It has been a while since I crafted an entirely new post, and it seems worthwhile to pull together many disparate themes from my normal, weekly posts to define your best retirement. Indeed, I will give you some broad guidance on generic ways to achieve your best retirement. First, I will summarize the best concepts and then elaborate for those wanting more background.
- Maximize pre-tax contributions to employer sponsored retirement plans
- Understand and minimize fees in all your investment activities
- Always invest with a strategy
- Remember your time horizon is very long term
- Understand your options
- Timing matters … when you retire
Maximize pre-tax contributions to employer sponsored retirement plans – This one is pretty basic inasmuch as pre-tax savings get you more to start and most plans deliver some employer matching program. Say your employer matches the first 3% on a dollar for dollar basis, saving 3% of each pay check gets you 6% right away (subject to vesting, of course). If you like the investment options in your retirement plan – cost structure and diversity – invest as much as you can. Even if you invest 10% in this scenario, you are starting with 13% each pay period. Plus, it is 13% of your pre-tax income. That means more invested now and lower tax liability this year. The general logic for investing pre-tax beyond that is the assumption that you will access the money when you are in a lower tax bracket (I cannot say I have seen any analysis which confirms that, but the logic is your total ‘earnings’ will be lower in retirement, placing you in a lower bracket, all things being equal).
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Understand and minimize fees in all your investment activities – I harp on this one as often as possible, and there are myriad articles and examples scattered throughout my weekly updates to reinforce this point. Still, it may be more important than that first point simply because most people do save what they can, but few focus on this vitally important element. Consider it this way, each percentage point of fees you pay is one percent less return … each and every year, compounded. It matters, whether you are selecting investment options in your employer based plan, buying mutual funds in your online brokerage account, or working with a broker or advisor … understand the fee structure and minimize it.
Always invest with a strategy – Just last week I posted a link to a great article that highlights this point through a $100/week investment strategy into the S&P index. If you did not read it, or simply do not believe me, please do read it. The bottom line is that since your time horizon is long term, weekly, monthly, even annual fluctuations in markets should not cause you to lose sleep. The example given there shows that $100/week for 20 years becoming $205,963.08. They go on to suggest if that were simply left alone, no more contributions, until retirement (23 years more in the example), that individual’s $100/week investment of $104,000 would be $1,041,317.04. That’s as simple a strategy as there can be, invest a modest amount, every week, into a broad market index. Just imagine if the investor (you) kept investing and increased the investment as your means increased.
Remember your time horizon is long – The important point here is to stop worrying about a bad day or bad week or even a market adjustment. So long as you are not retiring squarely into a bad market, these things work themselves out over time. In fact, that $100/week example over 20 years had ups and downs, including the tech bubble bursting. Still, it delivered a 7.3% compound annual growth over the period. That’s not bad and required not one ounce of consideration or worry.
Understand your options – Employer sponsored plans are not the only way to save for retirement. In fact, there are plenty of other ‘qualified’ and ‘non-qualified’ ways to save – IRAs, Roth IRAs and Keogh plans, for instance. Permanent life insurance, for example, is a less utilized, but powerful saving vehicle. Come on, you’re saying, life insurance. Yes because you get tax advantaged ‘build-up’ inside of permanent life insurance policies, you can get the same type tax deferral benefits you see in your employer sponsored plans, albeit not with pre-tax money. In other words those ‘earnings’ on the money inside your life insurance, or annuity, can compound without generating current year income. It is the same basic concept in a different structure – plus you get a death benefit on top of it. Another option you absolutely must consider is a longevity annuity, what are now referred to as QLACs (Qualified Longevity Annuity Contracts) in the retirement plans arena. Whether you use it in a retirement plan context (employer sponsored or individual) or outside the retirement plan with other savings, these income annuities are really interesting because they provide you with a guaranteed income stream at some later date. Let’s say you have that $1,041,317.04 from our earlier example. You have to consider your expenses in retirement and your life expectancy. The good news is we live longer than ever. The bad news is we generally don’t save enough. With a good advisor you should be able to determine the right withdrawal strategy, and may layer over one of these products to backstop you after reaching say 80 or 85. The trick is the later you start the payments, the higher the payments will be. Do yourself a favor and seriously consider this.
Timing matters … when you retire – Back to the matter of retiring into a down market, the problem is you are theoretically changing gears from the ‘accumulation’ phase to the ‘distribution’ phase. You will see plenty of banter about a 4% withdrawal rate, and if you dig around my older posts there are a slew of articles about this topic. Fact is, 4% is not a panacea, and you should work with an advisor to consider what is best for you. For simplicity sake, though, let’s assume you have saved this $1,041,317.04 from our example. Let’s further assume you are planning to retiring with that number, but the market ‘corrects’ by 20% just as you retire. Now with roughly $800,000 do you take the $40,000 you were planning on taking, or do you take $32,000? Even if you take $32,000, your principal balance is now $768,000 vs. $960,000 – Ouch. Not much you can do about this, but save as much as you can to buffer it.