Retirement planning is an intricate process with a lot of moving parts. You have to marry the retirement lifestyle you envision for yourself with the financial resources you have available. Finding the right strategies to turn a lifetime of savings into an income stream that can support you in retirement is a crucial and complex step to a happy and fulfilling retirement.
While everyone’s retirement and thus retirement plan is unique, there are certain key considerations investors should be aware of as they plan for retirement. This guide will walk you through those considerations, from the importance of multiple income streams to why everyone, regardless of net worth, should have an estate plan.
The earlier you start planning for retirement, the better off you’ll be once you get there. Here’s what you need to know to start retirement planning today.
One way to increase your financial security in retirement is by diversifying your income streams. While living on one large paycheck was fine when you were employed, in retirement, you’ll likely have multiple, smaller paychecks. The idea is for all of these smaller income streams to come together to create one larger and more predictable income stream. This will result in reducing the risk that one of your income streams will fall short and disrupt your overall retirement plan.
Your income streams can include any number of sources. It’ll likely start with your 401(k) or other retirement investments and perhaps a pension, but can also include Social Security, rental income or even a part-time job. Working part-time in retirement can provide the added bonus of workplace benefits like health insurance or paid time-off and sick leave.
To help you plan for how these income streams will come together, you should work with a financial advisor to estimate how much income you think you’ll need in retirement. From there, you can factor in what portion of your income will come from each source.
Just as it’s important to diversify your income streams, it’s also important to maintain a diversified portfolio both leading up to and in retirement. While the inclination can be to invest entirely in stocks before retirement, this can leave you overexposed to the stock market and result in stomach-churning drops in your portfolio during market downturns.
On the other hand, the desire to protect your hard-earned savings can lead retirees to become too conservative in their investments. Remember that you could easily be living in retirement for 30 or more years. Your portfolio needs to include investments with the potential to grow over that timeframe or you risk not keeping up with inflation and running out of money.
Keeping a diversified mix of stocks, bonds and other investments can help you build a more stable portfolio for the long-term. The trick is finding the right mix for your specific time horizon and risk tolerance.
This switch from accumulation to income can be a challenging one to manage. How do you turn a portfolio designed for growth into one that can produce an income stream for you to live on? This is a question some financial advisors have built their careers around answering. Working with a financial advisor who specializes in retirement planning can help you navigate this pivotal shift in your lifestyle and your portfolio.
Whether you manage your investments yourself or work with a financial advisor, finding the right allocation for your specific risk tolerance and investment objectives is key to retirement planning success.
Risk tolerance is the amount of volatility, or upward and downward movement, you are comfortable with in your portfolio. The trick is matching your risk tolerance with the return your investments need to generate to reach your financial goals. If you invest too conservatively, you may not get the investment growth necessary to reach your goals. But if you invest more aggressively than you can tolerate, you may find yourself panic-selling when your investments are down, which could handicap your long-term returns.
It’s important to be comfortable with the risk being taken in your portfolio, but remember, all investments include some form of risk to meet your goals. You and your financial advisor should have regular conversations about your risk tolerance as your situation and financial goals change. Some investors choose to do their own risk analysis using online risk tolerance questionnaires. However, even the most detailed questionnaire can’t replicate the reality of seeing your investments move up and down.
Retirees must contend with both state and federal taxes on retirement income. Some states are more tax-friendly to retirees than others. For instance, Florida and Nevada have no state income taxes. Other states, like New Hampshire, only tax interest and dividends.
Missouri falls somewhere in the middle of the tax-friendly spectrum. Social Security income for Missouri residents is exempt from state taxes for single retirees who have less than $85,000 per year in income and couples who have less than $100,000 per year in income. Retirees may also be able to get a deduction on public pension income. Beyond that, all other retirement income is taxable in Missouri.
This includes money you withdraw from a traditional retirement account, whether a workplace plan or Individual Retirement Account (IRA), which is taxed at your ordinary income tax rate. While, in theory, this could be lower in your retirement years as many retirees live on less income in retirement, taxes can still take a considerable portion of your overall retirement income.
Since your annual income in retirement may fluctuate, you could find yourself in a different tax bracket from year to year. Accidentally withdrawing too much from your retirement portfolio or selling appreciated securities or a second home could bump you into a higher bracket. This is why it’s important to plan carefully how much income you take in any given year. The upside is you’ll have more control over your income in retirement, and thus can structure income events so that you hopefully don’t get bumped into a higher bracket.
Other ways to minimize your taxes in retirement include living in a tax-friendly state and using tax-advantaged investments. States cannot tax retirement benefits earned in another state. So, if your pension comes from Missouri, for example, but you move to Nevada in retirement, you won’t need to pay state income taxes on your pension income.
Given the impact taxes can have on your total income in retirement, it’s important to work with a financial advisor or tax professional to continuously update your tax strategy each and every year.
A retirement plan is not complete without an estate plan. Without an estate plan, you have no say in what happens to your assets after you pass away. An estate plan can also make the inheritance process easier for your beneficiaries, as they shouldn’t need to go through probate or try to guess what you would have wanted. Everyone should have an estate plan, regardless of their net worth.
The first step in an estate plan is making sure you have named beneficiaries on all of your financial accounts. This is also the easiest step, as most financial institutions let you add beneficiaries online. However, the difficult part for a lot of people is remembering to update their beneficiaries. As life changes, you may not want to leave your assets to the same people you once did.
Your estate plan should also include a full list of all your financial information to make assuming ownership easier on your heirs. A Living Trust can help ensure your assets don’t go through probate.
Taxes also play a crucial role in estate planning. Properly constructed, an estate plan will account for these taxes and make sure your assets are transferred to your beneficiaries in the most tax-efficient manner. You should consider the tax consequences of how you leave your assets in an estate plan. Whether you bequeath them to your loved ones or a charity, each has its own tax impact.
Converting traditional retirement assets to a Roth IRA is a very popular strategy to reduce the tax consequences of inheritances. The idea is to pay taxes now while you are still alive (ideally at a lower overall effective rate than your heirs) and let the funds be tax-free to your beneficiaries. Likewise, future earnings on Roth assets are not taxed, so your future estate taxes will also be reduced.
It’s wise to work with a tax advisor as you construct your estate plan to determine which tax strategies are best for you and your heirs.
Business owners face unique challenges to retirement planning. As a business owner, your retirement is entirely in your hands. If you have employees, their retirement will also be partially in your hands. Put careful consideration into the retirement plan you use for yourself and your employees.
Business owners also need an exit strategy in place as part of their retirement plan. Your business could easily be your largest asset when you reach retirement. If you want to leverage it for income in retirement, you’ll need a plan for how you’ll sell it. This includes ensuring it can run without you at its helm. It’s never too early to start thinking about how you will hand over control of your business.
Market conditions can also impact your ability to sell your business and how much buyers are willing to pay. To prevent adverse conditions from hindering your business’s market value, consider building flexibility into your exit plan. Can you structure your plan so that you won’t have to sell if a recession hits near your retirement date? Although none of us want to keep working longer than we have to, being in control of when you pull the trigger on your retirement can be a powerful asset in your corner.