Retiring confidently is something that’s hard for a lot of people to do; even those who have saved diligently for their entire working lives. There are steps you can take throughout your career to make retirement success more likely, which will help you feel more confident when you do decide to take that permanent vacation.
Early-Career Steps
If you’re young and just starting your career, it’s important to get in the habit of saving early. Much of the success retirees have is due to creating those good habits from the start. There are several advantages to saving for retirement as soon as possible.
First is habit formation. Starting your saving early creates good habits, which makes it easier to save throughout your career. Second is the power of compounding interest. The earlier you start saving, the more time your money has to earn interest. Starting early allows you to save less each pay period than someone who starts later because they’ll have to play catch-up by saving enough to makeup for the compounding interest they’ve missed out on.
When you have to save less at a time, your retirement saving has less of an impact on your lifestyle, whereas someone who waited until much later must often choose between enjoying lifestyle enhancements like nicer cars or vacations, and saving enough for retirement. Unfortunately, many in that situation neglect retirement savings in favor of lifestyle enhancement because they never got in the habit of saving in the first place. It’s hard to start saving when you have to cut spending on the things you want to use your paycheck more wisely.
Another important step to take early on is to create tax efficiencies in the structure of your retirement plan. Younger workers usually have not reached their peak earning years, so they’re commonly in a lower tax bracket than they will be later in life.
Despite this, those same young people often lean heavily on tax-deferred retirement accounts like 401(k)s and IRAs. It might make more sense for them to make early contributions and rollovers into non-tax-deferred programs like Roths. This can help you avoid paying more taxes later if you convert or withdraw from those accounts when you’re in a higher tax bracket.
Mid-Career Strategy
Mid-career savers should also take certain steps to increase the probability of a successful retirement. This is the stage where your financial advisor should start running cashflow analyses of your retirement. This is a way of predicting the likelihood of retirement success based on your current strategy.
If the cashflow analysis shows you’re likely to run out of funds in retirement, that’s an indicator that you may need to increase your savings rate or change your strategy. You should be keenly aware of your projected likelihood of success, but many mid-career people aren’t. Even when they know they should, they often feel they have plenty of time to do it later, but “later” may never come.
Late-Career Moves
Once you’re at the later stages of your career and are five or six years away from retirement, it’s important to make your final preparations. Dial back your risks. Remember that the strategy shouldn’t just be about getting to your retirement date; you need to make a plan for the rest of your life.
Consider market conditions. Markets are cyclical. As we recently experienced, the market had an incredible 10-year run before experiencing a downturn. They don’t always go up, and there is typically a downturn somewhere on the horizon.
As you near the end of those upswings, it’s time to start thinking about pulling back to avoid the downturn. This does not mean you should cash out all of your investments and never invest again! However, it does mean that you need to be more conservative as you approach retirement while remaining aware of opportunities.
Once your investment strategy is set, it’s also time to begin getting used to the idea of spending on a fixed budget. At Asset Preservation Wealth & Tax, the clients who worry us the most aren’t the ones making $50,000 or so with $1 million saved for retirement. Rather it’s the high-income earners who only have half a million saved.
The lower-earning retirees are used to spending relatively small amounts of money each year and are likely to continue that habit in retirement. On the other hand, high earners with relatively low retirement savings are used to spending a lot of money. If they continue those habits after they retire and are no longer earning a high salary they can easily drain their retirement savings within the first couple of years!
Change of Mindset
That brings us to the mindset shift you need to make when entering retirement. You are moving from an outside income-based financial plan to one in which your income is derived primarily from your retirement savings.
You need to make sure your retirement income sources are at least in part assets that don’t fluctuate substantially with the market. That decade of incredible market growth was accompanied by a decade of extremely low interest rates. That was great if you were buying a house or a car, but not so wonderful if you wanted a safer investment that would earn money.
In that environment, retirees had no choice; they either kept their money in the volatile stock market to have a chance of earning sufficient interest to fund their retirement, or they kept it in safe investments with abysmal rates of return. Now that interest rates are becoming more competitive, it’s worth considering whether you should have assets that are protected and therefore safer as an income source.
This gives you better options; previously if you kept much of your money in volatile investments, you ran a higher-than-comfortable likelihood of having to sell some of those assets when their values were down in order to access funds for living expenses. Today, by having a portion of your assets in guaranteed investments, you’re less dependent on volatile assets for immediate funds, which enables you to reap the benefits of a long-term investment strategy.
Control Your Spending
Above all, it’s important to remember that in retirement it’s particularly critical that you not overspend. Spending too much money or racking up credit card debt when you’re young is bad enough, but at least you have several decades of often increasing paychecks with which to extract yourself from the situation.
In retirement, your options are much more limited. Overspending once retired can easily result in running out of money before your retirement ends, which necessitates you rejoining the workforce. That is one of the biggest fears retirees have; being required to apply for a job after having been retired for a length of time.
And it should be frightening: Reentering the workforce after retirement means you’re unlikely to earn as much as you did when you last worked. Plus, there are financial implications to earning a regular income while drawing Social Security checks or taking required minimum distributions from your retirement accounts. You could find yourself working hard only to lose benefits or be taxed to the point where you still face financial hardship.
In upcoming posts in this retirement series, I’ll go over ways to avoid having tore-enter the workforce as well as explore how to “unretire” in less cumbersome ways.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
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