Webinar: Big Questions for a Better Retirement
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Ben Rizzuto, CRPS®
Retirement Director
View Transcript
Ben Rizzuto:
Hello, there everyone, this is Ben Rizzuto retirement director with Janus Henderson Investors, and I’d like to thank you for taking some time to be with us today for this presentation Big Questions for a Better Retirement. Obviously, retirement is a big topic and there are a number of big questions that can go along with it. Our thought is that if you can answer, or at least consider these questions now, you can better ensure that you are better set up for a successful retirement. There are obviously several questions that we could consider, but here are five that we think are important, and that anyone out there would do well to think about.
It doesn’t matter if you are at the beginning, in the middle, or at the end of your career, these are things that all of us need to think about and plan for. Over the next several minutes we’ll be going over these five questions, and I’ll be giving you some ideas to think about as you answer these five big questions for a better retirement. If you think about it you can choose to retire really anytime you want, while that may be the case our lifespans have factored into this equation over the years.
These days when we think about retiring, we automatically think of the age 65, or something around 65, but, obviously, if you only expect to live to age 47 or 57 as was the case several decades ago that certainly changes things, but luckily, we now enjoy longer lives. Looking at this slide you can see how advancements in medicine, nutrition, and other areas in our lives have allowed us to have longer, and longer life expectancies over the past several decades. Currently, men and women can expect to live to age 84 and 87 years old respectively. There are a number of positives that go along with this, but there are also issues and risks that we need to consider. The issue to consider is when is the right time to retire?
In most cases, people think the main risk to consider is longevity risk, simply put how do we make sure we have enough money as we live longer and longer? Like I said, you plan on retiring at age 65, which for many of you will be the age when you receive your full retirement benefits from Social Security, how are you going to make sure that you have enough money to pay for those extra years of life? There are a few things to consider in order to answer this question, or at least a better plan for the future.
First, your health is one if not the most important factors to consider, sure, our health now allows us to live longer, but we will have medical expenses during those extra years of life, plus we need to think about out-of-pocket medical expenses in retirement. Some estimate that retirees can expect to pay $280,000 for health care, and unfortunately, that number isn’t going to go down in the future. We need to try to get an accurate idea of what these expenses will be, and then I feel it’s important to break down that big number into something more manageable, like an annual, or even monthly medical expense figure, we need to think about our health.
Second is age, and specifically, here we want to think about when we can access retirement assets, I mentioned the age sixty-five as the full retirement age for many, when it comes to Social Security, but remember you can start taking those benefits as early as age 62 or as late as age 70. There are significant changes that can occur to you, and possibly your spouse’s Social Security benefit based on this choice. We need to make sure of all the effects that can occur based on when you start accessing your retirement assets. Third, if we are going to have all this extra time, we need to think about how we want to spend it. Do you want to play golf? Do you want to travel? Do you want to be closer to family or do you want to work a little longer? There really isn’t a wrong answer, but it’s extremely important to think about this because this will play into how you budget your money in retirement. I don’t think it plays into the overall level of happiness that you’re going to have. Many times, we think about asset allocation when it comes to our investments, but we should also think about the idea of time allocation. Finally, we need to think about money. I always encourage people to sit down and go through a budgeting process as they get close to retirement. Things will change. Income will change. Expenses will change.
For example, if you’re not working anymore, then sure you won’t have that income, but on the other hand, you won’t be commuting to work on a daily basis so those expenses will decrease. You’re not clear on these changes. If you don’t have an up to date plan, this could lead to a less successful retirement. Those are four factors to consider. You’ve worked for years and years, you’ve saved money, the question is when did you start to use and enjoy all the fruits of your labor? Remember, your age can affect when and how you access retirement assets. For 401(k) plan, you can take money out of your 401(k) plan without IRS penalty if you separate from service at age 55. What this means is that if you retire at age 55 or older, you can access your 401(k) assets without an IRS penalty.
