No two retirements are ever going to look exactly the same, because each of us will enter that phase of life with a different set of circumstances, expectations and financial realities. But by exploring a few hypothetical scenarios, we should be able to shed some light on holistic financial planning opportunities, as well as risks, that may potentially arise in various retirement situations.
Early Retirement Rick and Rita
Over the course of successful careers, Rick and Rita, both 59, have diligently accumulated $1.5 million in a joint account and a little more than $2.5 million across their respective 401(k) accounts. Rick, who works in tech, is considering retirement from his longtime employer, since both their kids have graduated from college and have good jobs and bright futures. While Rick’s friends say he should do it and refocus his energy on his work with young entrepreneurs, Rita is concerned about having enough savings to last them over a lengthy retirement of several decades, despite the fact she will likely inherit a $1 million IRA from her elderly, widower father. Rita is willing to put in a little more time at her job in healthcare, but she’s most looking forward to spending more time with Rick when they hop the fence into retirement. The couple is not concerned with leaving a legacy to their kids or charity – yet.
Risks: Risks that Rick and Rita can expect to face with early retirement include lower-than-expected returns on their well-diversified investment portfolio, inflation, unforeseen circumstances and/or expenses (and outliving their money as a result), a costly health event, and higher-than-expected taxes.
Planning items to consider
To anticipate and help mitigate these risks, Rick and Rita should run a detailed retirement projection that includes a Monte Carlo analysis with various stress tests and what-if scenarios, including the potential for lower-than-expected Social Security cost-of-living adjustments, higher-than-expected inflation, low market returns or low market returns at the wrong time, and added costs for helping to support kids or grandkids (or themselves).
To minimize the income tax they will pay over their lifetimes and maximize the amount of wealth they will one day leave their kids, Rick and Rita will want to revisit their asset location decisions. In general, equities are most efficiently held in non-IRA accounts and bonds in IRAs or 401(k)s. They may want to consider delaying when they take Social Security, which will allow for Roth conversions while they in a lower tax bracket, especially since the couple will need to draw down the IRA inherited from Rita’s father within 10 years per the SECURE Act.
Sarah is 62 and divorced with a recently married son. Sarah retired from her career as a high school teacher two years ago, but to keep busy she now works part time as the bookkeeper for a nearby flower shop. The extra income helps her savings stretch, and she’s able to withdraw less from her retirement accounts than she would otherwise for the time being. Between her ex-husband’s Social Security, her pension from teaching, and her lack of any real debt, she has more than enough to cover her living expenses. She recently inherited almost $1 million in an IRA from her mother – which further secures her modest but comfortable lifestyle and allows her to do some traveling – to accompany her own $500,000 taxable account and $500,000 IRA. Sarah is charitably inclined, and she finds time to volunteer at a nonprofit working to fight childhood hunger in her community, a cause that’s close to her heart.
Risks: A major risk that Sarah faces is paying higher-than-necessary income and wealth transfer taxes, as well as the potential for increasing healthcare costs as she gets older.
Planning items to consider
To start, Sarah should evaluate her plan for care as she ages – whether to self-insure or buy long-term care insurance coverage. Because her income is stable, in part due to her decision to continue picking up a paycheck after her initial retirement, and because she needs to draw down her inherited IRA within 10 years, cash flow is not an issue. That said, creating a cash flow plan will help her stay on track.
Sarah should consider leaving her IRA to charity, since her son is in a high tax bracket and much of her IRA would go to the IRS. If she’s inclined to do so, she could look into increasing the equity allocation in her IRA to help maximize the amount she leaves to her favorite charity. That also means it may be time to brush off her estate plan and check her beneficiary designations to ensure they are aligned with her wishes. Sarah may also consider making qualified charitable deductions QCDs from her IRA while she’s alive to minimize income taxes.
Later Retirement Larry
Larry is 73 and a widower with three adult children and six grandchildren. A former small business owner, Larry has $10 million invested in an individual account and $1 million saved in an IRA. Larry founded his own professional practice and ran it for 30 years before selling the business and retiring. With his children all married and well out of the nest, and after finally downsizing the family home following his wife’s death, Larry only spends about $100,000 every year to support his lifestyle, and he receives another $40,000 annually in Social Security benefits. Larry’s family is very close, and while each of his children followed careers to different cities, they are all in the same state. He’d love to contribute to helping put his grandkids through college. Larry hates taxes and tells his advisor, “My kids are my charity.”
Risks: Prominent risks that Larry will need to address include paying higher-than-necessary income and wealth transfer taxes.
Planning items to consider
Larry should accelerate gifting now as part of his overall wealth transfer and tax planning, since his taxable estate is projected to be above the federal unified estate tax credit. Additionally, Larry lives in a state that has a 4% death tax on assets inherited by children. One option available to him is to contribute to a 529 college savings plan for each grandchild. Every $1 million he gives to his heirs reduces the potential state death tax by $40,000, and choosing the 529 plan route also helps him meet his goal of putting aside something to cover some or all of his grandchildren’s college expenses.
In addition to revisiting his financial plan and investment strategy to ensure that it balances his legacy goals and potential future needs, Larry may consider holding equities in his non-IRA to take advantage of the step up in basis at death and to help reduce the income tax his kids will pay when inheriting his IRA.
Whether you identify most with Larry, Sarah, or Rick and Rita, consider reaching out to your financial advisor to begin discussing what resonates with your own financial life plan!
The above scenarios are hypothetical and do not reflect any actual client experience or planning needs and should only serve as a high-level overview. Individuals should reach out to a qualified professional based on their circumstances. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Partners®. This article is for general information and educational purposes only and is not intended to serve as specific financial, accounting or tax advice. The analysis contained in this article may be based upon third-party information and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the adequacy or accuracy of this article.
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