Retirement Planning - Ensuring a Smooth Transition

by William Sabin, CPA

Retirement Strategy

As defined benefit plans and other retirement benefits are being greatly reduced or, in many cases, eliminated, the burden of retirement planning is falling on individuals more than ever.

Below are some basic guidelines that might trigger some thinking and planning on your part. Of course, each of these areas is more complex than what is written below; however, this could serve as a foundation for future study and retirement planning.

The big five "whats": What is your time horizon; what is your risk tolerance level; what do you plan on spending in retirement; what estimated rate of return should you use; and what estate planning needs you might want to consider.

1. What Is Your Time Horizon?

Foundationally, time is key to ensuring a successful financial retirement. While money is truly not everything (making a difference in the lives around you and health probably rank higher), having money set aside for retirement is helpful and helps enable you to focus on other important things.

The longer the time between today and your expected retirement age, in general, the more risk you can take now. Remember, stock markets move in long-term trends of ups and downs - 30-year or even 50-year trends. Of course, there are many other factors that affect your risk tolerance, many of which we will address below. Portfolio theory provides the investor with the ability to take more risk when younger as your portfolio can weather greater drawdowns in hopes that it will recover and continue to grow until you need to start taking distributions. In addition, higher returns generally mean that the younger you are, the more stocks, as a percentage of your total assets, you should have in your portfolio.

The key is that you are never too young to begin planning for retirement. I encourage even the youngest people to plow money into a Roth IRA as early and as often as possible.

Also, don't forget about inflation. Even small year-over-year inflation growth can substantially eat into your estimated savings. This is particularly important if you plan on living several decades more. No one knows for sure the day we will die - the best approach is to live like today could be your last day but plan like you will live to a very old age. Living for today frees you up from stress and worry, provides you the mindset to be kind to others, and to give freely of your resources to those in need.

In general, the older you are, the more your portfolio should be focused on income-related investments and ensuring capital preservation. This generally means that a higher percentage of your portfolio will be invested in relatively safer investments with less volatility. This might (not always) mean investing in bonds and other fixed income vehicles. As you age, as well as when your various sectors outperform the market substantially, remember to re-balance your portfolio.

2. What Is Your Risk Tolerance?

Everyone likes home runs - they are as exciting to see on the baseball field as they are in the investment field. Unfortunately, big returns almost always imply greater risks. While huge returns that outpace the market by 200% or more, if you can't sleep at night, don't buy them. Proper portfolio allocation that takes risk mitigation as well as overall returns into mind is probably the most important planning tool.

As mentioned, if you have a longer time horizon until the money is needed, you might be able to take more risk than someone that needs to tap into the money in the next 1-3 years. After accessing your retirement needs and your savings and spending habits, you might be able to throttle back on how much risk you are taking to meet your long-term objectives.

3. What Are Your Spending Requirements?

Your retirement plan needs to account for big payout periods - buying a house, a child's wedding, buying a new car, etc., meaning that you should estimate what your near-term, mid-term and long-term spending will be.

However, I have found that big expenses seem easier to plan for. The ones that seem to creep up on you are the daily expenses. Spending habits in retirement change; however, you might want to plan on spending more for travel and medical expenses and less, on say, business lunches. I have read that one should plan on spending 70-80% of what you are spending today for retirement. I feel that is bad advice - I would plan on at least spending the same or up to 20% more than your spending habits today (adjusted for inflation).

On average, people are living longer. This equates into you needing more money for longer during your life. Don't under estimate your retirement spending just to make you feel good today. Proper estimations will ultimately drive you to have to save more earlier and follow proper investing and spending habits your entire life. "Sorry Starbucks, but I need to only visit you once a week; I'm saving for retirement."

To determine your life expectancy, here is one of many tables to choose from.

4. What Rate of Return Do You Need?

Like underestimating retirement spending needs, factoring in a higher-than-average rate of return on your overall portfolio is also bad practice. While you might be able to beat the market in the short term, it is advisable to use the market's long-term returns by asset class for your analysis. You might even be more conservative and try your financial model out using a rate of return 120-180 basis points lower than the historical returns.

5. What Are Your Estate Planning Goals?

Disclosure up front - This can be a complicated area for both tax and legal planning. See a licensed professional as you venture down the estate planning road. Do you want to leave assets to your kids and grand kids? Want to provide assets to your favorite charity? Discuss generation tax skipping ideas. Look into Roth IRAs moving to the next generation. Power of attorney, wills, trusts, medical wishes, etc. should all be discussed and taken into consideration. Estate tax planning is also very important - you want to leave as much as you can to your heirs. Also, review the advantages and disadvantages of life insurance as well long-term medical care insurance.