Life expectancy is longer today. Interest rates are low, and
inflation is creeping back up. Taxes will likely increase in the next few
years. Will the stock market continue its steady climb? You can hope, but who
knows? Volatility could be part of that long-term equation.
All of these factors create financial uncertainty in the
future and make planning for retirement more complex. With that in mind, here
are five key components of preparing for retirement:
1. Get an income plan
How much money do you need, and where will it come from?
Those are two very important questions. As you enter your
prime earning years, it’s important to think ahead about how much income you
will need in retirement. Then invest accordingly.
When you are working, investing is fairly straightforward.
All your money has to do is grow. When you retire, your money has to provide
income, pay taxes, and grow in order to support your lifestyle. Investing
becomes much more nuanced and even more challenging once you start taking
As you near retirement, here are a few steps to get you
started on an income plan:
List all your guaranteed sources of retirement income —
Social Security, pension, an annuity with a guaranteed minimum amount, etc.
List retirement savings and investment accounts, such as a
traditional IRA, 401(k), Roth IRA or Roth 401(k).
Ask yourself whether your projected income will cover your
expenses and the kind of lifestyle you desire. Remember, a common rule of thumb
is that in retirement, most people need to replace roughly 60% to 80% of their
pretax, pre-retirement income in order to maintain their lifestyle.
2. Maximize your Social Security income
To maximize Social Security benefits for you and your
spouse, you need to know which of the estimated 567 separate claiming
strategies for married couples is right for you. Sometimes, it makes sense to
start taking Social Security while letting your nest egg grow. For others, it
makes sense to draw down on investments to let your Social Security benefits
continue to grow until full retirement age (usually around 67) or to when the
benefit amount peaks (age 70) before claiming the benefits.
An important note: If you and your spouse were born on Jan.
1, 1954, or earlier and have both reached full retirement age, you can claim
spousal benefits and let your own benefits keep growing. At age 70, you can
switch to the higher benefit. The strategy is an option called “restricted
filing,” and it isn’t available for those born on Jan. 2, 1954, or later.
3. Explore your tax strategies
Taxes catch many retirees off guard, because conventional
wisdom suggests that with less income than they earned during their working
years, taxes would be significantly lower in retirement. Many retirees find
that this isn’t the case. A key part of your planning strategy is to reduce the
taxes from withdrawn funds from tax-deferred accounts, such as 401(k)s or IRAs.
Required minimum distributions for tax-deferred accounts
begin at age 72, so it’s crucial to have a plan in place well before then.
One effective strategy is converting tax-deferred funds to a
Roth IRA or Roth 401(k). While the conversion amount is taxable in the year it
is converted, the upside is these Roth accounts let your retirement savings
grow tax-free and are not taxable when withdrawn (as long as you’re 59½ or
older and have owned a Roth for at least five years). Don’t let the upfront tax
bill prevent you from moving your retirement funds from accounts that are taxed
no matter when you take them out into accounts that are tax-free. The point is
to not be shortsighted at the expense of being hit with tax time bombs in
Roth IRA conversions are just one strategy to keep your
Social Security from being taxed. If your provisional income is between $25,000
to $34,000 (for single filers) or $32,000 to $44,000 for joint filers, then up
to 50% of your Social Security is taxable. If your provisional income is higher
than that, then up to 85% of your benefits may be taxable. These extra taxes may
force you to take more money out of your nest egg to support your lifestyle.
4. Forecast your medical expenses
Health care continues to be one of the largest expenses in
retirement. Many people assume Medicare will cover all of your health care
costs in retirement, but it doesn’t. One way to prepare is to enroll in a
health savings account (HSA), which some employers offer. When contributing to
an HSA, you can save pretax dollars (and possibly collect employer
contributions), which have the potential to grow and can be withdrawn tax-free
in retirement if used for qualified medical expenses. For 2021, the regular HSA
contribution limit is $3,600 for individual coverage ($3,650 in 2022), and
$7,200 for family coverage ($7,300 for 2022). Those enrolled in Medicare cannot
make new contributions to an HSA.
Another way to fill the gap not covered by Medicare is
long-term care insurance. While long-term care insurance premiums are not
affordable to everyone, an alternative is purchasing a life insurance policy
that has the option of adding a long-term care insurance rider.
5. Plan your estate
Estate planning isn’t just about how you want your assets
distributed after you die. It is about preparing for contingencies if you
become unable to make your own financial or medical decisions. It is about
creating a smooth transition for your loved ones in settling your affairs.
Key elements of an estate plan include a will; assignment of
power of attorney, which gives the person you name the authority to manage your
financial affairs if you are unable to do so; a health care proxy, which
authorizes someone you trust to make medical decisions on your behalf; and a
living will, a statement of whether you want life-sustaining medical
intervention if you become terminally ill and unable to communicate. Take the
hard decisions off of your children by having them follow legal directives in
the estate plan. Work with an attorney to make sure you obtain the right estate
planning documents for your situation.
For something as important as your financial future, it’s
important to work with a financial professional. Everything in the plan should
be coordinated — taxes, Social Security, income planning and investments. Your
adviser needs to understand your entire financial picture, how the elements
such as taxes and income generation interrelate, and how they can help you
reach your retirement goals.
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