With early retirement such a popular topic these days, discussions of how to make retirement assets last are pretty standard. It's a difficult task to know whether you're ready for retirement or not.
Americans are living longer than ever. That also means they're working longer than ever. A recent life expectancy study from the Brookings Institute illustrates this point. Though it seems counterintuitive, those with lower incomes retire early than those with higher incomes. According to the survey:
“Fifty-six percent of men and women in the bottom third of the mid-career income distribution—and with a full-retirement age of 66—begin claiming Social Security at or before age 62. They rely more on Social Security to supplement their retirement income. For many, it's the primary source.”
Living longer requires our money to last longer. Outliving our money is one of the biggest fears for those engaged in retirement planning. Having a secure retirement means saving enough money to provide the necessary retirement income. That also means you need to have enough retirement assets to support that income and make it last throughout your retirement, however long that might be.
Life expectancy and your retirement assets
Life expectancy is a crucial factor. Deciding how to plan for how long you will live is one of the more difficult decisions. Plan for a life expectancy that's too long, you risk living on less than you might want or need. Plan for one that's too short, you risk running out of money.
If you're a woman, on average, you will live from five to seven years longer than men. My advice is to err on the side of caution. It's much better to plan for a longer than expected life than to risk running out of money because you didn't.
So, what's the age to use? How do you know if you're saving enough?
Many use age 95 or even age 100. That may sound crazy, but with advances in health care, we are living longer than at any time in history. Also, people are much more health-conscious than ever.
Many retirees use the 4 percent rule to gauge how much income to pull out of investments each year. To use this rule requires you to put an ending age in the calculation for life expectancy. It provides a way to keep your original starting principle value intact. There is plenty of flexibility in the calculation to adjust spending and income along the way.
Get better returns on your money? Great. Take more income that year. Or be conservative and let that money grow. Get worse returns? Cut back. Be flexible and willing to make adjustments.
Whether you use the 4 percent rule or some other method, the conservative and safe way to keep from running out of money is to assume a long life-expectancy.
Five ways to make retirement assets last
The formula for getting to and maintaining financial independence is not a complicated one. It involves three basic principals.
- Spend less than you make.
- Save and invest the difference.
- Reduce or eliminate debt.
That's foundational for anyone trying to control their finances. Making your retirement assets last, developing your best retirement plan, involves these three principles and a couple more. Retirement planning without these principles will likely not be successful.
Here are the five things you need to consider.
Reducing spending seems obvious.
Many people believe they can enter retirement, spending the same amount of money as when they worked full time. Don't wait until you retire to figure this out. Make plans on how much you will spend well in advance of your actual retirement. I know that seems obvious. But you'd be surprised how many people wing it in retirement.
Consider moving to an area with a lower cost of living. Called geographical arbitrage, moving to a low cost of living area can save you a ton of money over the years. For many, moving isn't possible. However, if you can swing it, it's something to consider strongly.
Not sure where that is? Learn more at Sperling’s Best Places to Live – bestplaces.net.
My wife and I live outside of Washington, DC, in one of the highest cost areas in the country. According to Sperling, our area's cost of living is 143 percent of the national average! We will not be staying in this area when we retire.
An RV lifestyle is likely in our future, at least for a little while.
What about you? Are you willing to downsize? Move to a lower cost of living area? If so, that's a huge step to make your assets last longer.
Eliminate or reduce the wants and focus on the needs in your retirement spending? When we have this conversation, we find there's a lot of money to be saved, focusing on needs versus wants.
Reduce or eliminate debt
Reducing or eliminating debt is another obvious point. Many people entering retirement still have massive amounts of debt. Pay off high-interest credit card debt. If possible, have your mortgage paid off at retirement.
If you are empty nesters and live in the same house where you raised your family, it is likely more house than you need. Consider downsizing. Use the cash from equity from the home sale to pay for a smaller home. Retiring without a mortgage can substantially reduce your monthly costs. If you don't have a lot of equity, take a look at renting rather than buying.
The primary motivation for owning a home in the past was the tax deduction for the interest paid. With the new tax law change, that's a non-issue for many. Most will now file a standard deduction and not take advantage of the mortgage deduction.
Now, more than ever, renting may make sense.
Maximize your Social Security Income
To have a secure retirement, you'll need to have an income plan. For most, Social Security is the only guaranteed retirement income option. This Social Security Bulletin estimates that 40% of baby boomers' retirement income will come from Social Security.
Research sources indicate about half of all Americans file during their first year of eligibility, typically age 62. Starting at age 62 gives you reduced benefit but for a more extended period, assuming average life expectancy.
Waiting for full retirement age (age 66 for most baby boomers) increases your Social Security income by 25%. If you can wait until age 70, your income grows by another 32%.
If married, divorced, or widowed, you may have other options to increase your Social Security income, including a divorced spousal or survivor benefit. Make sure you thoroughly analyze your options before making a decision.
It is essential to get it right the first time. A 2010 rule change prohibits changing your Social Security election after twelve months. If you need help, consider hiring a financial planner. If you do that, be sure to talk to your advisor regarding their knowledge and expertise about Social Security claiming. At the very least, they should have a solid working knowledge of Social Security.
