BERLIN – More people than ever are living longer, healthier lives — and that simple fact will have a profound effect on all our lives after work. The Society of Actuaries estimates that the median average lifespan for Americans who reach age 65 is another 17 years for men and 20 years for women. Half the population will live even longer.
Because most of us will outlive our parents (and remain productive for a longer time), it’s necessary to view retirement in a different way than most people did a generation ago. Most critically, it’s more important than ever to regularly review your portfolio throughout your retirement years. By doing so, you can see that your financial strategy continues to provide for a longer, more active lifestyle. Over time, you will need to answer a host of important questions, such as when and in what order you sell assets. Your needs are also likely to differ between the early years of retirement and the later ones, when health becomes more of an issue and medical expenses rise.
“Ongoing portfolio management is important to protect your principal and continue creating wealth for your future needs,” explains Stephen Mitchell, Director of Educational Planning in the Merrill Lynch Retirement Planning Group.
Once you’ve retired, cash flow should be one of your main concerns. “If you stopped working, you would be dependent on your ‘floor’—the assets that generate your cash flow—to support your current lifestyle,” says Mitchell. Your floor is determined by adding up all your assets that generate income. These might include pension plans, qualified plan distributions, annuities, Social Security and dividend payments.
If a gap exists between your floor income and your lifestyle needs, you can make up the difference in a variety of ways. You can reduce your discretionary spending to help preserve your resources, or you may consider working in some capacity to generate additional income.
Another way of helping generate additional cash flow is through an annuity. “Annuities don’t make sense for everyone,” advises Mitchell. “But under some circumstances, you might elect to take a lump-sum pension payment and purchase an annuity to help provide income during retirement.”
One key to supporting an active retirement lifestyle is to continue investing. “An investment strategy focused on preserving your principal, keeping growth in pace with inflation and protecting your portfolio from market setbacks can keep your financial strategy on track for the long term,” says Mitchell.
With people living longer lives—and retirement timelines, accordingly, stretching out for longer periods—it’s important to continue growing assets with at least a portion of your portfolio, instead of only drawing down on them.
As part of your investment strategy, be sure to review your portfolio’s asset allocation regularly. As you grow older, your portfolio will likely become more concentrated in bonds, but the percentage of your assets that you draw on each year should remain consistent to minimize risk. As a rule of thumb, most financial strategies are based on a drawdown of no more than 4% of your total portfolio each year, says Mitchell.
When determining which assets to draw from in retirement, it is important to consider the tax implications of your decisions. Consider drawing from your taxable assets first, your tax-deferred assets second, and your tax-free assets last. Also, keep in mind that you will be required to begin taking required minimum distributions (RMDs) from your traditional IRAs and employer-sponsored retirement accounts (e.g., 401(k)s) beginning at age 70½. (Assets invested in a Roth 401(k) or Roth IRA are not factored into your RMD amount.)
“You need a strategy that generates enough cash flow to cover your expenses with the least taxable income,” suggests Mitchell. For example, for investments purchased outside of a qualified retirement plan, you can take advantage of the long-term capital gains tax of 15 percent by holding assets for at least a year before you sell, rather than paying ordinary income tax on any gains.
Another significant asset within your portfolio may be your home. You can use it to help provide income by tapping its equity or setting up a reverse mortgage in your later retirement years. If your home no longer meets your living needs, you might also consider moving and downsizing. “The cost of selling a home, buying a new one and moving may be offset by the value of having a smaller home to care for, living closer to family and friends, or relocating to a warmer climate with a lower cost of living,” says Mitchell.
One additional aspect to maintaining your retirement income is developing a strategy that accounts for the possibility of an unforeseen change in circumstances. “Every budget must include a savings strategy for unknowns, such as out-of-pocket costs for medical expenses and possible long-term care needs,” said Mitchell.
Developing a strategy to maintain your income can free you up for more important things, such as enjoying the life you want in retirement.
(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)