Next, for most tax-deferred retirement savings plan, you can start taking money out without a 10% premature distribution penalty at age 59 and a half. Now you may be subject to income taxes, but if you can save yourself 10% by waiting until the right time, I think that makes good financial sense. We touched on social security and as I mentioned, you can start taking your benefits as early as age 62, but they will be permanently decreased by up to 25%. Next, when you turn 65, you become eligible for Medicare and Medicaid benefit. Now, if you start taking social security at age 62, which is early, you would have to apply for Medicaid separately in order to get your benefit. If you wait to take social security until 65 or your full retirement age, you’ll automatically be signed up for Medicare.
With that said full retirement age for social security at age 65, but it could be up to age 67 based on your year of birth. Overall, if you wait to take social security until full retirement age, you will receive 100% of that benefit. Finally, remember that you don’t have to take social security at full retirement. You can wait. If you wait, the government will actually give you a credit. Those credits can add up until age 70 when you have to start taking your social security, but in waiting, you could receive a 32% increase so it may be worth it. Overall, you can see how timing matters. A 10% tax here, an 8% credit there, these things add up and over time, them getting longer and longer, they can equate to a larger and larger amount of money.
After thinking about the question of when is the right time to retire, we need to think about how we can help ensure our money lasts in retirement. First, it’s important to maximize the amount you put into your retirement accounts while you’re still working and take advantage of rules that allow you to put even more into those accounts. First, remember that for your 401(k), your 403(b) or other types of qualified plans, you can contribute up to $19,000 pre-tax per year. Along with that, if you’re over age 50, you can make an extra catch-up contribution in the amount of $6,000. That gets you up to $25,000 every year once you’re 50 years old. Along with that, you can make catch-up contributions into your simple IRA of $3,000 on top of the regular $13,000 and an extra $1,000 into your traditional IRA, which would get you up to $7,000 total. Overall, if we can put more money away, we can help ensure that it last longer. Next, we need to discuss and underline the fact that you can’t underestimate the impact that large drawdowns can have on your assets, especially if those drawdowns occur in the first few years of retirement. Another term that you might hear within this conversation is sequence of return risk, and this is just a fancy way of saying that when you experience returns, specifically poor returns, well that matter, because if they occur during the beginning of retirement, it makes it harder to make up your money over time. Let’s look at an example to see how this plays out be.
Then a hypothetical example. You have a study balance of $1 million at age 65, and then you have modest returns of 5% annually, but you experience drawdowns of possibly 10%,
20% or 30% in this third year of return. Along with those assumptions, we also assume a $45,000 annual withdraw, which is going to be adjusted by 3% each year for inflation. Everything is constant except for the size of the drawdown in year number three, and as you can see, this has a significant effect on when you run out of money. If you don’t experience that loss, your money runs out at age 94. If you have a 10% loss, it runs out at age 90. If you have a 10% loss, you run out of money at 91. For 20%, you run out of money at age 87, and if you have a 30% loss in your three, you’ll run out of money at age 84. Obviously, this can have a large effect on things, the massively changed the trajectory of your retirement, but you may be saying to yourself, “I can’t predict what’s going to happen in the markets.” You’re right. None of us know what’s going to happen in the market. We can better understand how current investments will react in different environments. Plus, I think it’s important to think through different scenarios in order to plan out and rationalize how we will behave or how we want to behave if these things happen.
Ask yourself questions like, “I’m about to retire. What if the markets go down 37% like they did 10 years ago? What will I do? How am I spending change? How can I better ensure that type of scenario doesn’t derail my whole retirement? How can I protect some of my assets from this drawdown?” These are definitely questions where different types of products and a conversation with a financial advisor may be helpful, but overall, understanding the impact of large drawdowns and asking yourself these questions can be important to help catch you up for the future.
