The average retirement age in the United States is 63, according to U.S. Census Bureau data. If you are part of that trend, get ready to have your financial world turned upside down in your 60s.
As you trade in your office keys and a steady paycheck for a pension (if you’re lucky), investment income and Social Security, you shift from an accumulation phase to a distribution phase. Once you do, many of the engrained investment lessons you learned no longer apply. While the most important retirement-based IRS rules come into play during your 50s and 70s, in your 60s you must learn about (and try to understand) government programs, such as Social Security and Medicare.
As you shift from accumulation to distribution, volatility becomes trouble. While market turmoil is tough to stomach whether you’re in your working years or retired, those wild swings can actually be beneficial for employees. If you participate in an employer-based retirement plan, you have a forced discipline to buy securities even when the market is down. You are practicing dollar-cost averaging, which, over long periods of time, can help you buy at a lower cost per share. The day you turn on that “income” switch, that volatility exposes you to sequence-of-return risk. In other words, the average return of your investments is not the only factor anymore. When you are living off your investments, the timing of returns is also critical. The earlier in retirement you take a big hit, the worse off you’ll be.
Financing Life After Retirement
Now that we know we want to reduce volatility as well as sequence-of-return risk, we must think about solutions. Not to sound like a broken record, but the first step is to diversify. Imagine retiring in 2000 with large tech holdings or 2008 with large amounts of real estate. To spread the risk, cut your pie into many pieces.
Once you have a diversified, retirement-appropriate portfolio, you must decide which pieces and how much to sell in order to make your money last. Here are two out-of-date strategies that I wouldn’t fully depend on.
1. Living Off Dividends
Living completely off your dividends is probably unrealistic and irresponsible, unless you are very wealthy. In today’s low-yield environment, you are likely to get a dividend around 2%. If you’re invested 100% in stocks (also irresponsible for many), that means you’ll need a $5 million portfolio to draw $100,000 a year before taxes are taken out. The other risk is that if you are properly diversified, you are drawing only from the stock side, which means the bonds will become too heavily weighted. A better strategy is to sell by rebalancing. Every year decide how much money you will need and sell from the portion of the portfolio that has gone up. This will bring your portfolio back into balance and help you avoid selling at a loss.
2. Using the 4% Rule of Thumb
The 4% rule — often used to determine how much money you withdraw from a retirement account each year — was created for much less healthy people in a much healthier market. The amount you can safely pull out of your portfolio depends on the return you are earning and your life expectancy, which should make you skeptical of any one-size-fits-all strategy.
When to Take Government Retirement Benefits
Now that we have handled the complexities of investing as a retiree, we can dip a toe into the murky, complex waters of government programs. Regardless of your birth year, you can claim Social Security retirement benefits early at age 62. However, you will be permanently penalized for doing so. If your full retirement age is 66 (if you were born in 1943-1954), you will receive 25% less in benefits every month if you claim at 62. The opposite is true if you wait. You will get delayed retirement credits (income increases) of 8% per year until age 70.
The first step to figuring out Social Security is to learn the language (PIA, AIME, DRC, FICA, etc.). Next, find an advocate. Whether they’re a financial planner or not, you need someone sitting on the same side of the table as you when you make the very important decision about when to claim. Lastly, if you’re married, you must plan as a couple. Survivor benefits can be permanently reduced or increased depending on when your spouse claims benefits. Social Security should be simple — in fact, it’s anything but.
It used to be that Social Security’s full retirement age and Medicare eligibility aligned at age 65 and you could knock out both benefit applications at once. However, now you’re eligible to apply for Medicare up to 3 months before you turn 65, and that enrollment period is open for 7 months. You should apply ASAP, at least for Part A, in order for your coverage to begin the first day of the month of your 65th birthday. If you are still working, you’ll need to decide whether it’s worth picking up parts B and D or whether you have adequate, affordable coverage through your employer. Once you retire, you’ll have 8 months to get full Medicare coverage before your premiums are increased by penalties.
While traditional Medicare will likely cover the expenses of many of your medical needs in retirement, it will not cover long-term care expenses, except for short stays in a skilled nursing facility. According to the U.S. Department of Health and Human Services, 70% of those turning 65 will need some type of long-term care (LTC) services during their lifetime. Therefore, it’s a good idea to stress-test your financial plan to help ensure that you can afford a LTC service if needed. If you choose to buy long-term care insurance, you must factor that into your monthly or annual expenses to see if you can afford what are likely to be increasing premiums. If you decide to roll the dice, you want to be sure you have enough in assets and/or income to cover the cost.
Don’t Forget About Taxes
You’ve heard the saying that in life only two things are certain: death and taxes. While we don’t know when the former will come, we know that the tax man comes every year. That’s true even in retirement. The common assumption — and sometimes misconception — is that you will pay less in taxes once you have retired. That is another belief that depends totally on you, where you live and fiscal policy at the time. Your Federal Insurance Contributions Act (FICA) taxes will likely disappear in retirement, but so will many of your work-related deductions, including your 401K, health savings accounts, etc. My advice: Plan conservatively. You don’t want a tax hike in retirement to change your lifestyle.
There are many things to think about as you transition from your working years to your fun retirement years. Planning is advised; rolling the dice is not.
Remember, the opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.