Retirement planning keeps getting more complex. And with that comes increased worries about having enough money to lead the lifestyle you want in retirement.
Those concerns have only intensified. In fact, a recent RBC Wealth Management survey found that running out of money in retirement and funding health care still top the list of concerns, while 32 percent of those near retirement worry about suffering investment loss, up from nine percent in a similar survey in 2018. And 25 percent worry about dying early, while 17 percent are concerned about estate taxes and leaving a legacy, up from 11 percent and three percent, respectively.
Yet, despite these worries, only half of respondents had a documented plan for retirement. And 75 percent agreed it is difficult to foresee the full extent of their financial needs once they leave the workforce.
If you want to retire in the next five years, now is not the time to coast—create a personalized plan for generating and spending income in retirement. Consider taking these seven steps to help you get started.
1. Consolidate your accounts to see the big picture
Consolidating your accounts gives you a clearer picture of how to best position your assets and help prepare for—and manage—retirement income.
Asset consolidation gives you more clarity, a streamlined approach, greater control and a deeper understanding of the role your investments will have in creating your retirement paycheck. It also makes it easier for both you and your advisor to have a view of your financial life in one convenient place.
2. Be smart about debt
Going into retirement with debt is not ideal. To start tackling those balances, consider accelerating your higher interest rate payments so that the loan will be paid off before you retire.
To curb new credit card debt, try paying cash for major purchases. By limiting new debt and reducing existing debt, you can minimize the amount of retirement income spent on those interest payments.
3. Determine the cost of your retirement
How do you picture retirement? One of the most important, yet often overlooked, steps in preparing is to visualize what you want those retirement years to look like and to prioritize your goals.
It’s a daunting task, but here’s one way to approach it: ask yourself, what are your retirement needs, wants and wishes?
Obviously, having a realistic idea of your essential expenses—food, housing, health care, taxes and insurance—is a top priority. Your wants—travel, entertainment, home improvements, memberships and gifts—reflect your desired retirement lifestyle. And wishes—a second home, bequests and legacy planning—fulfill your legacy.
Answering these questions is another key step in developing a personalized plan to simplify the complexities of retirement income planning and makes it easier for you to retire with confidence.
Those approaching retirement crave that peace of mind. This concept of a personalized income plan, or “retirement paycheck,” appealed strongly to RBC Wealth Management survey respondents, with 84 percent saying it would help them make the most of their retirement years.
4. Consider your options for claiming Social Security
When should you start collecting Social Security? It’s different for everyone. Most individuals can begin taking benefits at 62 years old but have the option to delay those benefits until 70.
Retirees often give up tens of thousands or even hundreds of thousands of dollars by unnecessarily taking Social Security benefits too early. For each year you delay retirement after your full retirement age, annual benefits increase eight percent, according to the Social Security Administration. If you claim Social Security at age 70 instead of 62, the monthly benefit could be 76 percent higher, adjusted for inflation.
For some with limited assets or health risks, it may make sense to take Social Security benefits early or at “full retirement age.” The same applies for those who can earn returns exceeding eight percent in other investments.
Most importantly, do not look at Social Security in isolation. Consider coordinating your spouse’s benefits decision with your own to optimize your combined income for your joint lifetime. And always consider your personal goals, taxes and overall cash flow needs before making a filing decision.
5. Take advantage of a Health Savings Account
Health Savings Accounts (HSAs) aren’t just a way to pay for immediate medical expenses. Their unique tax advantages and flexible withdrawal options can make them an important investment vehicle in your overall retirement strategy.
HSAs are a great, tax-free way to pay for qualified medical expenses in retirement. And once an account holder turns 65, HSA funds can be used for any purpose—non-qualified expenses are taxed at ordinary income rates—just like traditional 401(k)s.
They also offer a rare triple-tax benefit. All contributions to an HSA are made income tax-free; withdrawals for qualified medical expenses are made tax-free and interest earnings and investment growth from deposits are income tax-free.
If you can do so, max out your HSA now and pay for current health care expenses out of pocket. Once you enroll in Medicare, you can no longer contribute to your HSA under most circumstances—but you can still use those funds to pay for Medicare premiums, deductibles, co-pays, co-insurance and other qualified medical expenses.
6. Identify and classify your income sources
Managing retirement income starts with knowing what your sources of income will be and the rules that govern each.
First, start by defining sources that are predictable and certain. These may include Social Security, pensions, annuities and required minimum distributions (RMDs) from workplace savings plans and traditional IRAs.
After exhausting your reliable resources for your retirement needs, the next source of income that should be tapped is earnings and income—dividends, interest, income and earnings from part-time work.
The next step is to build a strategy to draw down assets, including investments, retirement savings and Health Savings Accounts.
Which assets should you draw from first? There are several approaches you can take. Traditionally, tax professionals suggest withdrawing first from taxable accounts, then tax-deferred accounts and finally Roth accounts, where withdrawals are tax-free. The goal is to allow tax-deferred and tax-free assets the opportunity to grow over more time.
If you are fortunate enough to have wealth beyond funding your retirement, you can start focusing on your legacy plan. These additional assets—including real estate, tax-favored assets and trusts—can be set aside for future generations or philanthropic giving.
When developing your legacy plan, give special consideration to some key questions: who are you responsible for financially? Who do you want to benefit from your assets? Are there minor children in need of a guardian? When and how do you want your heirs to receive the assets—and how will those assets be taxed? What are the potential estate costs, including estate taxes, probate costs and administrative costs?
It’s important to clearly define your legacy wishes since your choices can affect tax planning strategies in retirement. Tax-advantaged gifting strategies should be considered to confirm the smooth transition of assets to beneficiaries before and after death.
7. Optimize your income for timing and tax flexibility
In real estate, it’s all about “location, location, location.” That mantra applies just as much to your retirement-funding sources.
Tax diversification in retirement can make a major difference in how much you pay in taxes—and when those taxes are due. That’s because different investments are subject to different tax rules, and different types of accounts have different tax treatment.
Having a mix of accounts with different tax treatments—tax exempt, tax deferred and taxable—allows for greater flexibility when managing your lifetime taxes in retirement. And understanding their differences is key.
Many soon-to-be retirees save for their retirement in tax-deferred accounts such as IRAs, 401(k)s, and 403(b)s because they are funded with pre-tax income and reduce their current tax bill. But distributions from those accounts will be treated—and taxed—as ordinary income in retirement.
Tax-free accounts are funded with after-tax dollars. You pay taxes when you contribute, but your investment will benefit from years of tax-free compounded growth and withdrawals in retirement are also free from taxes.
Consider the benefits of allocating some retirement savings to a Roth 401(k) or IRA. A Roth conversion or partial conversion may also be beneficial, especially in lower income years or down markets. You will have to pay the taxes, but you will benefit from tax-free growth, and you can withdraw funds in retirement tax-free (if you’re over 59 1/2 years old and have had the account open for five years) when needed.
Evaluate withdrawal strategies to take advantage of lower tax years early in retirement before RMDs kick in. Everyone’s situation is different so make sure to personalize your distribution strategy to provide for the most tax efficient long-term planning strategy.
Remember, every successful journey begins with a starting point, a destination and a plan to get there safely.
The same is true for navigating your financial life throughout retirement. Created thoughtfully and managed over time, a personalized income plan enables you to set a course, define milestones, track successes and redirect you should your circumstances change.
That plan isn’t just there to chart a route to your goals. You want one that also flexes when life throws you a curveball. It’s wise to revisit your plan on an annual basis to give you the confidence you need to make the most out of retirement.