The other thing we have to consider when we’re approaching retirement is spending discipline, simply is you follow up a lifetime of savings with poor spending habits, well, that’s not going to lead to a successful retirement. As I mentioned earlier, I think it’s important to go through a budget process as you get closer to retirement, and one part of that is looking at income. A framework we use for this is to look at three tiers of retirement income. You can use these as tears or buckets, but either way you do it. I think they help you mark assets based on your needs, wants and wishes. Let’s walk through each.
Tier one, which we think should be made up of anchor income will cover all of your needs. That’s nonnegotiable stuff. That’s food, rent, utilities, insurance, Medigap insurance, for example. The next tier in red is what we consider your cushion income. Those are really for your walk. These are more discretionary expenses, like going out with friends. Maybe it’s a weekend trip, maybe you have to buy a new washing machine dishwasher, things like that. The last tier is tier three, and we wind that up with what we call you. More importantly, tier three is devoted to your wishes. These are bigger ticket items or the longer-term goals. It could be a bucket list travel item for your stretch retirement goals, or maybe it’s leaving some legacy for your children or grandchildren. All of that is possible, but in order to do that, you have to invest, and make investments or use investments that have a higher yield and you would, for your anchor income. We’ll walk through this over the next few slides. If you have that clarity of your needs, your wants, and your wishes, that really helps when the markets are anchoring or going down by a significant percentage. By doing this, by going through this framework, I think it helps you better prepare for downturns in the market and make sure that you don’t do the wrong things at the wrong time.
Let’s now take a little closer look at each tier and think about the income and investments that will be earmarked for the needs, and wants, and wishes we just discussed. In tier one, your anchor income is used to meet your essential needs in retirement. This is income that you should rely upon no matter what the market does. For example, let’s say, for housing, food, and utilities, you need $2,000 per month. The goal for this year is to be able to meet all of those expenses with income sources that you can depend on. This could be your social security benefits, a pension, royalties, or possibly annuity, as they can help generate guaranteed income in retirement.
This is where that budgeting exercise comes into play. You need to fully understand what these expenses are and then line them up with these sorts. sources of income. Your hope is that these sources of income are enough to equal those benches. Tier two you’ll remember is what we called cushion income. Again, this tier is going to be devoted to one. These will be discretionary expenses. Things like going out to eat a little more often, a weekend trip, or maybe for those unexpected expenses like, as I mentioned, a new dishwasher or refrigerator. Now, since these are discretionary or less frequent expenses, we can invest these assets a little differently. As you can see, we have a bank deposit, short term fixed income investments, or money market funds as possible examples. These are investments that will provide some growth, but they are still quite conservative in nature.
Not only is it important to think about your want in this tier, but I think it makes sense to think about an emergency fund as well. Your emergency fund should have anywhere between three all the way up to nine or even a year worth of expenses within. It really depends on your situation. Truly figuring out an amount that will help create peace of mind for you. I feel this is incredibly important since you want to make sure that you have this amount of money set aside in relatively liquid assets like the ones we just mentioned. You can access them if need be. The reason why I’m stressing this is you don’t want to end up in a situation where you need money after the markets have gone down significantly. If that’s the case, you may feel the need to sell longer-term equity assets after they’ve decreased in value at the exact wrong time. Again, this tier is important not just for being able to do things that you want to do, but also to help ensure that you don’t do things at the wrong time. Tier three is what we consider our yield bucket. This is a portion of your investments that can provide a way to add additional income in the form of higher-yielding investments. Now, with tier three, you have different choices, as far as the investments that you choose. It’s not just a high yield bond. It could be a government bond, long term government bond, long term corporate bonds that may vary by maturity or their credit quality. The thing to remember with this is that the lower the credit quality of the company, the higher the yield, and thus, the higher the interest rate you’ll receive. Remember, a lower quality credit means that the market sees that investment as relatively more risky. That’s not necessarily a bad thing, it’s just something you need to be aware of. You can also invest in high dividend-paying stock. Now there may be more risk involved with these investments as well, but this is a way to generate additional income or additional yield for the longer-term expenses that are part of this tier. Overall, remember that these three tiers for retirement income are simply a framework. The hope is that this allows you to think about your personal situation within this framework in order to develop a solid plan when it comes to your retirement income, your retirement expenses, and your retirement investments.
