Successful Retirement Plans Are Built on These 5 Pillars
Is your retirement plan solid? Check to see if you have all your bases covered, or whether your retirement "structure" is missing a key component.
There is so much that goes into preparing for retirement, sometimes it’s hard to know where to start. Having a comprehensive plan or blueprint will make the process easier by outlining the major areas you need to address.
Planning for retirement is like building a house. The fundamental features of any home are the foundation, walls and roof. Of course, there are the details of electrical, plumbing, finish work, etc., but unless the core components are constructed properly, in the correct order and working together as designed, the other components can’t be expected to perform as intended.
Just like you need a blueprint to build a house, you should also have a blueprint when building your retirement plan. The retirement blueprints we design for our clients include:
- The Foundation: Principal-protected, “safe” assets.
- Walls: Designed for growth and income, composed of assets not generally tied directly to the stock market.
- Roof: Typically growth-oriented equity investments with exposure to the markets.
Along with those core components, there are some other key elements to consider in the blueprint, which we refer to as the five “pillars” of retirement planning: Income Planning, Investment Planning, Tax Planning, Health Care Planning and Legacy Planning. Most importantly, these five pillars should be integrated into one comprehensive plan, working in unison to accomplish the objectives of each unique client.
1. Income Planning
Although it might seem obvious, many people fail to consider the full impact of their paycheck ending when they exit the workforce. If you intend to maintain your pre-retirement lifestyle, you need a plan to generate reliable income for the rest of your life. After carefully considering your income needs, you can start to form a strategy as to where those funds will come from. Social Security is a steady source of income, but each retiree must consider the best way to claim in order to maximize their benefits. If you’re married, you and your spouse should work together to figure out the best way to take your Social Security benefits. For example, based on the circumstances, what’s better, claiming a spousal benefit or two individual benefits? Should you take an early benefit of lesser amount or delay your Social Security for more monthly income in later years?
While Social Security benefits likely won’t satisfy all your income needs in retirement, they can provide a reliable income base that should never run out. Thanks to advances in medicine and technology, Americans’ life expectancies are increasing, making longevity planning especially important. Not only do you need to plan for your income needs over the next decade, you need to plan for potentially the next 30+ years. You also should consider that although inflation is relatively low right now, that could quickly change. Over time, the erosive effects of even a low inflationary environment add up, so it’s important to ensure your savings and investments aren’t quietly eaten away over 30-plus years in retirement.
Bottom line: Social Security will not be enough to carry you comfortably through retirement; you’re going to need multiple streams of income.
2. Investment Planning
While retirees should typically take less risk with their investment assets, it doesn’t necessarily mean that they should stop investing altogether. One of the first steps in investment planning is assessing your tolerance for risk. Protecting your money from market volatility and finding ways to reduce risk while simultaneously allowing for portfolio growth are especially important in retirement. Through in-depth discussions and with the use of powerful, technological tools like Riskalyze, financial professionals can identify their clients’ risk tolerance and use that information to allocate assets appropriately in their accounts.
The negative impact a drop in the market can have on portfolio holdings is visible and easy to understand, but what about fees? Many investors aren’t even aware of this “enemy” of growth hiding in plain sight. They have no idea how much they are paying in management, custodial, transaction and other account fees. A fee of 2% initially might not seem like much, but over the years while you’re accumulating assets, it may mean the difference between achieving your retirement goals or running out of money in your lifetime. Fees vary depending on account type and from firm to firm. Some investors may pay under 0.5% in portfolio or management fees, while still others may pay in excess of 2% or even 3%. A recent study by the Center for American Progress found that the typical worker earning a median salary of about $30,000 who starts contributing to a 401(k) at age 25 will pay about $138,336 in 401(k) fees alone over their lifetime — and that’s with a fee percentage of just 1%. So, it makes sense to periodically perform a fee analysis of your portfolio.
