Retirement Planning

When it comes to retirement, lots of people picture a laidback lifestyle where they slow down and enjoy the moment. They talk about downsizing and moving somewhere warmer, spoiling their grandchildren, and doing exciting things (like traveling) that they didn’t have time for during their careers.

They assume their lifestyle will change dramatically after they retire, and consequently, many people also assume their spending habits will change. In fact, one of the biggest misconceptions people have about retirement is that they’ll spend less than they do during their careers–when in our experience, people tend to spend the same or even more in the first ten years of retirement.

Sure, some costs like commuting might be eliminated, but others increase. That’s because in retirement, every day is Saturday, and that opens more opportunities for spending—you might spend more time eating out, golfing, shopping, traveling, and participating in other hobbies that cost money.

Consequently, it’s important to look at your retirement budget realistically and determine what your necessary expenses are; that way, you can wisely plan for the “fun stuff.”

Calculating “Needs” in Retirement

The necessary expenses you’ll have in retirement are much the same as your basic needs now—shelter, food, healthcare, transportation, and debt obligations. But when establishing your retirement budget, it’s important to remember there are variables that could alter these expenses—like inflation, cost of living in a new area, and a new lifestyle.

If you move somewhere where the cost of living is cheaper, you might spend less on housing; but if you decide to eat out more often, you might spend more on food. Knowing where you’ll live will help you better determine your expenses, since your location will affect not only the cost of housing, but other necessities like food and transportation. It’s also important to understand what kind of health insurance you’ll have (Medicare, a company plan, or something else) so you can determine the costs associated with it.

Paying Necessary Expenses in Retirement

For many people, it helps to receive a steady income in retirement to pay these necessary expenses. Social Security and pensions are the most common sources of “guaranteed” retirement income, and they can be a helpful way to manage cash flow because receiving the payments is similar to how one might receive a paycheck during their career. You can also supplement these guaranteed income sources with vehicles like income annuities.

Calculating “Wants” in Retirement

Additional expenses, of course, depend on the individual person and their desires. You might spend extra money on vacations, gifts, shopping, or new hobbies like painting or cooking classes. Some hobbies (like boating or restoring classic cars) are obviously more expensive than others.

(In our work with clients, we’ve found that the most overlooked “want” is a car. Sure, a Mercedes gets you from point A to point B, and in that sense, it’s a necessity—but a Honda can achieve the same goal, and sometimes for hundreds of dollars less each month.)

To calculate your “wants budget,” we recommend tracking your expenses for at least three years prior to your retirement. There are several online tools that can help you do this automatically, but you can also use a simple spreadsheet. If you’re close to retirement and haven’t tracked your expenses, our firm can pull your expenses from the past couple of years retroactively.

Knowing what you spend now will give you a general starting point that will help you determine your spending habits in retirement.

Retirement Expenses: Planning Tips

Here are some tips to help you plan wisely so you don’t encounter unwanted financial surprises during your retirement:

• Complete a Cash Flow Worksheet
  One of the best planning exercises you can do is to complete a cash flow worksheet. In this exercise, you first record what you think you currently spend; then you pull your expense data and review the real numbers. You might confirm what you already thought (which gives you confidence to move forward with planning), or you might be surprised by what you discover. Either way, it’s important to have as much data as possible to help you plan.
• Review Your New Salary
  When you retire, you’re essentially starting a new “job,” and that job comes with a new salary—your guaranteed income sources (pensions, social security, etc.). It’s important to review your retirement income and determine if it meets your current needs. If your income sources don’t offer enough cash flow to pay your necessary expenses, you might want to consider how you can make up the difference—and then take action as soon as possible.
• Outline & Schedule Major Expenses
  If you have exciting plans for retirement (and most people do), determine how much those plans will cost and when you plan to implement them. For example, if you want to vacation in Europe for three weeks, decide when you might take that trip. Will it be two years into retirement? Five? How much will it cost? Ask yourself the same questions about any major plans you have, whether that’s to help your grandchildren with college expenses or purchase a classic car.
• Prioritize Spending
  It’s great to dream and have fun, but not at the expense of having to return to work after you’ve been retired for ten years (unless that’s what you want to do, of course!). For most people, the goal is to retire and stay retired. And if you want to avoid running out of money in retirement, you have to be realistic and prioritize your spending. Don’t bite off more than you can chew, and make sure you have your basic needs covered before you start funding the fun stuff.

