When, and how, should I retire? The answer to this question is never simple. We approach retirement armed with a lifetime of experience but at the same time we have no idea what to expect. Making the transition with confidence requires careful attention to many interconnected issues.
Individual experiences will vary widely, influenced by a host of factors, including family circumstances and the prevailing economic and market environment. But there are a few crucial questions everyone should consider in making a retirement plan. The overarching goal: to make sure you can live the lifestyle you want for the rest of your life.
How long will I live? It’s not a pleasant thought, but contemplating how long you will live matters hugely for retirement planning. Longevity risk, or the potential to outlive your retirement savings, is by far the biggest worry cited when moving into retirement. This life stage may last 30 years or more, so be conservative by building a retirement strategy that aims to cover spending needs for that timeframe.
How much will I spend? Whether it is a percentage of pre-retirement income or a percentage of wealth at retirement, rules of thumb can provide helpful guidance as to what you can afford, but in practice they are impractical and inefficient. A more fluid approach to drawing on savings that adapts withdrawal rates and asset allocation in response to changes in economic and market environments and shifts in personal circumstances can produce a better outcome. Because it’s a flexible approach it can help protect against the risks of outliving savings while maximising spending over time.
What’s my house worth? A family’s home is often thought of as their biggest asset, but depending on mortgages and other costs, it can also be a considerable ongoing expense if repayments or maintenance expenses are high. If you plan to pay down all or part of your mortgage before retirement, make sure the decision won’t jeopardise long-term retirement funding and risk making you ‘house rich and cash poor’.
How fast will prices rise? Rising consumer prices and higher inflation is the scourge of any fixed income investor because over time rising prices eat into what that income can buy in ‘real’ terms. Investment strategies for retirement should include growth and income-generating assets to help protect against the corrosive effects of inflation.
What will the market be like when I retire? In the decades before retirement, when we’re saving and investing for the long term, when we make investment returns makes no difference. The wealth we end up with reflects the long-term average of our lifetime returns. But once we retire, and shift from being savers to spenders, the timing matters a lot. Poor market returns just before, and just after, we retire can put a retirement plan at risk. To mitigate that risk, we need to manage market volatility early in retirement, which can be done through a variety of diversification strategies.
Thinking about transitioning into retirement is both exciting and a little scary. Uncertainty is inevitable: There is no perfect time to retire or perfect retirement plan. Focusing on the issues and risks discussed here —and asking some tough questions — should help you make sensible choices about when, and how, to retire.
The timing of retirement distributions and what’s known as “sequence of returns” is an important consideration for people beginning or in the distribution phase of their retirement, says AARP. Market conditions—bull or bear—in the first few years of retirement can have a significant impact on whether or not a nest egg lasts throughout the full retirement period.
If you are fortunate enough to retire at the beginning of a bull market, like in the 1990s, your savings might easily last. If you retire during a bear market, you may find it tough to meet your retirement income needs.
The ‘timing of distributions’ concept is demonstrated by the portfolio illustrated in the charts below during both the accumulation phase (saving/growing retirement assets) and the withdrawal phase (using savings and investment income to fund retirement). The portfolio assumes that the client will take $50,000 distributions annually (5% rate) during the withdrawal phase.
For investors whose priority is to minimize volatile returns in their portfolios during the early stages of retirement, there are a number of short-term fixed income instruments that can reduce the risk exposure of your principal. Generally regarded as highly liquid and less affected by the performance of the markets, these include U.S. Treasury Bills, U.S. Treasury inflation linked securities (TIPS), FDIC- insured CDs, and FDIC insured bank deposit accounts. While appropriate for investors seeking short-term security, these instruments may not provide returns sufficient to keep pace with inflation.
While the details vary greatly from one variable annuity to the next, most annuities offer minimum income guarantees or principal guarantees, regardless of investment performance. Depending on your needs and timeframe, you might decide that guaranteeing your principal investment or an annual income is appropriate for your situation.