Hoping For A Smooth Transition To Retirement? Here Is What You Need To Know...

Best Practices For A Smooth Transition To Retirement

In our role as financial planners, our main job is to assist folks in transitioning to a new phase of life – i.e. retirement, sale of a business, working in a less stressful profession, etc.  Through this journey, we typically uncover a few areas folks do not think of as they make these important decisions.

For example, most people we meet with have done a great job saving for this next phase of life (saving ‘enough’ to retire), which is how they are able to even make the decision to work less or stop working all together.  However, this is only half of the equation, as they should also have a plan for cash flow (withdrawals), taxes, healthcare costs, insurances, and estate planning.

As you begin to take money out of your investments, proper planning becomes significantly more important to ensure you maximize what you have, while working to minimize your risk for loss.

Let’s dive into a few examples:

1. Cash Flow

Designing a cash flow plan may seem very basic, but it is often surprising how little planning folks actually dedicate here. 

When you are working and have a paycheck coming in every two weeks, it is easy (and perfectly normal) to simply save, spend, and repeat, as you do not need to worry about the well ‘running dry’.  However, when you are living mostly off your investments, you do need to pay a bit more attention to the level and frequency of your spending to ensure your assets will last your lifetime.

To make this area easier for clients, I often start by asking them how much they think they need to live in, factoring in mortgage payments, car payments, insurances, utilities, groceries, entertainment expenses, healthcare, TAXES (often forgotten about 😊), to name some common ones.  Once we have this basic living expense figure, we make sure to account for future / once or twice a year type expenses – future car purchases / payments, travel expenses, wedding contribution (for children or grandchildren), funds for a vacation home or boat purchase.

From here, we run the projection (with high current & future inflation assumptions), to determine the level of expenses their lifestyle will require, then we back into how we go about raising the income for these expenses.

Again, this may seem extremely basic, but it can be surprising to learn how much (or how little) you may actually need to live on during your retirement years, or post life transition.  Especially when you consider the bigger ticket purchases – travel, car, wedding, boat, and how you could consider funding these (lump sum payment or finance).

2. Tax Planning

In my opinion, taxes may be the most under planned for area of our lives.  While this may be OK while we are working since Federal and State taxes are withdrawn from our paycheck automatically, the dynamic ultimately flips once you use your investment for income – as you will need to elect the level of taxes to be withheld from your investments.

A lack of planning in this area could lead to significant under or over payment of taxes during one’s lifetime.  This is why I highly encourage clients to consider doing some tax planning, and to think long term, instead of simply trying to reduce taxes as much as possible in one single year.  Spreading taxes out efficiently over one’s lifetime could lead to a huge reduction in their lifetime tax bill.

A few strategies I have clients consider:

• Understanding the level of taxes that may be owed on their withdrawals
  • For example, if a client needs $60k/year ($5k/month) post taxes to live in retirement, then they will need to withdraw $80k (assuming 20% Federal & 5% State taxes) from their investments, rather than only $60k.
    • Without truly understanding their cash flow and factoring in taxes, they could be withdrawing too much in the early year of retirement or withholding too little in taxes!
  • Social Security Taxability
    • Your Social Security benefits could be up to 85% taxable depending on your income level and tax filing status
      • Using the above example, if one is taking Social Security benefits, then the $80k withdrawal could make more of their Social Security Benefits more taxable
    • Understanding which accounts to take income from first
      • If properly planned around, this is an area where folks can create lots of opportunity and efficiency
      • Along these lines, one should consider where assets currently positioned (tax wise)
        • Pre-tax vs. ROTH vs. Taxable
          • In addition, be aware of additional retirement income sources that are taxable – pension, Social Security, rental income, business income etc.

With the above narrowed down, you can begin to formulate a plan of attack

3. Asset Allocation & Location

Once you have a good sense of your income / expense needs, and plan of attack for withdrawals, it is imperative to design an asset allocation and location strategy that aligns with these areas. 

In its basic form, asset allocation is the action of diversifying your investments holdings across a wide range of asset classes for diversification and return purposes – i.e. allocation stocks vs. bond.  Whereas asset location is positioning your investment holdings within certain type of accounts based on the asset’s growth potential, tax implications, and the taxability of withdrawals from different account types.