Maximizing Your Cash Flow in Retirement

Once you retire, it’s important to review your investment allocation—you want a balance that’s appropriate for your risk tolerance and not overly aggressive, as volatility becomes an extreme disadvantage when you’re withdrawing from a portfolio. Depending on your age, marital status, and financial situation, you might be able to leverage an income annuity with a cost-of-living adjustment rider to help you generate more income in retirement.

It’s also important to be realistic about how much you can spend and when. Once you’ve created a plan for your expenses, stick to it. That doesn’t mean you can’t adjust your plan, but if you don’t set guidelines ahead of time, you could eventually run out of money.

Make it Easy on Yourself

It’s a pretty basic concept—needs are different than wants. But sometimes the line gets blurry in retirement, so it helps to plan early and budget accordingly. Once you understand the difference, your retirement distribution planning will go much smoother.

That said, recognizing just how much money you need and when can be overwhelming. If you’d like assistance with your retirement planning and distribution strategy, we’d love to talk! You can schedule a consultation with us here.

Retirement is meant to be an exciting time of freedom, a season to enjoy the investments you’ve made after years of hard work. You get one shot to do it right, and it can be scary to imagine a “failed” retirement–one where you end up going back to work not by choice, but out of necessity. Fortunately, there are ways to ward off these kinds of scenarios and protect yourself from risks as you prepare for life after work.

Planning for the future can be complicated, so we’re sharing our simplified checklist to help you get started. Below are some tips to prepare your finances so you can make the most of your golden years and avoid unnecessary risks along the way.

I: Paint a Picture

The first question you need to ask yourself is this: What does my retirement look like? Once you know how you’ll spend your time, you can create a more detailed plan for spending your money.

Ask yourself the following questions:

Will I transition to working part time in my current job, start a new part-time job, or not work at all?
Are there any hobbies I want to explore that I’ll need to budget for?
How often do I plan to travel?
Will I live in the same house (or apartment) or downsize? Will I want a “summer home?”

Something else to consider is whether you want to spend time volunteering—some volunteer opportunities might require you to travel, which will of course impact your spending. You might enjoy traveling frequently (whether to vacation, volunteer, or visit family) early in retirement but decide to stay closer to home as you get older.

The more detailed answers you can come up with, the more accurate your projected retirement budget will be. Of course, you may not have definite answers for all these questions now, and your preferences may change over time, but as you consider your options and how to budget for them, you’ll create greater financial flexibility for yourself in retirement.

II: Evaluate Your Expenses

One of the best ways to determine how much you’ll spend in retirement is to review how much you spend now. Remember, though, that once you stop working, every day becomes a Saturday—many people spend more when they retire than they did while working because they travel more or participate in other forms of entertainment more frequently. Some people spend the same amount as during their careers, but few people spend less when they retire.

If you don’t already, start tracking your expenses with an online budget tool or tracker. Then consider additional expenses you might have when you retire—for instance, if you want to travel, take cooking classes, or experience other new hobbies, you’ll need to factor those into your budget. If you plan to live somewhere other than your current residence, you’ll want to review the cost of living expenses in that location.

Another thing to consider is your health and how it might change over time. You’ll want to create a plan for unexpected medical expenses, especially if you have health conditions that could worsen as you age. If you retire before 65 (when you would qualify for Medicare), you’ll also need to account for the cost of medical insurance, especially if your current policy is through an employer.

As you create a rough draft of your budget, remember to evaluate your needs versus wants. Some of your needs, like healthcare and housing costs, might fluctuate in retirement, and that will affect how many of your “wants” (like vacations, eating out, and buying gifts) you can practically budget for.

III: Create a Distribution Plan

Most people focus on saving money for retirement–but you also need to determine how you’ll spend that money once you’re no longer generating income. There are two primary ways to create cashflow during retirement: through guaranteed sources and non-guaranteed sources.

Guaranteed sources include funds like pensions, annuities, and social security that provide guaranteed income in retirement.

