For many reasons, retirement is not what it used to be. Americans are living and working longer, with many choosing to work full- or part-time well into their later years. Those who do retire tend to be active travelers who want to spend quality time with their families, pursue new hobbies, and volunteer in their communities.
Planning for retirement has also changed dramatically, as investors try to ensure they can maintain their current standard of living for 20-25 years after leaving their full-time jobs. For retirees with ample time on their hands, costs can add up quickly, especially as they enter the first few years of retirement and take on an active lifestyle. Where a pension and a monthly Social Security check was once more than enough to live on, it is no longer the case, as most companies have eliminated pension plans altogether. The amount of Social Security available to retirees has also shrunk significantly and will likely phase out by 2035.
The "New" Retirement Defined
Research conducted by Age Wave tells us that the "new" generation of retirees is facing a host of issues, compounded by the coronavirus pandemic. Most baby boomers are now retired or semi-retired and are concerned about sustaining their lifestyles and long-term health. Many are offering financial support to family members, and are worried about managing their portfolios given the current instability in the markets. They feel anxious about maintaining physical and financial health, and how they will pay for their own long-term care when the time comes. How can investors prepare for the unexpected and save for retirement while also living the life they want? We offer a few tips below.
Calculate What You Will Need in Retirement and Start Saving Early
The decline of pensions and the American social safety net necessitates that investors plan for longer life spans and are prepared to cover their own expenses. However, the data suggest that about one third of American adults have not started saving for retirement yet, and about 40 percent of Americans nearing retirement have little to no savings. The number of older Americans with debt has also increased over the years.
For these reasons, the importance of establishing a savings plan as early as possible for retirement cannot be overstated. "As soon as you start earning money, you should save 10-15% of your annual income and continue to do so as long as you are working. When I help clients with their retirement planning, I advise them to plan on spending more income in their early retirement years than they did when they were working. This is because it is likely they will become involved in things like hobbies or travel, which can be costly," says Lisa Marcelli, a financial advisor in Houston.
Marcelli also says that if possible, investors should try and calculate how much they will need in retirement. Factoring in inflation rates, age, current income, and portfolio evaluations should give them a rough estimate of what they will need. Investment planning tools like retirement calculators generally say that most investors will need to replace about 80 percent of their income when in retirement; however, by factoring in anticipated spending on entertainment and health care, the actual amount of income needed could be much higher.
Consider the Cost of Long-Term Care
As retirees move into their later years, healthcare costs start to rise sharply. While anyone over the age of 65 is eligible for Medicare, it is important to factor in the potential cost of services not covered by Medicare, such as hospital stays, prescriptions and long-term care. Typically, a stay in an assisted living facility or nursing home can cost up to $200,000 per year. Because long-term care is most often an out-of-pocket expense, it may be worth considering the purchase of a long-term care insurance plan to cover you or your spouse in your later years.
Diversify Your Portfolio Beyond Your 401(k)
Instead of pensions, employers now use defined contribution plans, such as 401(k) and 403(b) accounts, allowing employees to contribute up to $19,500 tax-free per year. If your employer offers a 401(k) plan, it is important to consider contributing as much as you're able to since employers will often match employees' contributions. "Start saving at the highest percentage you can and try to gradually increase the amount you're contributing by one percent every year. Most people find that they can successfully reach their savings goals this way," Marcelli adds.
In addition to any employer savings accounts you may have, consider opening a Roth IRA, or, if your income level is too high, making a Roth IRA conversion using your traditional IRA. Roth IRAs offer tax-free growth so that when retirees draw upon the accounts later in life, they do not have to pay taxes on the distributions. In 2018, Congress lifted income restrictions for Roth IRA conversions as part of the Tax Cuts and Jobs Act (TCJA). For this reason, converting a traditional IRA to a Roth IRA using the backdoor method has become an attractive method for putting money away. Although investors must pay income taxes on the funds converted from a traditional IRA to a Roth up front, the results pay off later, as assets continue to grow long-term and can be withdrawn decades later without being taxed.
"Many people only save using tax-deferred 401(k) plans, but one of the biggest things I emphasize when I speak with clients about retirement is that if they do not have a source of after-tax- money to live on when retirement comes, they may be faced with having to pay an excessive amount of taxes. Everyone knows that the more income you have, the more taxes you pay, so if the only source of income you have during retirement is wrapped up in tax-deferred accounts, you could end up back in a high marginal tax bracket by taking large withdrawals from those accounts," says Jason Fair, a financial advisor in Memphis.
For this reason, Fair encourages clients to consider Roth retirement contributions in both IRA and 401(k) accounts. While Roth IRAs have income limitations regarding who can make contributions, Roth 401(k) accounts do not. "Not every 401(k) offers a Roth option, but it is becoming more common for plan sponsors to offer this feature. If an employer has a Roth option, I always encourage my clients to make at least some of their deferrals into a Roth. By having those additional funds outside of tax-deferred accounts, they will be able to control the amount they withdraw from tax-deferred retirement accounts, which helps them optimize their tax brackets," Fair says.
Fair also gives his clients rule-of-thumb advice to maintain the same amount of taxable accounts as tax-deferred accounts, and adds that "the other way to make sure you have a non-tax-deferred bucket to draw from in retirement is to have traditional investments outside of retirement accounts like stocks, bonds, ETFs, and mutual funds."
Be Prepared for Market Volatility
All investors should ask their financial advisors about strategies that protect them from market volatility, especially as they near retirement. Marcelli advises that since Interest rates are especially low at the moment, it means there isn't a lot of return in bonds, CDs and other types of conservative investments; however, it is still important to have these low-risk, liquid investments in your portfolio. "With at least two years' worth of your spending needs in these kinds of investments, investors are covered in case the markets drop."
Retirement will never be what it once was, and it will keep changing as retirees remain active, improve their overall health, and continue to live longer. It is never too early or late to start building your nest egg. Start calculating what you'll need, consider planning ahead for your healthcare needs, and maintain a diverse portfolio of assets. For more information on how you can best manage your retirement planning, reach out to your B. Riley Wealth Management financial advisor or visit www.brileywealth.com.