Make smart decisions when withdrawing from investment accounts
Conventional wisdom says to take income from taxable accounts first, and then retirement accounts (IRAs, 401(k)s, etc.). However, that may not be the best option.
Calculate whether it makes sense to withdraw from retirement accounts first. To minimize taxes, limit withdrawals to amounts that don’t exceed your marginal bracket. If that's 15%, only withdraw an amount of money that keeps you from going into the next tax bracket.
Often, taking this income means you can delay filing for Social Security, your benefit will grow, ideally, until age 70 (see above example).
Also, it reduces IRA account balances, reducing the amount of money taken from your IRAs due to the required minimum distributions (RMDs). RMDs must begin in the year following the year you reach age 70 ½.
Converting those traditional IRAs to Roth IRAs is another consideration. Though you pay taxes in the year of conversion, withdrawals from a Roth IRA are tax-free.
Note: If you need additional income, consider selling stocks or stock mutual funds held longer than a year in taxable accounts. Under the current tax code, you pay these taxes at capital gains tax rates (15% or 20%).
One Roth conversion strategy to consider is called the “fill-up-the-bracket” strategy. You may have heard it described as a Roth conversion ladder. Here's how it works.
Investors convert just enough of their traditional IRAs to keep them in their current marginal tax rate. Let's say their 2018 marginal tax bracket is 24%.
If filing as an individual, the income band is $82,500 to $157,500. If married filing a joint return, the range is between $165,000 and $315,000.
In the fill-up-the-bracket strategy or Roth Conversion ladder, an investor would convert just enough money each year to prevent their adjustable gross income from going above the top income level for that bracket (either $157,500 or $315,000).
Granted, they're going to pay more taxes in the years you convert. Some people don't like that idea. Here's the question – would you rather pay more tax while you're making a higher income or in retirement when, presumably, your income is lower?
For me, I'd much rather pay higher taxes when I'm making the most money.
Get retirement assets in the right accounts
Pay attention to which type of accounts you place your assets. Since you pay ordinary income tax on bonds, bond funds, and real estate investment trusts income, consider putting those in retirement accounts (traditional IRAs, Roth IRAs, 401(k) plans, etc.).
Granted, with near-zero interest rates the last several years, this has been less meaningful. However, the trend is for interest rates to move upward. Granted, as of this writing, we're in an inverted yield curve. But that fact is that there is little room for interest rates to go much lower. As interest rates rise, it will be more advantageous.
The economy is growing (depending on what report you believe), meaning inflation could become a factor. As such, the Fed has indicated they will be on a consistent, slow path to increase interest rates. That fact means that having fixed income in nontaxable accounts will have a more significant tax-reducing impact.
Conversely, stocks and stock funds get taxed at capital gains rates and should be in taxable accounts. Reducing taxable income and minimizing taxes on that income help your money last longer. And remember, if you own tax-free municipal bonds (or bond funds), the income from these counts toward the income calculation for taxing Social Security.
The lesson – look at the total financial picture when determining which accounts hold which investments.
A note to the younger generation
I read numerous personal finance blogs. Many of them focus on early retirement. Though there are exceptions, most of these bloggers decide not to include Social Security in the calculation.
I get the logic.
Many feel it won't be there for them when they reach the age of eligibility. Still, I believe you should add Social Security should, at the very least, to the Plan B retirement scenario. After all, any good plan has contingencies, right?
Planning on not having any benefit is a more conservative approach. And I always advocate being conservative in planning assumptions. However, I believe Social Security will be there when these folks reach their age of eligibility.
Yes, the trust fund will be taking in less than it's paying out by 2034. And yes, Congress is about as dysfunctional as at any time in modern history. If history is any indicator, they will deal with the issue before its demise. It may look different than it does today. But I don't see Congress doing away with it.
It would be political suicide.
And let's face it. Being a member of the Senate or House is a pretty darn good gig!
With life expectancies increasing, planning to make your retirement assets last is more important than ever. Hopefully, your planning started early. If not, it's never too late.
Stick to the basics – Spend less than you make. Save and invest the difference. Reduce or eliminate debt. Whether you're twenty-two or fifty-two, having the discipline to implement these steps can put you on the path to financial success.
Preparation is the key to success in life and in preparing for retirement. Following these five steps will significantly improve the probability of not outliving your money. And isn't that the goal of retirement, whatever age that comes for you?
Now it's your turn. Where are you in your planning process? Have you started? Are you almost there? If not, what steps will you take to get and stay on track?
Fred started the blog Money with a Purpose in October 2017. The blog focused on three primary areas: Personal Finance, Overcoming Adversity, and Lifestyle. During his time at Money with a Purpose, he was quoted in Forbes, USA Today and appeared in Money Magazine, MarketWatch, The Good Men Project, Thrive Global and many other publications.
In April 2019, Fred, along with two other partners, acquired The Money Mix website. To focus his time and energy where he could be the most productive, Fred recently merged Money with a Purpose with The Money Mix. You can now find all of his great content right here on The Money Mix, along with content from some of the brightest minds in personal finance.