Saving for retirement is one of the most popular topics that clients want to discuss with their financial advisers. In fact, Boston Private's recent WHY of Wealth Survey found that preparing for a comfortable retirement was the most important factor driving the wealth planning efforts for nearly a third of all high-net-worth respondents.
But how do you begin planning for such an important financial milestone like retirement? It’s a question I hear quite often. And while there’s no magic formula or right number that works for everyone, I have found that the following three steps can help almost any individual build a successful plan for what I like to call the “seven-day weekends” of retirement.
1. Begin with organizing your financial life
Though not the most exciting, this is an absolutely crucial step. Before you can plan a future, you’ll need to understand the full financial picture of your life today. The easiest way to start is by creating a net worth statement that details all of your assets and liabilities.
As you’re taking note of your assets, be sure you’re reviewing how your financial accounts and other assets are owned and invested. What is the interest rate on your cash balance? How are your retirement accounts invested? As you review your mortgages and other liabilities, make note of the loan terms in addition to the balances. Do you have a 15- or 30-year mortgage? What’s the interest rate on your credit cards? How long do you have left before you are debt free? Don’t forget to include other assets, such as real estate, collectibles and life insurance.
As you prepare your net worth statement, this is also a great time to review all of your accounts with beneficiary designations to make sure the correct person is listed.
Once you have a full view of your current financial picture, make a list of the income sources you might be eligible for in retirement. This might include pension income from your employer, or perhaps you own rental real estate. For most individuals this would include Social Security benefits.
The easiest way to find out how much your Social Security payment will be is to obtain a copy of your Social Security statement. You can download copy of your statement from the Social Security Administration at www.ssa.gov. Your official statement will show your projected Social Security benefit at retirement and your entire work history. An important note: If you spot any inaccuracies in this statement, be sure to clear them up now.
One question I often receive as clients review their potential income streams is: “How should I factor in a potential inheritance?” Unless you know the particulars of this potential benefactor’s financial situation and legacy wishes and the inheritance is imminent, I typically recommend not including an inheritance in your projections because it is never a sure thing. If it happens, then great! You will be that much better off financially. However, you don’t want to bet your long-term financial security on something that doesn’t materialize.
2. Get an idea of how much money you’ll need
One of the most common questions I receive is: “How much do I need to retire?” Because everyone’s circumstances are unique, my answer is always, “Well, it depends.”
Even though answering this question might feel like aiming at a moving target, these guiding questions will help you arrive at a best guess, which is critical to building your plan:
- How much are you spending now? Sometimes the easiest place to start is with what your lifestyle looks like today and think about how it might change once you retire. Review and categorize your spending over the last year. If you spend a lot of money on dining out, will that budget increase once you have more time on your hands? If you spend a lot of money on clothing and dry cleaning, will that budget decline in retirement? Try to quantify these things as best as you can.
- What are your most important goals in retirement? Now is the time to dream big! What do you want your retirement to look like? Gardening is going to require a much different budget than traveling the world, so make sure you factor in these goals as well. Try to get as specific as possible. An annual round-the-world cruise with your spouse, children and grandchildren is going to cost a lot more than visiting a few national parks in an RV each year.
- When do you want to retire? Required minimum distributions from retirement accounts must begin at age 72, but you have the ability to begin some distributions sooner. Your Social Security benefit will change depending on when you begin collecting. If you collect early your benefits will be reduced, but if you delay collecting your Social Security benefit it will increase by 8% each year you wait until age 70. When it comes to planning your cash flow, it’s important to understand all of your options so that you maximize your income over the course of your retirement.
- How healthy are you? Longevity is one of the most important variables when planning for retirement. It’s best to overestimate here as underestimating can mean your nest egg runs dry prematurely.
- Will you have health insurance when you retire? If you retire early, make sure you factor in the cost of obtaining health insurance. Some individuals mistakenly think that once you turn 65 Medicare covers all of your medical costs. You will still need to plan for supplemental policy premiums, deductibles and other out-of-pocket costs. Additionally, Medicare does not cover long-term care. If you’ll need long-term care, you should factor in the costs of self-insuring for these costs or consider a long-term care insurance policy.
- Where do you plan on retiring? The cost of living and tax environments of different states and municipalities can have a significant impact on how much you’ll need and how far your savings can go.
3. Don’t forget to take taxes into consideration
Now that you have a better understanding of how much money you’ll need and where it will be coming from, it’s equally as important to understand how much of that money will need to be paid to the government. Each asset and income source has its own tax treatment, so it’s important to understand the rules that apply to each. For example, if you plan on taking portfolio withdrawals from a brokerage account, you will most likely need to pay capital gains taxes as you sell investments to raise cash.
Each retirement investment vehicle and benefit plan has its own unique tax structure and rules, so make sure to understand the differences and requirements of each. For example, while distributions from traditional IRAs, 401(k)s, 403(b)s and Social Security benefits are all taxed as ordinary income, how much of your Social Security is taxed is dependent on how much other income you have. If you take distributions from a Roth IRA, those distributions are not taxable as long as you meet certain conditions.
Going through this exercise often helps illuminate changes that may need to be made in your current savings plan. Many individuals know that it’s important to diversify your investments, but fewer understand the importance of diversifying their savings from a tax perspective. If all of your retirement nest egg is held in your 401(k), for example, you might want to build up your savings outside of your 401(k) so you can lean on this account to help you decrease your taxable income in retirement.
By following the three steps above and asking yourself all the right questions, you’ll be well on your way to creating the life you want to live during your seven-day weekends. And if you remember nothing else, remember that the best time to start planning for retirement is now.
Kathleen Kenealy, CFP®, CPWA® is the Director of Financial Planning and a senior wealth adviser for Boston Private, an SVB company. She specializes in working with successful individuals and families to manage, protect and grow their assets. Kenealy provides guidance on investment, retirement, philanthropic, estate and tax-planning strategies.
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