Non-guaranteed sources have the potential to provide a greater return than some guaranteed sources, but that return can vary depending on market fluctuations and individual investments. These include investments like stocks, bonds, mutual funds, exchange traded funds (ETFs), and real estate.

Once you have an idea of a budget, you need to determine how you’ll manage your income and investments during retirement. For example, if you have a pension, consider whether it will cover your necessary expenses, or if you should supplement it with an annuity. How much money will you need to withdraw each month? Will you automate that process or handle it on a case-by-case basis?

Coordinating cashflow from multiple sources can be complicated, and sometimes hiring a professional to manage the details can provide the peace of mind it takes to enjoy your retirement. When you talk with an advisor, they can also help you determine what types of income sources make the most sense for your lifestyle and how to best manage them both now and in retirement.

Iv: Manage Risks

Retirement should be a time of celebration and enjoyment, but even with careful planning, life doesn’t always happen as we expect it to. That’s why it’s important to create contingency plans for your life after work. You’ll want to ask yourself these questions:

• What happens if my health is compromised and I need critical or long-term care?
• Will my nest egg last throughout my retirement? How do I make sure I don’t outlive my savings?
• Will my income and investments keep up with inflation?
• What if taxes increase (as they notoriously do)?
• Is my investment portfolio in line with my risk tolerance?
• What happens if I lose money in the stock market shortly before I retire?

Some of these questions might evoke hypothetical scenarios you don’t yet have a plan for—and that’s why you should think about them now, while you have a chance to prepare. Managing these risks before retirement ensures you can enjoy your golden years without nagging “what-ifs”.

V: Stress Test

Over time, your financial situation and goals often change. Maybe you or your spouse decide not to work part time in retirement, or you decide you’d like to leave a donation to your favorite charity. You might also have negative experiences that affect your finances, like a prolonged bear market or unexpected expenses from a stay in long-term care.

All these things impact your finances in retirement, so once you have a plan in place, you’ll want to have an advisor run an analysis to see how your funds hold up to unexpected financial stress. A good advisor will be able to forecast these kinds of scenarios and determine if your wealth is positioned for success in a volatile environment, or if you need to adjust your strategies to create a more substantial cushion.

You’ll want to factor in these possibilities as soon as possible. That’s why it’s important to regularly review your retirement strategy and portfolio. We recommend meeting with a financial professional annually so they can perform a stress test and help you adjust your budget accordingly.

VI: Implement

A plan is only as good as its follow-through—so once you have an idea of where you are and where you want to be in retirement, create a timeline to help you implement your retirement planning checklist. If you have trouble getting started, feel unsure of your next steps, or need help articulating your long-term goals, we recommend discussing your situation with an advisor. We can help you prioritize your objectives, identify strategies to help you meet your goals, and hold you accountable as you grow.

There are many factors to consider when preparing for retirement, and this checklist is just a brief overview to help you get started. If you’d like to learn more about creating (and implementing) an effective retirement plan, stay tuned for our upcoming blogs where we’ll discuss each step in more detail. As always, feel free to reach out to us if you have questions or want to discuss your personal financial situation.

When you’re managing money and creating a plan for the future, there are multiple factors to consider. You have to determine which of your goals are most important to you, how comfortable you are with financial risks, and how much time you have to reach certain objectives. The more detailed your plan is, the better chance you have of being satisfied with the outcomes.

That said, custom financial plans require regular maintenance, so some investors leverage what’s called a target date fund to establish a simpler retirement investment plan. In this blog, we’re discussing how these funds work and what you should know before using one.

What is a Target Date Fund?

A target date fund (TDF) is designed to be a “set it and forget it” approach to investing for retirement accounts. They’re meant to be more aggressive (with the chance of earning greater returns) when an investor is younger, and less aggressive as the investor gets older and closer to his or her retirement date. This usually means the fund’s asset allocation shifts from more stocks (and fewer fixed income sources) to more fixed income sources (and fewer stocks) over time. This gradual shift in asset allocation is called the TDF’s glide path.

A TDF is typically set up as a mutual fund that decreases its overall risk as the fund approaches its target date, or “retirement year,” which theoretically corresponds to the investor’s retirement year. For this reason, they’re sometimes called age-based funds or lifecycle funds. They’re usually offered via 401(k)s or other types of retirement plans, but you can also purchase them as part of brokerage accounts or IRAs.

