they must manage to successfully live off their money for multiple decades. The last several years have made it look easy. It may not always be like that.
Important Disclosure: The information contained in this article is for general informational purposes only. Opinions referenced are as of the publication date and may be modified due to changes in the market or economic conditions and may not necessarily come to pass. Forward-looking statements cannot be guaranteed. Past performance is not a guarantee of future results. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified or attested to the accuracy or authenticity of the information. The discussions, outlook, and viewpoints featured are not intended to be investment advice and do not consider specific investment objectives or risk tolerance you may have. All investments involve risks, including the loss of principal. Consult your financial professional for guidance specific to your circumstances.
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