If you have retirement in your sights, you can feel good about all the work you put into building your retirement nest egg—not an insignificant accomplishment by any measure. However, as you gaze into your future—the next 25 to 30 years of your life—it’s essential to understand that the more challenging aspect of your retirement plan still lies ahead. That’s because the distribution phase of your plan can be much more complex than the accumulation phase. There are many more moving parts to planning your retirement income with the potential to make many more mistakes.
Here are three of the more serious mistakes to avoid as you approach retirement.
Investing too Conservatively
After 30 or 40 years of enduring market fluctuations to generate the returns on your retirement assets, it’s tempting to want to settle in on safer investments that offer peace of mind while you collect your retirement income. However, that strategy ignores the ever-present threat of inflation which can result in asset loss over time. As inflation reduces your purchasing power, you will need to spend down more assets to keep pace with higher costs. Even a low inflation rate can have a significant impact on your future purchasing power.
Investing too conservatively can be just as harmful to your lifetime income sufficiency as investing too aggressively. It’s essential to maintain a level of exposure to equities that can ensure your portfolio continues to grow. A retirement income investment strategy should seek to balance portfolio growth and risk to arrive at an asset mix that reflects your return needs, risk tolerance, and time horizon.
Planning for Unrealistic Spending Needs
Forget all the rules of thumb about how much income you’ll need in retirement. Retirement income planning should be grounded in today’s realities, anticipating all the costs of aging. That includes the possibility of increasing medical expenses and the potential costs of long-term care. On the upside, your living costs could decrease depending on your consumption needs. The key is having a spending plan that’s based on your vision of retirement while incorporating contingencies that are likely to come up.
Having a realistic spending plan (with consideration for inflation) allows you to calibrate your retirement income planning so you can optimally arrange your retirement assets with the right balance of growth and risk to generate the necessary returns.
Pro Tip: Start tracking your spending now to have enough time to make the necessary adjustments as you approach retirement. Some pre-retirees even go so far as to start living like a retiree several years ahead to make the transition into retirement smoother.
Neglecting the Tax Implications of Your Retirement Income
If you’re like most pre-retirees, you spend the better part of your life accumulating retirement capital inside a 401(k) or IRA. While all that tax deferral seemed like a good idea at the time, it can create an unwanted tax burden in retirement. That’s because the income you receive from those retirement accounts will be taxed at ordinary income tax rates. That may not be a problem if you expect to be in a lower tax bracket, but who knows what the tax rates will be in five, ten, or fifteen years.
Plus, you may be confronted with required minimum distributions (RMD), having to take minimum withdrawals starting at 72, even if you don’t need the income. That can also push you into a higher tax bracket.
Now is the time to consider the tax implications of your income sources and look at diversifying your taxes in retirement. One way to accomplish that is by converting a portion of your tax-deferred retirement assets into tax-free assets through a Roth IRA conversion. Income from a Roth IRA is not taxable, and RMD rules don’t apply to a Roth IRA. While you will have to pay immediate taxes on the amount you convert, you can control that by converting small portions over time. The Roth IRA conversion strategy will protect your income from the possibility of higher tax rates and ensure maximum cash flow free of taxes.
It’s crucial to properly plan for your retirement income now because your options become more limited once you’re in retirement. Planning for lifetime income sufficiency can be complex, which is why it’s vital to seek the guidance of a financial advisor experienced in retirement income planning.
If you need a guide, we encourage you to reach out to us. We serve clients locally in Janesville, WI as well as virtually throughout the country. Retirement isn’t a time for mistakes. Make the most of your income with a smart, solid plan.