The past few years have stressed the way we look at and even define retirement. With the rise of the gig economy, COVID-19 shutdowns and higher-than-average inflation and market volatility in 2022, many people are questioning the status of their retirement plans.
These current conditions highlight a challenging reality of retirement planning: It’s dynamic. A quality retirement plan won’t be the same in 10 years as it is today. Instead, you need to plan around the certainty of today while keeping the uncertainty of tomorrow in sight.
Envisioning and Defining Retirement
But planning around uncertainty alone isn’t enough. Retirement planning in the United States has been focused mostly on saving, not spending. Instead of focusing on what happens in retirement – when you need to spend money – you’ve mostly focused on how to save money for retirement through pensions, Social Security, 401(k)s, investments and IRAs.
But the harder part of retirement planning isn’t actually the saving – it’s the spending, or decumulation, part. This is often due to the uncertainties – like inflation, sequence of returns and longevity risks – that can have dire consequences for a retirement portfolio over a 30-year time horizon. As such, you need to rewire the way you think about retirement from a savings to a spending mindset – I often call this Rewirement®.
When you get to retirement income planning – or the how to spend money and make it last in retirement – you need to start by defining retirement. What does it even mean to you? I’ve used the term Rewirement® before as a way to encourage people to focus on their retirement income instead of just savings. But definitions of retirement vary.
We have people who describe retirement as a work-optional phase and others who stick to the more traditional definition of not working at all. How will you live, spend your time, find meaning and fund the things you love to do in this period? Retirement is just a word you need to define for yourself, but know that it should be about you and your happiness. Take control by defining what it means for you – you don’t have to accept anyone else’s definition.
Once you envision your own retirement – really define and envision it – you can start the retirement income planning process, which will help you lay down a path for success. Process can provide a blueprint for success, but it doesn’t guarantee success.
The Process of the Plan
Often, planning starts with understanding where you are to figure out where you want to go. I recently asked Dana Anspach, CFP®, CEO and founder of Sensible Money, about the importance of a retirement income planning process.
“When we start our process, it’s a lot of information gathering,” Anspach told me. “We spend a lot of time getting the cash flows right and break the process into three strategy meetings to provide the client plenty of time to offer edits.”
Anspach noted she starts with the big picture, then she sets the tone and finally gets into the details of the plan.
Planning is a process. It’s not the plan itself that’s crucial, but the process you take. While not for everyone, it can be helpful to lay out a process for retirement income planning. Let’s look at a structure that follows a 10-step process.
1) Evaluate your current situation
2) Determine your retirement goals
3) Estimate retirement income needs
4) Identify your sources of retirement income
5) Calculate financial preparedness
6) Develop a strategy to address any shortfalls
7) Develop a tax-efficient withdrawal strategy
8) Understand the risk facing your plan
9) Convert assets into income
10) Retire, put the plan in motion and enjoy your life
This plan starts with you looking at where you are today. Like Anspach stated in a recent interview for a retirement income series we did on the Framework podcast, you need to review where you are to get going.
Next, I say you need to lay out your goals – keeping in mind they’ll likely change along the way. Remember: Goals are just mile markers; they aren’t the end of the journey. Instead, we should aspire to have a certain type of freedom in life and become who we want to be. Goals just show us progress along the way to our life aspirations.
After that, you need to figure out what income needs you might have if you aim for those goals. Figure out your expenses for your projected life. This gives you a target you can now aim at reaching through good retirement income planning. If you’re still many years out from retirement and a detailed retirement expense view isn’t possible, consider that you might need 70% to 80% of your current income today, adjusted for inflation, to maintain your standard of living in retirement.
Then, after you know your goals, your current cash flow situation and your retirement income needs, you’ll need to see what income you might have in retirement. This means looking at things like Social Security, pensions, retirement accounts, annuities, home equity or any other savings you could tap into to meet your needs.
Don’t limit your retirement income to one or two things – think holistically. Now you can compare your projected retirement income against your projected retirement expenses. If you have a large gap between the two, you can start to identify new ways to save, invest or cut back expenses to make your plan work.
Getting Into the Details
Once you get a good handle on your current situation and a view of your future, you can start to get into the details and make your plan more efficient. This might be tax location, like moving money from an IRA to a Roth IRA through Roth conversions. Maybe it’s saving more in an after-tax manner or shifting your investment philosophy. We also want to look at how we can minimize taxes on our retirement income, which might mean layering in tax diversification strategies, keeping Medicare premiums down, pushing off required minimum distributions or using charitable giving techniques. Tax planning can add a lot of value into a retirement income plan, and can mean the difference between running out of money or living a financially free retirement.
After you look at tax-efficient planning, you also need to address a number of retirement risks that could derail your planning. For instance, much like it did this year, inflation can creep up and erode your purchasing power throughout retirement. Even if inflation comes down from current levels, a modest increase in long-term inflation can quickly become a huge issue for a retiree living on a more fixed income.
We also have to deal with health care risks, long-term care and longevity risks, which can all be extremely costly to our plans. Sometimes insurance – like an annuity or long-term care insurance – can play a role in mitigating those risks. In other cases, we might self-manage the risks by holding more assets aside for them. Whatever the solution, you need to at least review risks that could derail your retirement and have a plan in place.
After you look at solutions to some risks, you need to start converting your assets into income. Are you going to use a flooring approach and buy lifetime income options like annuities or purchase a bond ladder to help with income? Or do you want to take systematic withdrawals from your investments, similar to a 4% withdrawal strategy? Or do you want to approach retirement income planning by bucketing your income sources over different periods of time? Whatever approach you take, you need to understand how it works and feel comfortable with the approach.
Lastly, you need to retire – whatever that means to you – put the plan into motion and enjoy life. If you aren’t sleeping well and enjoying your retirement, maybe it’s time to review the plan. A well-designed retirement income plan should help you live the life you want to live, financially free and with dignity.
Rewiring how we look at retirement needs to start with looking at the big picture, changing from a savings to a spending mindset and getting started with a planning process. Retirement income planning is often more complex than saving for retirement because there are so many risks and unknowns. So control what you can, design the retirement you want and don’t settle for someone else’s version of retirement.