It feels okay to talk about retirement again. With the economy beginning to look up, many workers who chose to delay retirement during the recession are now planning the transition to the next phase of their lives, albeit with cautious optimism. Interestingly, financial services companies have caught onto the nation’s guardedly hopeful mood for a retirement where more realistic goals have replaced pie-in-the-sky dreams. For example, in a recent Charles Schwab advertisement, an investor scoffs at the retirement dream of “starting a vineyard” and states, “Just help me figure it out in a practical, let’s make this happen kind of way.”
This pragmatic approach is especially helpful when we’re planning for retirement for folks between the ages of 50 and 60 who have been laid off and are too young to retire, but perhaps too old to jump back into the workforce in a different career. Many have just enough cash from their layoff to retire if they are careful with spending in the early years and will also receive a minimal amount of Social Security.
For these Boomer clients, the need for practical advice and prudent planning is more critical than ever. As Joe Coughlin, founding director of the MIT AgeLab, says, “The Baby Boomers are the first to have to piece their financial future together on their own without the certainty of defined benefits and with the uncertainty of being sandwiched between the needs of care giving and living longer.”
Here are five steps designed to manage these unique pressures and create a sustainable retirement income stream.
- Proactively guard against inflation. Even moderate inflation can negatively impact your future purchasing power, so a retirement portfolio must include stocks as well as bonds. Currently, on the fixed income side, we favor short-term bonds that will be impacted less by a future hike in interest rates and, on the equity side we believe in asset allocation plan that is globally diversified.
- Cultivate multiple income streams. Advance planning for an early retirement should include the cultivation of alternative income streams. Rather than relying solely on savings to fund retirement, many retirees generate income from rental properties or a side business that has grown out of a hobby. Because these income streams take some time to establish, it’s ideal to have them in place before you retire. Alternatively, rather than retire fully, you could choose to transition slowly into retirement. Many Americans step down from full-time work, first to three-quarters time, then to one-half time and after that one-quarter time. Others leave the more formal 9 to 5 yet remain engaged with their company on an occasional consulting basis. Either way, your earnings allow your nest egg to continue to grow in the early years of “retirement.”
- Diversify from a tax perspective. As future tax rates are unpredictable, having assets in both taxable and non-taxable accounts affords you maximum flexibility when it comes to withdrawals. Remember, you now have the opportunity to convert a traditional IRA to a Roth IRA where qualified withdrawals are tax-free. While your conversion will trigger a one-time tax bill based on the value of the newly converted Roth IRA, because ordinary income rates likely will increase in 2013, many investors, particularly those who earn more than $100,000 and were formerly excluded from the conversion opportunity, plan to convert now to avoid higher taxes down the road.
- Lost in all the math is the fact that you can re-characterize your Roth IRA if you convert and later feel you’ve made a mistake. In fact, because you have until October 15th of the year following your conversion to do a Roth “re-characterization” and change your account back to a traditional IRA, if you convert in January, the IRS effectively grants you up to 21 months to track the performance of the IRA and decide if paying taxes now pays off with tax-free appreciation later.
- The re-characterization benefit makes it wise to convert one traditional IRA into multiple Roth IRAs, each invested in a different asset class. For example, if you had a $2 million traditional IRA, you might split your conversion into four equally funded Roth accounts. For illustrative purposes only, let’s assume that two accounts grow from $500,000 to $1 million and two drop from $500,000 to zero. Because the IRAs were split into four, you can change you mind on the two that fell in value and convert them back to traditional IRAs. Thus, you owe taxes on only the two converted accounts that increased in value, and nothing on the two that went down.
- Let your kids stand on their own feet. The parental instinct to help our children is strong, but helping your children out of financial trouble can compromise your own financial security. For example, if a child is going through a divorce and you are tempted to help by co-signing a mortgage or paying your grandchild’s tuition bills, you first need to ensure that your portfolio can handle those extra, unplanned expenses. As flight attendants instruct us every time we fly, “In the event of an emergency, please put on your oxygen mask first before assisting others.”
- Keep your emotions in check. With the credit crisis and the Great Recession, we’ve had plenty to get emotional about in recent years, but cooler heads must prevail. While no one wants their investment portfolio to go down in value, it’s crucial to understand that markets fluctuate daily. To prevent yourself from making emotionally-charged snap decisions that could hurt your portfolio, focus on the long-term. To help you maintain that perspective, it’s helpful to review your investment plan, your financial roadmap for achieving your goals.
Finally, we’ve all heard it said that it is preferable to “retire to” something of interest rather than to “retire from” a career. This is especially true of an early retirement. While you might picture yourself traveling the world or simply enjoying time at home by exercising more and eating better, keep in mind that negative health effects have been correlated to early retirement, starting with memory decline. As Lisa Berkman at Harvard’s Center for Population and Development says, “If you do crosswords or Sudoku, you get better at crosswords and Sudoku. You don’t get better at cognitive behavior in life.” Clearly, having a reason to get out of bed each morning is a powerful factor when it comes to our happiness. Accordingly, although your finances may be in place for an early retirement, it’s equally important to ensure that your retirement has a sense of purpose.