Are all TDFs the same?

Despite their common goal, all target date funds are not created equal. Different fund managers and companies manage TDFs in different ways; consequently, even TDFs with the same target year follow different glide paths. For example, one fund manager might manage a Target 2025 fund with the assumption that an investor’s stock-bond ration should be 40/60 at retirement, while a different fund manager might aim for a stock-bond ratio of 30/70 at retirement.

In 2008, some investors experienced the harsh reality of this when their Target 2010 funds lost more than 40 percent just two years before retirement. Investors expected their ready-made funds to perform like other 2010 target date funds, but because some fund managers had vastly different investment styles, some investors remained “safe” while others lost big time – despite them having portfolios with similar goals.

As such, there’s really no “standard” or precise method to managing a target date fund—which is why it’s incredibly important for an investor to understand what their individual plan looks like. Then they can determine if their TDF aligns with their goals and risk tolerance.

What are some pros and cons to using a Target Date Fund?

Aside from “looking under the hood” and making sure you choose a TDF whose allocation is consistent with your risk tolerance (as described above), target date funds require minimal ongoing maintenance on the investor side, which is great for DIYers who want something simple. By nature, TDFs are reasonably diversified portfolios, so there’s no need to regularly rebalance one on your own or worry about asset allocation.

On the downside, TDFs lack transparency about their underlying investments; it’s difficult to know exactly what you’re investing in without going through the fund’s prospectus or looking at the annual report. A target date fund also assumes its investors are retiring in its designated target year, even though individual investors may not actually retire that year. (For example, someone may have a 2030 TDF but plan to retire in 2027.) TDFs also don’t account for individual risk tolerance, income needs, or an investor’s overall financial situation, which makes it difficult to synchronize a TDF with a comprehensive investment strategy. Like mutual funds, generally, target date funds involve a risk of loss. They are subject to the same risks as the underlying stocks and bonds they hold.

What do I need to know before investing in a Target Date Fund?

If you’re considering a TDF, do your research and consider what your appetite for risk is. Remember, just because the retirement year of the fund aligns with yours, that doesn’t mean the asset allocation matches your risk tolerance or individual goals. Find out what a TDF is investing in before you invest your own money. Ask your advisor for help doing the research; if you decide a particular TDF is too risky, your advisor should be able to present another solution.

For more complete information about any target date fund, please request a prospectus from your registered representative. The prospectus explains the investment objectives, strategies, risks, charges and expenses of the fund and should be read carefully before investing.

The Bottom Line

Even though target date funds are designed to grow with you, that doesn’t mean the specifics of any given fund will actually align with your goals or risk tolerance. So whether you already have a TDF or you’re considering one, do your due diligence to better understand what’s under the hood. If you purchase one through your 401(k), you can reach out to the 401(k) provider, the advisor on the 401(k), or your personal financial advisor for help with the research and decision-making process. If you’re purchasing a TDF outside an employer plan, we highly recommend talking with your advisor.

If you don’t have an advisor and you want help with your financial strategies, just give us a call or send us an email! We’d love to answer your questions and get you on track to achieving your goals.

This article is intended to be for general information about the topic(s) described only, and should not be used as financial advice specific to your situation. For financial advice pertinent to your lifestyle, goals, risk tolerance and opportunities, please contact a financial professional.

¹www.thinkadvisor.com/2021/06/08/target-date-funds-a-time-bomb-in-a-retirement-tool-for-the-masses/?slreturn=20211017105750

²www.finra.org/investors/learn-to-invest/types-investments/retirement/target-date-funds-find-right-target-you

One of the primary reasons people establish a financial plan is to make sure their hard work pays off. The fact is, you can make good money and save your whole life, but that doesn’t ensure you’ll have enough assets to maintain your lifestyle in retirement or that you won’t waste some of your hard-earned cash on taxes you could have avoided. That’s why strategic retirement income planning is so important—it helps you position your assets to accomplish your goals in the most tax- and time-efficient way possible. After all, what good is all that return if you don’t get to keep it?

