Have you thought much about how to make your retirement assets last longer?
If not, I would suggest you put a plan in place to do just that.
Americans are living longer than ever. A recent life expectancy study from the Brookings Institute illustrates this point.
For married couples, there is an 88% chance that one will live to age 80, and a 45% chance that one will live to age 90.
Living longer requires our money to last longer. Outliving our money is one of the biggest fears for those planning for retirement.
The role of life expectancy in retirement planning
Life expectancy is a crucial factor. Deciding how to plan for how long you will live is one of the more difficult decisions.
Plan for a life expectancy that's too long, you risk living on less than you might want or need.
Plan for one that's too short, you risk running out of money.
If you're a woman, on average, you will live from five to seven years longer than men.
My advice is to err on the side of caution.
So, what's the age to use?
Many use age 95 or even age 100. That may sound crazy, but with advances in health care, we are living longer than at any time in history.
In addition, people are much more health-conscious than ever.
Many retirees use the 4 percent rule to gauge how much income to pull out of investments each year. To use this rule requires you to put an ending age in the calculation for life expectancy. It provides a way to keep your original starting principle value intact. There is plenty of flexibility in the calculation to adjust spending and income along the way.
Get better returns on your money? Great. Take more income that year. Or be conservative and let that money grow.
Get worse returns? Cut back. Be flexible and willing to make adjustments.
Whether you use the 4 percent rule or some other method, the conservative and safe way to keep from running out of money is to assume a long life-expectancy.
These five strategies will keep you on track
My regular readers know that my mantra to achieve and maintain financial independence involves three basic principals.
Spend less than you make. Save and invest the difference. Reduce or eliminate debt. That's foundational for anyone trying to control their finances. With that background, here are five things you can do to make your money last longer.
There's no surprise that these principals are part of the list.
Reducing spending seems obvious.
You do not want to wait until you retire to figure this out. Make plans on how much you will spend well in advance of your actual retirement.
Consider moving to an area with a lower cost of living. Not sure where that is? Learn more at Sperling’s Best Places to Live – bestplaces.net.
My wife and I live outside of Washington, DC in one of the highest cost areas in the country. According to Sperling, our area's cost of living is 143 percent of the national average!
We are investigating other places to hang our hats when we retire.
An RV lifestyle is likely in our future, at least for a little while.
What about you?
Are you willing to downsize? Move to a lower cost area? Eliminate or reduce the wants and focus on the needs in your retirement spending?
If so, that's a huge step to make your assets last longer.
Reduce or eliminate debt
Reducing or eliminating debt is another obvious point.
Many people entering retirement still have massive amounts of debt. Pay off high-interest credit card debt. If possible, have your mortgage paid off at retirement.
If you are empty nesters living in the same house where you raised your family, it is likely more house than you need.
Use the cash from the home sale to pay for a smaller home. Retiring without a mortgage can substantially reduce your monthly costs. Better yet, take a look at renting rather than buying.
The primary motivation for owning a home in the past was the tax deduction for the interest paid. With the new tax law change, that's a non-issue for many. Most will now file a standard deduction and not take advantage of the mortgage deduction.
Now, more than ever, renting may make sense.
Maximize your Social Security Income
For most, Social Security is the only guaranteed retirement income option. This Social Security Bulletin estimates that 40% of baby boomers retirement income will come from Social Security.
Research sources indicate about half of all Americans file during their first year of eligibility, typically age 62. Starting at age 62 gives you reduced benefit but for a more extended period, assuming average life expectancy.
Waiting for full retirement (age 66 for most baby boomers) increases your Social Security income by 25%. If you can wait until age 70, your income grows by another 32%.
If married, divorced or widowed, you may have other options to increase your Social Security income. Make sure you thoroughly analyze your options before making a decision.
It is essential to get it right the first time. A 2010 rule change prohibits changing your Social Security election after twelve months.
