For families contemplating retirement, the prospect of moving on to a new stage of life may feel even more uncertain than ever in light of the pressures and uncertainties brought on by the coronavirus. As advisors, we’ve come across two very common questions over the last few months from soon-to-be retirees:
1) I had been planning to retire this year for a while now, but with the pandemic and the volatility in the stock market, should I delay my retirement?
2) I was given an early retirement option or was forced out of my job due to COVID-19, can I still make my retirement work?
While COVID-19 certainly can throw a few extra uncertainties in the mix for prospective retirees, many of the same retirement planning principles still apply. If you are wondering whether you can still retire the way you want to, ask yourself if you have figured out the following essentials to retirement:
The first step, particularly for those who may not have been planning to retire this year, is to think about what retirement means for you. What will you do? It’s easy to dream of days filled with nothing when you are 30+ years into the nine-to-five grind. But, a few months of ‘nothing’ gets old for some retirees. Will you work part-time? Travel extensively? Relocate to be near children and grandchildren? Engage in charitable pursuits? There are a lot of directions retirement can take you that require adequate planning to ensure success.
If you are married, its important to sit down with your spouse and discuss the nature of retirement. For couples that have not done this exercise, often we find that spouses are not on the same page when it comes to the timing or direction of retirement. While differing opinions on retirement are perfectly fine, it usually requires additional planning to make work for both parties.
Once you have a general idea of what retired life might look like, the first planning step will be get a handle on spending. You might be familiar with an old rule of thumb that suggests retirement requires 80% of your pre-retirement income. While true for some, in practice we find that reality often sees retirees spending more than they did pre-retirement. More time at home usually means more time to find things that need improving around the house or more travel and activities to fill the days. It is common for expenses to surge in the first few years of retirement before falling into a more predictable rhythm.
One expense to be mindful of in retirement is healthcare – especially if retiring before age 65 and reaching Medicare eligibility. It sometimes comes as a shock to those that have received coverage from work at how expensive plans on the healthcare exchange can cost. A 64-year old obtaining coverage similar to what she will be eligible for through Medicare the following year can expect to pay 2-3 times as much for insurance than she will pay in Medicare premiums. If retiring sometime in your 50s, healthcare will be a significant challenge to early retirement cash flow.
Another retirement rule of thumb suggests that you can withdraw 4% of any investment portfolio without incurring significant risk of depleting the principal over time. For a diversified portfolio that has a healthy allocation to both equities and fixed income, 4% is probably a good starting point.
However, it is important to recognize the risks present in today’s market and how that may affect retirement investors with portfolios that lean more aggressive or more conservative than the average.
For investors who carry more conservative allocations in their retirement portfolios, it may be challenging to meet a 4% withdrawal rate with long-term interest rates at historic lows. According to Fidelity Institutional, the current yield on 10-year US treasuries is 0.69%. Investment grade corporate and agency debt hover right around 1.00%. Current yields on fixed income bear a very high correlation to the long-term returns of those assets. It should go without saying that a fixed income investment portfolio yielding around 1% will be unlikely to support long-term withdrawals of 4%.
The other side of the coin presents different challenges. With the run-up of US Growth stocks since the March lows, expected returns on these assets may be lower going forward – not to mention with the possibility of high volatility. Experiencing a bear market at the beginning of retirement is usually considerably more damaging to a retiree’s ability to accomplish goals than if it were to occur later in retirement – even if long term returns average out to be the same. While aggressive assets may have been an excellent vehicle for a 401(k) while you were working, it may not be suited to the cash flow needs of retirement.
If the pandemic has resulted in an earlier than expected retirement, the time horizon for retirement needs is extended. A retirement investment portfolio needs to be tailored to the specific expenses and time horizon applicable for an individual or family’s personal situation.
One of the most impactful decisions about retirement will be when to draw on Social Security benefits. The sage advice has usually been to defer Social Security benefits for as long as possible. The difference between claiming benefits as early as possible (age 62) vs. at full retirement age results in a permanent reduction of 30%. Then, a further 8% boost per year is earned by delaying beyond full retirement age to age 70. Typically, the “break-even” age for delaying benefits falls in the early 80s.
However, earlier than expected retirement may change the calculus on traditional Social Security benefit decisions. If retiring well before full retirement age, there will be excess pressure put on an investment portfolio to fill in the intervening years between retirement and eligibility for Social Security benefits. If a retirement portfolio is insufficient to distribute excess income during this period, it may be necessary to draw benefits at an earlier age than ideal.
If there is an expectation of returning to work in some capacity, its important to be aware of the affect earned income will have on early Social Security benefits. For every $2 earned above $18,240, Social Security benefits are reduced by $1. For example, if you earned $25,000 through part-time work and had claimed Social Security benefits before full retirement age, your benefits would be reduced by $3,380.
If you have a plan for what retirement will look like, how much your retirement goals will cost, have built a portfolio suited to meeting those goals, and have determined the optimal strategy for claiming Social Security benefits, then a pandemic probably isn’t going to derail the retirement you’ve planned for. If any of those pieces have not been fully thought out, then there’s probably more work to be done before committing to retirement on sure footing.
Ferguson-Johnson Wealth Management and our advisors specialize in working with families thinking about retiring or who have recently retired. Reach out to us if you want help in planning for and optimizing your retirement – we’ll be happy to help.