Another thing that we have to think about when it comes to making our money last is of course tax. Here, we want to Make sure that you understand that your personal tax situation, as well as the type of account and possibly other factors, need to be taken into account as this will impact the amount of money that you’ll receive net of taxes. In this illustration, you can see how this could play out. Here we have a couple; they have a million dollars in investable assets, and they have $100,000 that they need to take out every year for retirement expenses. Now based upon Social Security, their pension or the 401K they’re able to take out 77,400. Along with that, note that they are in the 12% tax bracket. Obviously, they have fallen short of the $100,000 they need for the year. The question for them is, from where do we pull this extra money so that we can make up the difference, but also don’t have to pay extra taxes?
As you can see, if they take the money from a 401K account, it will be taxed as ordinary income and they will be pushed into the next highest tax bracket to 22% tax bracket. However, if they’re able to take money from my Roth IRA, those withdrawals would not be subject to any taxes. In the end, they save nearly $5,000 by having this flexibility. We don’t know what taxes are going to look like over the next 10, 20,30 years. It’s important to diversify not only your assets but diversify your tax situation as well. Here’s a great example of why that can make sense.
Social Security is very important as it serves as the foundation for many of our retirement. The question that always comes up however and really is the linchpin for Social Security is when should I begin taking my bed? We touched on some of the details earlier, but let’s dig in a bit more here. First, it’s important to understand how your Social Security benefits are calculated. Simply put, it’s based on how much you earned over your working career and the age at which you apply for benefits. First, Social Security looks at your annual earnings over your entire lifetime, indexes them for inflation, and pics the 35 highest years earnings to include in their form. Then we need to look at when you start taking benefit. For retirement age is the age at which you can claim full on reduced benefits. Your full retirement age is based on the year you were born. At this time for everyone born between 1942 1954 for retirement age is 66. For everyone Born in 1960 or later, for retirement age is 67.
If you take the benefits at full retirement age, you’ll receive 100% of what social security calls your primary insurance amount. As you can see here and as I noted earlier, you are able to take benefits as early as age 62, but as late as age 70. If you’re for retirement age is 66 and you apply at age 62, you will only receive 75% of your benefit. At age 63, 80% so on and so forth. If your full retirement age, on the other hand, is 67 and you will apply at 62 you will only receive 70% of your primary insurance amount. On the other hand, if you apply for Social Security after full retirement age, you earn delayed credits of 8% for each year you delay. If your retirement age is 66 and you apply at 67, your benefit will be 108% of your primary insurance amount. At 68, it’ll be 116%, and so on and so forth. After age 70, you can’t earn any more delayed credits, it doesn’t pay to wait after age 70 to apply for Social Security. Overall, as you can see, this decision can have a large effect on the amount you will receive and could mean hundreds of thousands of dollars in difference over your retirement.
A couple of the things to consider when it comes to social security. Remember, social security was instituted in an earlier era when most married women did not work. But in order to give women a major of financial security in their old age, the program offers spousal benefits. Today, this helps both men and women. The spousal benefit is 50% of the workers’ primary insurance amount, if he or she applies for it at their full retirement age. A few rules to keep in mind, the primary worker must have filed for benefits. The lower-earning spouse must be at least 62 for a reduced benefit or 66 for the full spousal benefit. Finally, spousal benefits do not earn delayed credit after age 66.
Now, we just talked about those 8% delayed credits on the previous slide and while they won’t affect spousal benefits, they will affect survivor benefits. Now, survivor benefits are a bit more complicated. Here there are two factors that influence the amount of the survivor benefit. The first factor is the age at which the deceased spouse originally claimed his own retirement benefit. If the spouse originally applied for Social Security before for retirement age, the survivor benefit will be limited to his or her actual benefit, or 82.5% of his primary insurance amount, whichever is higher. If the deceased spouse applied at full retirement age, the survivor benefit will equal 100% of his or her PIA. If the deceased spouse applied at 70, the survivor benefit will include those delayed credits.