One of the most important things to consider is where to invest your money for retirement. A Roth IRA (individual retirement account) allows you to invest post-tax dollars that grow over time—then when you retire, you get to reap the benefits of your investments and their gains, knowing those taxes have already been paid. With a traditional IRA, you invest pre-tax dollars (a strategy that’s advantageous for individuals who want to deduct these contributions) and pay income taxes later when you withdraw the money.

Roth IRAs are great for individuals who want to avoid paying additional taxes in retirement, but there are limits to who can invest in a Roth and how much they can contribute. In this blog, we’ll talk about some of those limitations and alternative ways to minimize your tax burden in retirement.

What are some restrictions for people who want to fund a Roth?

For the year 2023, the maximum amount an individual can contribute to a Roth IRA is $6,500 (or $7,500 if you’re 50 or older). If your income exceeds a certain amount, you’re disqualified from making contributions to a Roth at all. These income limits are based on an individual’s modified adjusted gross income (MAGI), which is your adjusted gross income with deductions and other tax-exempt income added back in.

Here’s how those limitations break down:

Roth IRA Contribution Limits (Tax year 2023)

Roth IRA contribution limits 2023

1. You may contribute simultaneously to a Traditional IRA and a Roth IRA (subject to eligibility) as long as the total contributed to all (Traditional and/or Roth) IRAs totals no more than $6,000 ($7,000 for those age 50 and over) for tax year 2022 and no more than $6,500 ($7,500 for those age 50 and over) for tax year 2023.

Individuals can contribute the full $6,000 if their MAGI is less than $125,000. But if your MAGI is between $125,000 and $139,999, that contribution limit decreases incrementally as your MAGI increases. If your modified adjusted gross income is $140,000 or more, you are no longer eligible to contribute to a Roth IRA.

Married couples filing jointly with a MAGI of $198,000 or less are eligible for the full contribution amount ($6,000 per person, $7,000 for individuals 50 or older). If their income is between $198,000 and $207,999, their contribution limit decreases (again, incrementally as their MAGI increases), and once a couple’s modified adjusted gross income reaches $208,000 or more, both individuals become ineligible to contribute to a Roth IRA.

It can be frustrating if you’re a high earner who wants to create tax-free gains later, but luckily, there are some ways around these limits.

What can I do if my income exceeds the contribution limits?

The first option is through your employer—if you have access to a Roth 401(k), you can contribute up to $19,500 (for the 2021 tax year) to that Roth 401(k) regardless of your income level. Individuals 50 or older can contribute up to $26,000 to their employer-sponsored plan.

The second option is to convert money from a traditional IRA or 401(k) into a Roth account. This strategy only recently became feasible. Before 2010, individuals with a modified adjusted growth income of $100,000 or more could not perform a Roth conversion. At that time, the income limit for Roth contributions was $105,000 for individuals and $166,000 for married couples filing jointly —so individuals earning $105k or more had no method of investing in a Roth (unless their employer offered a Roth 401(k)). Since that $100k limit was removed in 2010, individuals can now convert money into a Roth from another account.

In the industry, this is referred to as a “backdoor Roth” because of the roundabout way it allows individuals to leverage this type of account. So while you may hear the term “backdoor Roth,” it’s important to note that this doesn’t refer to a type of retirement account—it’s simply a strategy for contributing to a Roth.

How does this Roth IRA strategy differ from a regular Roth conversion?

Normally, when investing in a traditional IRA, you would deduct those IRA contributions from your taxes in order to lower your income bracket for that year. Then, if you did a Roth conversion, you would have to pay the income taxes on the contributions when you transferred the money from the IRA to a Roth.

But if a backdoor Roth is done correctly, you should have a zero-dollar tax liability. The key is to not deduct the IRA contribution from your modified adjusted gross income—this qualifies the money as a post-tax contribution. That frees you from being taxed on those contributions when you convert them to a Roth.

What about money in my 401(k)? Can I use that for this Roth IRA strategy?

You can also fund a Roth with post-tax contributions from your 401(k)—this includes any money that was contributed without a MAGI deduction. Just like IRA contributions made without a deduction, nondeductible 401(k) contributions qualify as post-tax dollars. You can then take the total of your post-tax contributions and transfer them to a Roth IRA. Something to note, though, is that only the after-tax contributions themselves (not the gains from the 401(k)) can be rolled over to a Roth. You can, however, transfer the gains to a traditional IRA.

