underwood fuhrer: Four Essentials to Consider when Thinking about Retirement ...

Sadly, some people spend more time planning a two-week vacation than they do planning for retirement. Nearly 80 percent of Americans acknowledge they have made mistakes in handling their finances and the largest group says not saving enough for retirement is their biggest mistake. According to a recent study the median household retirement account balance for those nearing retirement was only $120,000. One third of households don?t have a retirement account of any kind. And guess what, the average monthly Social Security benefit of $1,230 won?t go far. People have not sat down to analyze their financial situations. Less than half have tried to calculate how much money they will need to have saved by the time they retire to maintain their standard of living. In 2012 Fidelity Investments issued guidelines suggesting that people save at least eight times their final salary to meet basic income needs in retirement. So, if one?s final salary was ? let?s say $60,000 ? then one needs to have at least $480,000 to meet basic income needs on top of Social Security.

So, clearly we have a retirement crisis on our hands. There are four main areas to address when thinking about retirement. One is planning, two is saving, three is investing and four is having a tax-savvy and sustainable withdrawal strategy.

Number one, to start planning we have to figure out how much income will be needed to maintain a comfortable? or more than comfortable lifestyle. This all has to be done taking into account potential health care costs, long-term care insurance and so on. Inflation can be volatile and unpredictable, posing a constant threat to purchasing power, so we have to take that into account. It ranks as the #1 concern among pre-retirees and retirees and rightly so. I talked about this type of purchasing power risk in the second video of the six part series on ?Risk? on my YouTube channel. Since the 1920s inflation has grown at an average compound rate of about 3% annually. So, when planning for retirement we have to project an annual income need that is adjusted for inflation at an annual compound rate of 3%. Generally speaking, the cost of things we consume every day double roughly every 20 years, so if one is 20 years away from retirement and today you need $4,000 a month to cover basic expenses such as rent, food, clothing, gas, cable-TV, internet and so on? you will need $8,000 to cover those same expenses in 20 years.

So, once we have figured out the yearly amount we will need to live on, then second, it is necessary to determine an annual savings rate ? right now, here in the present ? that we can manage which when invested in a retirement account will get us there. Given the time horizon before retirement, our savings rate and a properly calibrated investment portfolio should bring about the lump sum needed to facilitate the desired income in retirement that was established in step one. You need to begin by looking at your current financial situation and existing retirement assets in IRAs, ROTHs, 401(k)?s, deferred executive compensation plans, non-qualified accounts, stock ownership plans, and so on, and an approximation of future Social Security benefits that you will receive. This information is easily obtained on the Social Security Administration?s website. Considering the bad numbers out there as far as preparedness for retirement, you may need to save at least 10% of your annual income per year if about 30 years away from retirement, and close to 20-30% if 10-15 years away.

Once we look at what we already have socked away and how much will be needed at the start of our retirement we need to close that gap. So, then third, in conjunction with an established savings rate, an investment portfolio has to be constructed and aligned with your unique situation, time horizon and tolerance for risk to reach the desired lump sum you will need at the start of retirement. For example, someone who has a 30 year time-line would most likely have a large percentage of their portfolio in stocks as opposed to bonds. For someone who is nearing retirement, the risk-profile would gradually be dialed down. You may have heard the joke ?the good news is: people live longer lives. The bad news is: people live longer lives.? We are healthier and living longer. Someone who is retiring in their 60s has a very good chance of living another 30 years. Therefore, it would be ill-advised to allocate our portfolio mostly to bonds when starting retirement because we need to combat inflation and purchasing power risk.

When saving and investing for retirement what is called ?asset location? becomes very important (not Asset Allocation), i.e. in what type of account to carry what kinds of assets. Choosing the right account, taxable vs. tax-deferred can help you cut taxes and keep more of your investment gains. It can make a major difference in how much you can earn, after tax, over time. For a couple of examples, those whose gains are taxed as ordinary income would obviously belong in tax-deferred accounts (such as REITs and bonds). More tax-efficient investments (such as stock ETFs and tax-free municipal bonds) would belong in taxable accounts, typically in retail brokerage accounts outside of IRAs, 401k?s, etc.

A periodic review is warranted?typically annually?to make sure the savings rate and investment portfolio is on track.

And last but not least: you should have a tax-savvy strategy for withdrawals in retirement. There are required minimum distributions or RMDs from certain individual retirement accounts, and there are Social Security and other sources of income to consider. Therefore, one needs to have a plan as to which accounts to withdraw from, when and how much. This is unique for each individual or couple, but generally speaking the simplest withdrawal strategy is to take assets from your retirement and savings accounts in the following order:

When looking at our retirement portfolio of investments and strategizing about an optimal withdrawal strategy, Social Security and all other sources of income need to be considered in an integrated fashion. There is a strategy I?m a fan of: the ?bucketing approach.? It?s a strategy where the portfolio is broken up into three buckets. Bucket One is held in ?cash equivalents;? very safe and steady vehicles such as short-term CDs and money market funds, and provides for funds to draw from for 2-3 years. Why? Because withdrawing assets during volatile markets early in retirement can ravage a portfolio. This safe and steady 3 year bucket will usually allow you to ride out volatilities. The second bucket would be an intermediate-term set of investments, i.e., high-quality short-term and intermediate-term bond funds for years 3 to 5. This is an additional layer of protection. And third, our last bucket would be designed for longevity, i.e. it would be a portfolio where we mix in some stocks to fight inflation and purchasing power risk, but in a fairly conservative, balanced portfolio. The size of each bucket can be adjusted slightly depending on needs. Additionally, a bucketed portfolio doesn?t stand still. Because assets are being depleted from Bucket One, you need to put in place a system for moving assets from the long-term bucket to the short-term buckets in a constantly rotating fashion every quarter or at least every six months. What this approach does is help retirees?who need a steady stream of income?ride out market volatility and help mitigate the risk of running out of money in retirement.

There are many different withdrawal strategies, such as the ?4% spending rule? ? as it is known ? which means withdrawing 4% of your prior year?s portfolio balance annually, adjusted for inflation. So, one needs to add the rate of inflation every year to that 4%. Let?s say inflation is at 2.5%. One needs to add 2.5% to the amount that was determined to be withdrawn. If, for example, you have 1 million, then the 4% would be $40,000, right? Then next year you would add 2.5% to this $40,000 to keep up with inflation thereby maintaining spending power, so you?d withdraw $41,000, and so on. Through extensive research and analysis it has been found that using this 4% rule made a retirement portfolio last through 30 years.

As you near retirement, you have less time to recover from a severe bear market. It would be prudent for a near-retiree to start gradually dialing down the risk profile of their portfolio and allocate more and more towards conservative investments as they are getting closer to their retirement, at least 5-7 years before, possibly earlier. Three years before retirement create bucket one and set it aside. This is the bucket I mentioned before from which you can start drawing for 2-3 years to cover your retirement spending.

There are some useful websites with very good retirement planning advice, calculators and other resources for planning, saving, and investing for retirement as well as managing your money when already retired. Three of my favorites are fidelity.com, troweprice.com and morningstar.

Contact us and let?s discuss your special situation. A free, no-obligation complimentary consultation is offered to all potential clients. ? See more at: http://www.fmastery.com/investment-management.htm

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