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By Troy Fore, CFP®
Legendary motivational speaker Zig Ziglar said it well: “When you sow an action, you reap a habit; when you sow a habit, you reap a character; and when you sow a character, you reap a destiny.” While most of those entering retirement have probably already “sown” most of the habits that determine character and destiny, there’s one important habit that, if planted and carefully tended from the very beginning of retirement, can allow retirees to “reap” greater peace of mind throughout their “second act.” That habit is having a solid, yet flexible retirement spending plan.
Why does a retirement spending plan need to be flexible?
We all know that “change is the only constant.” And that certainly applies to the financial markets and the economy in which they function. No matter when you retire or how much money you’ve managed to set aside in your various accounts, your investments and savings are going to be continuously affected by the “big picture”: the markets, the economy, and the ever-changing global landscape.
That means that your spending plan needs the ability to adapt to changing conditions and concerns. So, while the “4 percent rule” (annual spending equal to about 4 percent of your total savings) may have been a useful rule of thumb at one time, it may not be the best guide for those retiring in today’s fast-moving, technology-driven investment environment. But, if you have flexibility built into your spending plan, you can position yourself for less worry and more control as you enjoy your retirement.
What are the building blocks of a flexible retirement spending plan?
There are some common-sense principles for putting together an effective, flexible spending plan for retirement, and then there are some considerations that you may not realize at first. Let’s talk about both.
1. Your retirement budget is the foundation. This just makes good sense, doesn’t it? For any spending plan, or almost any other type of project, for that matter, the best place to start is with a solid and carefully considered budget. As you approach and enter the early years of retirement, you should have an accurate working estimate of both nondiscretionary items like housing, transportation, healthcare, and groceries as well as discretionary categories like entertainment, travel, and hobbies. Ideally, most or all of your essentials are covered by predictable sources like Social Security, pensions, or annuities, leaving your investments and other retirement income sources free to cover the non-essential (but still important) other categories.
2. Time-allocated funding “buckets.” Ideally, your portfolio embraces assets that range from short-term, highly liquid resources to long-term, growth-oriented holdings (with an appropriate amount of “mid-range” investments as well).
- In the early years, having two or even three years’ worth of income in your short-term bucket is an important protection against the risk of encountering unfavorable market conditions as you begin your retirement. Addressing this risk, often called “sequence-of-returns risk,” may be one of the most important elements of your retirement spending plan, since it can help you avoid the need to prematurely liquidate assets needed for long-term growth. This, in fact, is one of the most important keys to managing longevity risk: the risk of outliving your money.
- Next, your mid-term bucket should contain assets that generate income with no more than moderate risk: high-quality corporate and government bonds, stocks with a history of paying consistent dividends, and similar holdings that earn more than cash, but still exhibit conservative risk characteristics.
- Finally, your long-term bucket should contain assets that can grow faster than inflation, like stocks, mutual funds, and exchange-traded funds focused on long-term capital appreciation. This bucket is essential for helping you maintain your future purchasing power over the next 7–15 years.
3. Tax flexibility. During retirement, the tax efficiency of your investments and income sources is still important for helping you keep more of what you earn. For this reason, in addition to time-allocated buckets, you also need to diversify the character of your income sources with respect to taxation. Your accounts should include a mix of taxable (regular investment and savings accounts), tax-deferred (deferred annuities and traditional IRAs, 401(k)s, or 403(b)s), and tax-free (municipal bonds and bond funds, Roth retirement accounts) sources to give you greater control over each year’s tax bill. In years when you anticipate being in a lower tax bracket, consider converting a portion of traditional retirement accounts to Roth accounts. This can not only increase your future sources of tax-free retirement income; it can also give you more control over how much of your retirement income is derived from required minimum distributions (RMDs). Since Roth IRAs are not subject to lifetime RMDs, you get to decide when or if to make withdrawals.
4. Establish market-driven “guardrails.” As mentioned earlier, none of us can control what the markets do from year to year. But you can control your spending by making adjustments, depending on market performance. In years when the market is doing poorly, you may wish to skip an inflation-adjusted increase in your income or spend less on non-essentials. In years when the market is doing well, you may want to give yourself a “raise.” In either case, you can rest easier, knowing that your spending plan is aligned with how your accounts are performing.
As a fiduciary wealth management firm, Aspen Wealth Management works with clients to design flexible retirement spending plans that take into account the impact of inflation, market performance, and above all, the priorities and values that shape the client’s desired retirement lifestyle. Let us help you chart a course toward the retirement you’ve envisioned.