That means if you make a $10,000 post-tax contribution to your 401(k) and it grows to $15,000, only $10,000 can be transferred into a Roth. Five thousand dollars (your gains) could be transferred into a traditional IRA or left in the 401(k).

What are some of the pros and cons of leveraging this strategy?

Pros:

• The backdoor Roth strategy allows you to turn post-tax dollars (which would normally be subject to capital gains tax if you invested them elsewhere) into Roth IRA dollars, which gain value tax-free.
• It can be difficult for high-income earners to grow their assets tax-efficiently, and backdoor Roths provide an option for tax-free gains.
• Lots of people have post-tax contributions in their 401(k)s, typically because they’ve over-contributed some years. Backdoor Roths allow you to take advantage of those post-tax contributions and have them grow tax-free (rather than paying income taxes on the distributions if you leave them in a 401(k)).

Cons:

• To set up an effective backdoor Roth IRA, you must forgo the tax benefits of deductible IRA contributions.
• If you have existing IRAs that were funded with pre-tax dollars as well as post-tax dollars, any Roth conversion you make is subject to the IRS Pro-Rata Rule, which could mean you pay taxes on part of the conversion. (More on this below.)

Who can leverage these strategies?

Technically, anyone with earned income can use a backdoor Roth strategy. But it’s only necessary if your modified adjusted gross income (as an individual) exceeds the $125,000 limit for contributing to a Roth IRA.

What are some things to consider before leveraging this Roth IRA strategy?

One thing to note is that if you have both post-tax and pre-tax money in your IRAs, something called the Pro-Rata Rules determines how much of your conversion is taxable. The Pro-Rata Rule involves a bit of math—here’s how it breaks down:

Let’s say you have $75,000 in pre-tax IRA dollars (which are deductible) and you want to make a $6,000 nondeductible contribution to an IRA. Even though you contributed $6,000 of nondeductible dollars, the Pro-Rata Rule takes into account additional factors to determine your taxable rate for a subsequent Roth conversion. The equation looks something like this:

• Current IRA Balance = $75,000
• Nondeductible contribution to traditional IRA = $6,000
• Current IRA balance + contribution = $81,000
• You can’t convert your nondeductible contribution to a Roth as a separate transaction, so your nondeductible balance divided by your total IRA balance determines the percentage of your conversion that is not taxable:
  • $6,000/$81,000 = .074 or a 7.4% ratio
• Your nondeductible contribution is then multiplied by that ratio to determine your nontaxable balance. o $6,000 x 7.4% = $444 (not taxed)
• Then, whatever amount is left from your nondeductible dollars is taxed during the conversion. In this case, that would look like this:
  • $6,000 – $444 = $5,556 (taxed conversion dollars)

Because of the Pro-Rata Rule, you won’t experience the same zero-dollar tax liability that you would if you had only nondeductible contributions in the account. If you’re considering a backdoor Roth strategy, you’ll want to talk with your advisor to determine if the transaction would minimize your tax burden or not.

What advice would you give a client who’s interested in this type of Roth IRA strategy?

It’s incredibly important to make sure your financial advisor (or whoever manages your investments) and your accountant (or tax advisor) are on the same page. If they don’t collaborate or communicate, your accountant might implement a strategy that your advisor could inadvertently undermine with their own strategies. That’s why it’s important to consult your financial advisor and your accountant to ensure your strategies are cohesive, support your overall goals, and minimize your tax burden.

What’s Next?

If you have more questions about minimizing your tax burden while you prepare for retirement, we’d love to help! We know it can get a little complicated, so we’re happy to discuss your options with you. Just shoot us an email or give us a call!

*Contributions to a Roth IRA may generally be withdrawn at any time without tax consequences. Earnings may generally be withdrawn tax-free if the account is held at least 5 years and withdrawals are made after the account owner reaches age 59 ½. If earnings withdrawals are made before the 5-year period or age 59 ½, income taxes are due, and a 10% federal tax penalty may apply.

[1] https://www.bankrate.com/finance/taxes/