The second factor influencing the amount of the survivor benefits is the age at which the surviving spouse claims that benefit. If the surviving spouse claims at age 60 or 50 if disabled, the survivor benefit will equal 71.5% of the decedent PI. If he or she claims at full retirement age or later, the survivor benefit will equal 100% of the original amount. The spouse may, of course, apply for anytime between ages 60 and 70, and the reduction would be prorated based on that age. Remember, as I noted, here is where the delayed retirement credit come into play. If the deceased spouse took benefits after full retirement age and received those 8% credits, the surviving spouse will be able to take advantage of that. Overall, the point here is that you really need to understand the rules associated with social security, in order to make sure you maximize this important on the benefits.
Health care is, of course, a huge part of retirement. It’s important to understand your options in the Medicare system. The general rule is that you are eligible for Medicare at age 65. If you or your spouse have worked long enough to be eligible for Social Security benefits, enrollment occurs automatically at age 65 if you are receiving those benefits. Now, if you’re not receiving benefits at age 65, you will need to contact Medicare to get signed up. If you’re already receiving benefits from Social Security, you will automatically be enrolled in Parts A and B, starting the first day of the month you turn 65. If you do nothing, you will keep Part B and pay premium. Along with that, if you do not enroll in Part D during the initial enrollment period, you may incur a penalty of 1% per month added to the premium for each month you delay. Overall, on this slide, you can see the premiums, the deductibles to co-pays, and importantly, the coverages provided by part A, B and D. one other thing that I think is important to consider is the idea of Medigap insurance, this is notable because Medicare doesn’t cover everything, you can see some very routine procedures on this slide that aren’t covered by Medicare, things like dental clean, eye exam, hearing exams, and hearing aid, these are all extremely important, but they aren’t covered by Medicare. Because of this, a Medigap policy may be something to consider in order to bridge this financial gap.
To finish up I think it’s important to review what we discussed and provide you with some ideas on how to start your plan. First audit your expenses, to fully understand your income sources and expenses as you enter retirement, remember, these items are likely to change along with that, think about your need, your want and your wishes for your financial future. Next review your risk profile, ask yourself some of those questions that we talked about earlier, so you truly understand how much risk you want to take and how much risk you’re able to take, plus make sure you review the allocation of all of your account.
All right, next we want to review our assets location, we just touched on asset allocation, but as I mentioned, let’s think about asset location. As I mentioned earlier, we don’t know what taxes are going to look like in 10 or 20 years, because of that we need to have our assets in different pots or in different types of accounts, that idea of tax diversification. Ideally, maybe that’s including a ROTH IRA or a ROTH 401K.
These can be very helpful as we move into the future so we can access different types of money from different types of accounts. This is something to keep in mind as well. Also, diversify your assets that consolidate those cash flows as well, what a lot of people tend to do in retirement is they have different accounts that they’ve accumulated over the year, for example, maybe your social security comes into your checking account, but you have another account that pays out into another account, it can become messy. In order to make life easy, we encourage folks to consolidate account or make sure that all of those disparate income streams flow into one single account. This will make managing expenses and income much easier as you get into retirement.
Finally, you want to make sure that you’re working with the right retirement team, this could be a financial advisor, this could include an accountant, this could include an estate attorney. Overall, you want to make sure you’re working with the right people, the type of people that will ask the right questions and be able to provide the right type of expertise to make sure that this plan is followed and put into place appropriately. Overall, those are five big questions, five big questions that we feel many of us should be thinking about and answering as we enter into retirement. As I mentioned, this is Ben Rizzuto with Janus Henderson Investors, I’d like to thank you for taking the time to be with us today and bid you a good day.
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