 Utilizing the power of asset location looks a bit like this:

• ROTH Accounts: holds the assets with the highest growth potential
• Aggressive investment allocation = 80% stock / equity or above

• 100% tax free upon withdrawal as long as the account has been open for 5 years and over age 59 ½

• Pre-tax Account: holds the assets that are the least tax efficient, have modern growth potential
• REITs, bond funds, high dividend pay mutual funds or stocks, etc.
• Withdrawals – 100% taxable at your income tax rate
• Taxable Investment Account: holds the most tax efficient assets
• Individual stocks, low dividends stocks / funds, ETFs
• Assets held longer than 1 year then sold are subject to capital gains rates – 15% for most people at the federal level
• Assets held less than 1 year then sold are subject to income tax rates

By aligning your investment and distribution strategy using the above guidelines, you give yourself the opportunity to maximize diversification, minimize taxes on withdrawals, and properly plan for future income needs. 

For example, I often encourage clients to set aside 1-3 years of income in something more stable – this could be a money market fund, short-term bond, etc.  So, for a client who needs $60k/year to live on, we set aside anywhere from $60k-$180k for future income purposes. 

Building this into allocations accomplishes a couple of things

• Provides confidence that we have the income set aside in advance
• Buys us time
  • If the stock market is experiencing some volatility or the economy faces a recession (potential time for a market decline), we have bought ourselves time for the market to recover since the income needed is already set aside!!
• Allows the aggressive portion (equities / stocks) of the asset allocation to continually growth overtime, as we will not need to sell these assets to raise income when they are down

Nothing is perfect by any means, but the above allows us to gain some level of control

4. Insurance & Estate Plan

Insurances

As humans, when we make a transition to a new phase of life, we tend to try and eliminate items to bring less ‘baggage’ along.  While this can be good in some cases, when I help people transition to retirement, they sometimes jump to get rid of things like – life insurance, long term care insurance – or try to reduce coverage across their home, auto, and umbrella policies. 

Now, some of this may be warranted, but in certain cases, reducing or eliminating these coverages could be detrimental if something were to happen (unnecessary exposure to risk).  In some situations, this action is taken when folks do not understand the type of insurance they have, why they have it (what risk they are protecting against).

In my opinion, once you understand what you are protecting, why, and the cost to control this risk, you can make a more informed decision.

Therefore, when folks transition, we always go through the following areas:

• Life Insurance
• Disability Insurance
• Home & Auto Insurance
• Liability Protection (Umbrella Policy)
• Business Insurances (if self-employed)

For many of these, I make sure my clients are connected with the appropriate trusted professionals who can properly assist them with their coverage needs.  The goal is to review what they have, understand what gaps there are, and take the required steps to protect what they have built!

Estate Plan

It does not matter how old a person is, if they have children, or the level of their net worth, every single person should be thinking about their estate plan at some level.

Unfortunately, I find that many family’s / individuals who come to see me do not have any documents in place.  So, our goal is to assist them in understanding why they need to form an estate plan, and how they can go about getting started.

While, I am not an attorney, nor do I claim to be one, within the planning process we review with clients the meaning and purpose:

• Wills
• Medical Directives (healthcare proxies)
• Powers of Attorney (financial powers)
• Guardianship of children if both spouses pass away
• Trust vehicles
  • Revocable vs. Irrevocable
• Charitable gifting strategies

Moreover, we find that the retirement transition is a great time to establish your plan or review the documents you have in place to confirm that they align with your goals and wishes.

Many of the above actions can allow for folks to have a better handle on what types of assets they have, who they will go to upon their passing, how to protect these assets while they are living and when they pass, and (if applicable) how they can potentially reduce estate taxes for the next generation.

I always instruct clients to meet with a qualified estate planning attorney to walk through and execute these documents.  With this, we aim to work closely with the client’s attorney to be sure they have all the information they need to assist folks in implementing these strategies.

If you have made it this far, congratulations!  I realize this type of information can be a lot to digest.  But from our experience, we can say that folks who have the above areas covered prior to making their retirement / life transition, always seem to experience a smoother journey than the people who do not. 

Accomplishing the above elicits a greater level of control and financial confidence!