Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

What a difference a few weeks can make.

As recently as mid-February, stocks were logging new highs by the day, and investors could take comfort in their ever-enlarging balances. Maybe retirement was closer at hand than they thought.

As volatility surfaced in the following weeks, many of those same investors have likely had their confidence shaken and are revisiting their plans. Recent losses have been bad, but an even bigger worry is whether they were just a foreshadowing of even worse to come.

If you are approaching retirement and mulling what recent stock market losses mean for your plan, here are some key steps to take.

Step 1: Stress-Test Planned Withdrawals
From a financial standpoint, the key determinant of retirement readiness is balancing withdrawals that supply enough money to live on but do not imperil your plan’s sustainability. If your balance has dropped a bit, assess whether a 3%-4% initial withdrawal amount of that lower balance is enough to supply your needed living expenses, in addition to whatever amounts you are pulling from non-portfolio income sources like Social Security. (Needless to say, the lower you can go, the more sustainable your plan, but you are obviously also balancing quality-of-life considerations.) And because the market could drop further still, it is reasonable to stress-test withdrawals even further, too. If your balance dropped by a third or even by half from where it is today, could you live on 3% to 4% of those lower amounts? Big drops like those are not out of the question: After all, the S&P 500 fell by more than half from peak to trough during the global financial crisis.

Step 2: Weave in Your Social Security Strategy
If your portfolio withdrawals look livable even after factoring in the potential for further losses, that is a good sign. But bear in mind that the best portfolio-withdrawal strategies also maximize non-portfolio income sources like Social Security: how much of your cash flow needs they will provide and when they start. Thus, it is worth thinking through how you will balance cash flows from portfolio and non-portfolio sources throughout your retirement time horizon. Will you claim Social Security and simultaneously draw upon your portfolio at the beginning of retirement? Or will you delay Social Security filing in an effort to enlarge your eventual benefit, even if it means drawing more heavily on your portfolio early on?

The math favors delaying, even if it means tapping retirement accounts earlier, especially for people who expect to have above-average longevity. After all, the roughly 8% guaranteed benefit increase that comes along with delayed Social Security filing is impossible to match with guaranteed investment products (the only true comparison group), and that enlarged benefit is a lifetime benefit.

The tricky part about delaying Social Security, however, is if your early years of retirement coincide with a bear market and you are also taking larger portfolio withdrawals at that time. Taking too much from a falling portfolio leaves less in place to recover when the market eventually does. Thus, if delaying Social Security is part of your plan, make sure that doing so does not nudge your withdrawal rate too high (say, over 3%-4% of your balance) if your early-retirement/pre-Social Security years coincide with a weak market.

Step 3: Determine Whether You Need to Course-Correct
If your plan looks uncomfortably tight based on your findings from Steps 1 and 2, there are a few adjustments you can make to get it on track.

The most obvious is simply to delay retirement, continue making contributions, and defer spending from your portfolio. Deferring withdrawals helps ensure that you are not pulling from a declining portfolio; you will not have to worry about turning paper losses into real losses. Making additional contributions can also add up: Those new contributions may not compound a lot within the next few years, between now and when retirement commences. But retirement is a 20-year or more proposition for most of us, so contributions you make now may stay in your account for many more years and are likely to grow over time, assuming they are investing in something with some growth potential.

In addition to tweaking your retirement date, there is also the spending side of the ledger to consider: Can you trim your in-retirement spending to make retirement doable sooner rather than later? Take time to consider your in-retirement budget; as retirement draws close, back-of-the-envelope calculations that haircut current income by 15% or 20% to arrive at spending needs will not cut it. Downsizing and/or relocating to a different geography can deliver the highest payoff from a budget standpoint, but of course such decisions are about much more than money.

Remember: You do not have to choose just one of these strategies; a combination will work. For example, a pre-retiree who is concerned about coming up short might delay retirement by just 18 months and also downsize to a cheaper home in her same community. She does not necessarily have to take drastic measures to make a retirement “save.”

Step 4: Assess Your Asset Allocation Relative to Your Drawdown Plan
Based on your fact-finding so far, you should have a sense of whether you will be able to retire when you had hoped or will need to push your start date further out into the future, and how much you will be withdrawing from your portfolio when you do.

You can then turn your attention to your portfolio’s asset allocation based on your proximity to retirement and your planned spending. Your stock portfolio is likely occupying your attention right now, but focus for the moment on your portfolio’s weighting in cash and high-quality bonds. The yields on such investments have shriveled and may fall further still, but bonds and cash have a key benefit: They have managed to hold their value in periods of equity market weakness. For most retirees, the idea of building a runway of eight to 10 years’ worth of portfolio withdrawals in such safer securities could be a solution; you could draw upon those holdings if equities dropped and stayed down for a good long time. If retirement is close at hand and you are nowhere close to having that much in safe securities, the usual admonition to leave stocks alone in periods of market tumult may not apply to you.

Step 5: Take Steps to Improve Your Tax Position
In addition to reviewing the basic outlines of your plan and investment portfolio, also assess whether there are any steps you can take to improve your tax position now and/or in retirement.

With balances down, converting a portion of traditional IRA assets to Roth can make sense, in that the amount of taxes due on the conversion is based on your balance at the time of the conversion. By converting to Roth, you will have more assets available that are not subject to taxes or required minimum distributions upon withdrawals. Check with a tax advisor for guidance first, however: You may be able to convert just enough of your balances over a series of years to avoid pushing yourself into a higher tax bracket.

Moreover, IRA conversions are not for everyone; many investors are better off paying taxes in retirement, at lower tax rates, than when they are working.

 

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