Retirement Planning

You might not think saving a few bucks here and there in your 20s means much, but the power of compounding will make it worth much more by the time you need it.

In general, the older you are, the more your portfolio should be focused on income and the preservation of capital. This means a higher allocation in securities, such as bonds, that won’t give you the returns of stocks but will be less volatile and provide income you can use to live on. You will also have less concern about inflation. A 64-year-old who is planning on retiring next year does not have the same issues about a rise in the cost of living as a much younger professional who has just entered the workforce.

You should break up your retirement plan into multiple components. Let’s say a parent wants to retire in two years, pay for a child’s education when he or she turns 18, and move to Florida. From the perspective of forming a retirement plan, the investment strategy would be broken up into three periods: two years until retirement (contributions are still made into the plan), saving and paying for college, and living in Florida (regular withdrawals to cover living expenses). A multi-stage retirement plan must integrate various time horizons, along with the corresponding liquidity. needs, to determine the optimal allocation strategy. You should also be rebalancing your portfolio over time as your time horizon changes.

Having realistic expectations about post-retirement spending habits will help you define the required size of a retirement portfolio. Most people believe that after retirement, their annual spending will amount to only 70% to 80% of what they spent previously. Such an assumption is often proved to be unrealistic, especially if the mortgage has not been paid off or if unforeseen medical expenses occur. Retirees also sometimes spend their first years splurging on travel or other bucket-list goals. In order for retirees to have enough savings for retirement, I believe that the ratio should be closer to 100%. The cost of living is increasing every year—especially health care expenses. People are living longer and want to thrive in retirement. Retirees need more income for a longer time, so they will need to save and invest accordingly.

As, by definition, retirees are no longer at work for eight or more hours a day, they have more time to travel, go sightseeing, shop, and engage in other expensive activities. Accurate retirement spending goals help in the planning process as more spending in the future requires additional savings today. One of the factors—if not the largest—in the longevity of your retirement portfolio is your withdrawal rate. Having an accurate estimate of what your expenses will be in retirement is so important because it will affect how much you withdraw each year and how you invest your account. If you understate your expenses, you easily outlive your portfolio, or if you overstate your expenses, you can risk not living the type of lifestyle you want in retirement. Your longevity also needs to be considered when planning for retirement, so you don’t outlast your savings. The average life span of individuals is increasing.

Additionally, you might need more money than you think if you want to purchase a home or fund your children’s education post-retirement. Those outlays have to be factored into the overall retirement plan. Remember to update your plan once a year to make sure you are keeping on track with your savings. Retirement-planning accuracy can be improved by specifying and estimating early retirement activities, accounting for unexpected expenses in middle retirement, and forecasting what-if late-retirement medical costs.

Once the expected time horizons and spending requirements are determined, the after-tax rate of return must be calculated to assess the feasibility of the portfolio producing the needed income. A required rate of return in excess of 10% (before taxes) is normally an unrealistic expectation, even for long-term investing. As you age, this return threshold goes down, as low-risk retirement portfolios are largely composed of low-yielding fixed-income securities.

If, for example, an individual has a retirement portfolio worth $400,000 and income needs of $50,000, assuming no taxes and the preservation of the portfolio balance, he or she is relying on an excessive 12.5% return to get by. A primary advantage of planning for retirement at an early age is that the portfolio can be grown to safeguard a realistic rate of return. Using a gross retirement investment account of $1 million, the expected return would be a much more reasonable 5%.

Depending on the type of retirement account you hold, investment returns are typically taxed. Therefore, the actual rate of return must be calculated on an after-tax basis. However, determining your tax status when you begin to withdraw funds is a crucial component of the retirement-planning process.

Whether it’s you or a professional money manager who is in charge of the investment decisions, a proper portfolio allocation that balances the concerns of risk aversion and return objectives is arguably the most important step in retirement planning. How much risk are you willing to take to meet your objectives? Should some income be set aside in risk-free Treasury bonds for required expenditures?

You need to make sure that you are comfortable with the risks being taken in your portfolio and know what is necessary and what is a luxury. This is something that should be seriously talked about not only with your financial advisor but also with your family members.

Estate planning is another key step in a well-rounded retirement plan, and each aspect requires the expertise of different professionals, such as lawyers and accountants, in that specific field. Life insurance is also an important part of an estate plan and the retirement-planning process. Having both a proper estate plan and life insurance coverage ensures that your assets are distributed in a manner of your choosing and that your loved ones will not experience financial hardship following your death. A carefully outlined plan also aids in avoiding an expensive and often lengthy probate process.

Tax planning is another crucial part of the estate-planning process. If an individual wishes to leave assets to family members or a charity, the tax implications of either gifting the benefits or passing them through the estate process must be compared.

A common retirement-plan investment approach is based on producing returns that meet yearly inflation-adjusted living expenses while preserving the value of the portfolio. The portfolio is then transferred to the beneficiaries of the deceased. You should consult a tax advisor to determine the correct plan for the individual.

Estate planning will vary over an investor’s lifetime. Early on, matters such as powers of attorney and wills are necessary. Once you start a family, a trust may be something that becomes an important component of your financial plan. Later on in life, how you would like your money disbursed will be of the utmost importance in terms of cost and taxes.

The burden of retirement planning is falling on individuals now more than ever. Few employees can count on an employer-provided defined benefit pension, especially in the private sector. The switch to defined contribution plans, such as 401(k)s, also means that managing the investments becomes your responsibility, not your employer’s.

One of the most challenging aspects of creating a comprehensive retirement plan is striking a balance between realistic return expectations and a desired standard of living. The best solution is to focus on creating a flexible portfolio that can be updated regularly to reflect changing market conditions and retirement objectives.

• Retirement planning should include determining time horizons, estimating expenses, calculating required after-tax returns, assessing risk tolerance, and doing estate planning.

• Start planning for retirement as soon as you can to take advantage of the power of compounding.
  

• Younger investors can take more risk with their investments, while investors closer to retirement should be more conservative.
  

• Retirement plans evolve through the years, which means portfolios should be rebalanced and estate plans updated as needed.