A note to the younger generation
I read numerous personal finance blogs. Many of them focus on early retirement. Though there are exceptions, most of these bloggers decide not to include Social Security in the calculation.
I get the logic.
Many feel it won't be there for them when they reach the age of eligibility. Still, I believe you should add Social Security should at the very least to the Plan B retirement scenario. After all, any good plan has contingencies, right?
Planning on not having any benefit is a more conservative approach. And I always advocate being conservative in planning assumptions. However, I believe Social Security will be there when these folks reach their age of eligibility.
Yes, the trust fund will be taking in less than it's paying out by 2034. And yes, Congress is about as dysfunctional as at any time in modern history. If history is an indicator, they will deal with the issue before its demise. It may look different than it does today. But I don't see Congress doing away with it.
It would be political suicide.
And let's face it. Being a member of the Senate or House is a pretty darn good gig!
Make smart decisions when withdrawing from investment accounts
However, that may not be the best option.
Consider withdrawing from retirement accounts first. To minimize taxes, limit withdrawals to amounts that don’t exceed your marginal bracket. If that's 15%, only withdraw an amount that keeps you from going into the next tax bracket.
Often, taking this income means you can delay filing for Social Security, your benefit will grow, ideally, until age 70 (see above example).
If you need additional income, consider selling stocks or stock mutual funds held longer than a year in taxable accounts. Under the current tax code, you pay these taxes at capital gains tax rates (15% or 20%).
This strategy reduces IRA account balances, ultimately, reducing the amount of money taken from your IRAs due to required minimum distributions (RMDs). RMDs must begin in the year following the year you reach age 70 ½.
Converting those IRAs to Roth IRAs is another consideration. Though you pay taxes in the year of conversion, withdrawals from a Roth IRA are tax-free.
One Roth conversion strategy to consider is called the “fill-up-the-bracket” strategy. Here's how it works.
Investors convert just enough of their traditional IRAs to keep them in their current marginal tax rate. Let's say their 2018 tax bracket is the new 24% bracket.
If filing as an individual, the band is $82,500 to $157,500. If married filing a joint return, the range is between $165,000 and $315,000.
In the fill-up-the-bracket strategy, an investor would convert just enough money each year to prevent their adjustable gross income from going above the top income level for that bracket (either $157,500 or $315,000).
Granted, they're going to pay more taxes in the years you convert. Some people don't like that prospect.
Here's the question – would you instead pay more tax while you're making a higher income or in retirement when, presumably, your income is lower?
For me, I'd much rather pay higher taxes when I'm making the most money.
Get the right assets in the correct accounts
Pay attention to which type of accounts you place your assets. Since you pay ordinary income tax on bonds, bond funds, and real estate investment trusts income, consider putting those in retirement accounts.
Granted, with near zero interest rates the last several years, this has been less meaningful.
However, the current trend is for interest rates moving upward. The economy is growing (depending on what report you believe) meaning inflation could become a factor. As such, the Fed has indicated they will be on a consistent, slow path to increase interest rates. That fact means that having fixed income in nontaxable accounts will have a more significant tax reducing impact.
Conversely, stocks and stock funds get taxed at capital gains rates and should be in taxable accounts.
Reducing taxable income and minimizing taxes on that income help your money last longer.
And remember, if you own tax-free municipal bonds (or bond funds), the income from these counts toward the income calculation for taxing Social Security.
The lesson – look at the total financial picture when determining which accounts hold which investments.
With life expectancies increasing, planning to make your assets last is more important than ever. Hopefully, your planning started early. If not, it's never too late.
Stick to the basics – Spend less than you make. Save and invest the difference. Reduce or eliminate debt. Whether you're twenty-two or fifty-two, having the discipline to implement these steps can put you on the path to financial success.
Preparation is the key to success in retirement. Following these five steps significantly improves the probability of not outliving your money.
Now it's your turn. Where are you in your planning process? Have you started? Are you almost there? If not, what steps will you take to get and stay on track?
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