Retirement Plan Essential Elements
By Mark Wendell
Until recently, many retirees have been able to rely upon the three-legged stool of retirement income sources: A defined benefit pension plan that guarantees a lifetime income, their own savings, and Social Security. More recently however, the first leg of the stool has all but disappeared as many defined benefit pension plans have been replaced with defined contribution plans such as a 401(k) plan. In addition, many beneficiaries of pension plans have preferred to manage their own retirement accounts outside of company pension plans, by moving their pension balances into IRA Rollover accounts when they retire. This has shifted the responsibility for creating a retirement income source to the individual. With expanding life spans and increasing retirement costs, serious retirement planning is required to ensure that your income will last a lifetime. Here are the four essential elements of a sound retirement plan:
Set Clearly Defined and Realistic Goals
With an increasing life expectancy, it’s no longer enough to state, “I want to retire at age XX” as a goal. In order to inspire a well-conceived plan and the will to faithfully execute it, you need a clear vision of your life in retirement.
- Do you plan to actually retire, or work in some other field?
- How will you live in retirement and where will you live?
- What would you like to accomplish in this phase of your life?
- Have you defined a realistic monthly budget, income vs. expenses?
- Will your monthly income sources support your budget?
- Will your investment assets become depleted within your lifetime?
- Have you thoroughly investigated your Social Security and Medicare benefits?
Calculate Your Retirement Costs
One of the more popular rules of the past suggested that retirees will need just 70% to 80% of their pre-retirement income to maintain their standard of living. Now the realistic number is 100%. The major flaw in the old rule is that it didn’t account for the true cost of aging. In calculating the cost of retirement, the equation has become more difficult due to the new reality of expanding life spans, which means you can plan on higher health care costs over time. The cost of your retirement must factor in realistic spending assumptions based on your goals, desired lifestyle, AND increasing health care costs as a percentage of your annual budget throughout your retirement lifetime.
Long-Term Investment Strategy
Accumulating enough capital to provide lifetime income sufficiency is a daunting task, made more difficult in an environment of low returns on savings and increased stock and bond market volatility. It requires a serious commitment to a long-term investment strategy with the confidence and discipline to follow it. It starts with a well defined investment objective, which can be stated as the long term return on investments that must be achieved to meet your cash flow needs.
The next step is to develop a risk profile that matches your tolerance for risk and volatility with a portfolio of investments that can reasonably be expected to achieve your objective. Developing and optimizing an asset allocation plan that diversifies investments and/or strategies is usually best left to professionals, since changing economic conditions requires constant vigilance and occasional adjustments.
For decades we have been told that the best way to accumulate capital for retirement is through tax deferred savings vehicles, such as a 403(b), 401(k) plan or various IRA plans. Although it still makes sense for accumulating capital, it doesn’t take into account the tax consequences of income withdrawals and its impact on the total spendable income available in retirement. Retirement planning used to be almost entirely about capital accumulation; however, in view of the possibility of living 30-60 years in retirement with increasing health care costs, the emphasis shifts to managing your income during retirement. Professionals should be consulted prior to and during retirement to be certain that your tax situation is being optimized in your specific household situation.