3. Tax Planning
Just because your paycheck pulls a Houdini when you retire, it doesn’t mean your taxes will disappear in a similar fashion. Tax planning is a crucial part of any comprehensive retirement plan and takes a long-term view of your tax liabilities. Particular focus should be on assessing the taxable nature of your current holdings and then determine how to draw on each asset in the most tax-advantaged manner. Understanding how to best use qualified assets, such as an IRA or 401(k), is important in retirement, as most withdrawals from traditional retirement accounts are taxed as ordinary income.
In retirement, ideally you will draw income from both taxable and tax-free sources. During the tax-planning process, the goal should be on minimizing current taxes through tax-deferred or tax-preferential vehicles and eliminating future taxes using strategies like Roth IRA conversions as one way to provide tax-free income in retirement. Although most conversions from a traditional IRA into a Roth IRA are deemed as a taxable event, the benefits down the road may justify the tax expense today. While it may be impossible to eliminate all taxes in retirement, proper planning now can significantly reduce your future exposure to income, capital gains and estate taxes.
4. Health Care Planning
Due to rising health care costs, increased deductibles and restrictive insurance plans, a chronic illness or sudden medical emergency can lead to financial disaster. Like taxes, health care costs don’t just vanish when you retire, in fact, they tend to become a larger portion of your expenses the older you get. One common misconception we encounter is that Medicare is free and will take care of all your health care costs in retirement. If that’s what you think, well, think again. Medicare Part B premiums and supplemental insurance will cost you. If you believe you don’t need to worry about long-term care costs because Medicare will step in should you need custodial care, again, we’re sorry to disappoint you. Medicare generally doesn’t cover long-term care stays in a nursing home or similar facility.
According to government estimates, someone turning 65 now has almost a 70% chance of needing long-term care services at some point in their life. A solid retirement plan looks at health care expenses, helps retirees choose the best Medicare plan for their needs, and includes options for funding long-term care.
5. Legacy Planning
Finally, the fifth pillar of your retirement blueprint is legacy planning. You’ve worked hard all your life to build your wealth, and you deserve to have it passed on to your beneficiaries in the most expeditious and tax-efficient manner. Estate tax laws are complicated and can change year to year, therefore it’s paramount that you have an experienced professional to help you navigate the process. By having an estate plan, you can benefit your heirs by avoiding confusion, expensive probate procedures and an unnecessarily large tax burden when your time on Earth has expired.
An experienced and competent financial adviser will work together with your estate planning attorney and CPA to make sure that your assets are titled properly, protected during your life and positioned for a smooth transition upon death. The time for legacy planning is now, during the calm and quiet times of life, not when you are old, sick or confined to a hospital bed, and it’s certainly not the right time after you’re already dead. Don’t make the mistake that many, including prominent figures like Philip Seymour Hoffman, Martin Luther King Jr. and Abraham Lincoln, made by avoiding or not properly planning their legacy through a properly designed and executed estate plan.
As financial advisers, we don’t see these five areas of planning as separate: They are all connected, and a comprehensive financial plan should reflect this. The five-pillar process isn’t so much a checklist as it is a template to ensure the full scope of your retirement planning needs, including the ones you might not even have considered, like long-term care costs and reducing investment portfolio fees, are covered.
Just as a general contractor responsible for building a home will coordinate with and oversee the electrician, plumber, framer, roofer and other subcontractors, your financial adviser should play the same pivotal role in building your retirement plan. While this approach may involve more than one individual, such as a CPA and attorney, it’s important for your adviser to be conversant with all aspects of the planning process and ultimately have oversight on the design and buildout of your retirement blueprint.
About the Author
Jammie Avila, Registered Representative
Managing Partner/Co-Founder, Cornerstone Wealth Management
Jammie Avila is the managing partner/co-founder of Cornerstone Wealth Management in Las Vegas and Henderson, Nevada. Jammie has passed the Series 7 and 63 exams and is licensed to sell insurance products. Jammie and his wife, Danielle, have four children.