by Chris Murray, founder of Murray Financial Group, Inc. and author of “The Financial Protector“
Planning for all of the variables of retirement, and understanding how they intertwine, can be tricky.
More and more, inflation is becoming a concerning variable that people should factor into their financial plan for retirement.
Inflation, which has hit a 40-year-high, has always been an important aspect to consider in retirement plans. But its eye-popping surge in recent months should impress upon people the deteriorating effects it can have on money when both saving for retirement and while in retirement.
Inflation is a key reason that it’s more important than ever for people to have a process in place for retirement planning. A proper plan should be developed well in advance of retirement and must be built to allow for expenses, taxes, and inflation while providing income and growth through investments. Following a plan, and the budget established within it, helps prevent a devastating revelation a few years into retirement. Then is not a good time to say, “Wow, I’m putting a big dent into all of my savings, and it’s not going to last me even 10 more years.”
Here are some important steps to take when developing a process for your retirement planning.
1. Project your retirement income and expenses.
Begin by estimating your retirement income needs as a percentage of your pre-retirement household income, or your income replacement rate. Often, financial advisors suggest planning to replace about 75% of your gross pre-retirement income to maintain your current lifestyle. That number takes into consideration your decreased living expenses, potentially lower income taxes and no more contributing a portion of your wages toward retirement savings
Once you figure out your 75% income replacement number, subtract the amount of benefits you’ll get from Social Security. The balance – multiplied by how many years you and your spouse expect to live – is what you’ll need to provide from your own savings and resources. Don’t forget to consider how your household income would drop if one spouse passes, which generally reduces Social Security and any pension benefits. Verifying all assets is important at this stage of the planning process. These details are important when working with a financial planner.
When assessing future expenses, however, I always encourage clients to err on the side of caution and estimate high. Healthcare costs and long-term care insurance are important to keep in mind. The “fun money” – exotic vacations you wish to take, the airfare to visit friends or relatives, hobbies such as golf, etc. – must be incorporated into the plan as future expenses. By doing so, anyone closing in on potential retirement should begin thinking harder about just what it is they want to do in retirement. When they evaluate future expenses and notice that money could get really tight as they age, prudent people will re-evaluate, make a few alterations to their aspirations, and let a financial advisor take a look at stretching their retirement dollars a bit further.
2. Fine-tune your risk tolerance.
As we age, we want to fine-tune our risk tolerance. Those funds you worked so diligently to save over the years should never be squandered. Yet, this is particularly true when nearing retirement because you do not have enough time in your work career to recover if you lose a sizable chunk of your savings.
Unfortunately, people often do not realize just how much they are exposing themselves to risk. Pleasant runs in the stock market make us feel even more bullet-proof. For example, going back to the dot.com bubble burst in the early 2000s, the market valuations of those technology companies became outrageously inflated.
Respecting the hazards of risk through proper diversification is essential. When diversification of assets is structured properly, you enjoy a peace of mind that not only comforts you in times of trouble but also in good times – when wise investors are aware that market corrections can arise and quickly short-circuit steady gains.
3. Plan for taxes and Uncle Sam’s RMD appetite.
One of the bigger issues retirees face is the bite taxes could take out of the savings they think should be ample for retirement. Those who are diligent about saving money sock away a portion of their earnings into accounts such as a 401(k), IRA or something equivalent. These accounts are tax-deferred. Realize, however, that the word “deferred” does not equate to something that is free. The government satisfies its appetite through the concept of required minimum distributions (RMDs), which can have disastrous consequences if you forget to account for this particular tax assessment on your traditional retirement account. Beginning at age 72, Americans are required to withdraw a certain minimum amount every year from their 401(k) or IRA. Failure to do so, or if you do so incorrectly, results in a 50% tax penalty on any RMD dispersal you should have withdrawn but did not.
The administration of RMDs can make a Roth IRA a favorable alternative. Taxes on Roth IRAs are paid on the front end. Early withdrawals on the principal, or on the growth of the Roth IRA after you reach the age of 59 ½, are not subject to taxes, particularly those enforced by dreaded RMDs. A Roth account must be owned for a minimum of five years before all of its features can be realized. Contributions to a Roth IRA are bound by a cap, which in 2022 is $6,000 for an annual contribution if you are under 50, and $7,000 if you are 50 or older. The amount applies to all traditional and Roth IRA accounts collectively, although it does not limit the amount you can convert from traditional accounts to their Roth counterparts.
In most cases, a blend of pre-tax accounts, such as a 401(k) and traditional IRA, and post-tax accounts (Roth 401(k) and Roth IRA) is beneficial. No tax on the front end can be beneficial to investors who are also building families and must balance the cost of kiddos with other expenses such as mortgage payments. No tax on the back end is welcome relief to those who are no longer in the workforce and are incapable of building a bigger nest egg.
The Tax Cuts and Jobs Act of 2017 lowered tax rates and made conversions from traditional IRAs into Roth IRAs more affordable. However, political winds can always change abruptly. The income tax cuts in the bill will expire at the end of 2025, and the ever-increasing federal deficits make it likely that tax rates will rise again. That probability makes it wise to incorporate potential tax hikes into retirement planning. Understanding your tax bracket is vital so you can determine the difference between the next lower and higher tax bracket.
Frankly, retirement should be the most wonderful time of your life. Wouldn’t it be nice to know how far your retirement savings will go and how to make them last? Proper planning can achieve that goal.
Chris Murray is the founder of Murray Financial Group, Inc. and author of “The Financial Protector“. Murray started his company in 1995 to help individuals and families overcome the challenges of creating a steady financial foundation. Murray has been recognized nine times as best financial planner by Frederick Magazine and hosts a popular 24-year-old radio show, Your Financial Editor, which has won multiple awards.
