The biggest fear I hear from those approaching retirement is the possibility of outliving their money.
The bull market weâve experienced over the last nine years has caused many of us to forget how it felt when our 401(k)s became 201(k)s in 2008.Getty Images
Many of us have been taught that, if we stash our retirement savings into our employer 401(k) plan, weâll be fine when itâs time to retire â unfortunately, this isnât necessarily the case.
Baby boomers have seen some difficult times in the market over the last 20 years and might wonder what the next 20 have in store. In order to make the most of your savings and help efficiently generate income in a volatile market, itâs important to stay on top of your retirement accounts.
Here are two retirement killers that can be a threat to your retirement plan and how you could combat them.
1. Market Loss
The bull market weâve experienced over the last nine years has caused many of us to forget how it felt when our 401(k)s became 201(k)s in 2008.
Experiencing a large correction five years before or after your retirement date can make a huge difference in the amount of income your investment accounts can generate.1 It also will significantly decrease the amount of time these accounts can consistently distribute retirement income. Those who had retired or were planning on retiring had to go back to work or keep working to try and recover from the loss.
Market volatility has led many financial advisors and analysts to change their recommended withdrawal percentage from 4% to 2.8%,2 meaning that you could need more money than expected to generate enough income to supplement your Social Security check in retirement. Pulling money out of an account that has taken a large loss can multiply those losses even more.
Helping guard against market loss
Itâs important that your portfolio is properly diversified among different, uncorrelated asset classes. I see too many portfolios with several mutual funds that all hold the same core funds, or employees with too much of their 401(k) invested in company stock.
To help guard against a market decline, you need asset diversification and a plan in place. Your strategy should give you the ability to get out of losing asset classes and into a defensive position during a decline, or get out of the market altogether to reduce further loss.
Risk can be mitigated in a volatile market by diversifying your assets with other products outside of the market, such as fixed or index annuities, which are often used as bond alternatives.3 Â
Fixed annuities offer a specified interest rate, generally higher than what banks are offering, for a certain period of time. Because fixed and indexed annuities are protected from market risk and provide higher returns than what is available at your local bank, they do limit access to funds.
It doesnât matter how much your retirement account is worth; it matters how much you get to keep from Uncle Sam.
The vast majority of people I see have almost all of their retirement savings in tax-deferred accounts, such as 401(k)s, IRAs, or 403(b)s. When a distribution is taken out of these accounts, itâs taxed as regular income. Iâm sure you have thought to yourself that you are going to be at a lower tax rate during retirement than your working years, but this might not be the case. I rarely see people who want less income in retirement than in their working years.
Not only is it important to be diversified in your investments, but diversification among these four differently taxed accounts is important as well: taxable, tax-deferred, tax-free, and income and estate tax-free.
A taxable account would be a bank CD or non-qualified investment account that has its gains taxed each year. It is important to have some money in taxable accounts because they are liquid and good to have for emergencies.
Tax-deferred accounts are retirement accounts, as we have already discussed, as well as annuities. Distributions from these accounts will be taxed as income, but the gains or principal are not taxed on an annual basis if left in the account. Many tax-deferred accounts have IRS rules that force you to take a minimum distribution once you reach 70Âœ years old, which could cause a significant tax problem if you fail to prepare in advance.Â
Tax-free accounts, such as Roth IRAs, are one of the most underused tools for retirement income planning. They allow you to pay tax upfront and never pay tax on any gains or distributions from the account (after age 59Âœ and if held for more than five years), and they can be passed on from generation to generation with no tax liabilities. There are ways to convert your current tax-deferred accounts into Roth accounts, which might provide tax-free income for multiple generations.
Estate and income tax-free
Estate and income tax-free accounts is code for life insurance. These accounts provide tax-free benefits to the owner or beneficiary of the policy and can provide a supplemental tax-free income during retirement and a tax-free death benefit to your heirs. Generally, the premiums are paid after tax, and the gains inside the policy arenât taxed, if distributed properly.
With the current tax cuts scheduled to be reversed in 2025,4 thereâs a seven-year window to convert some of your pre-tax dollars to tax-free Roth accounts. Having the proper amount of money in each of these categories can allow you to more efficiently distribute income during retirementâputting more money in your pocket and less money in Uncle Samâs.
There are solutions and strategies to combat these retirement killers; it just takes some research and good advice to create a cure for your own plan. Speaking with a well-seasoned financial professional can help you weigh your decisions and find the investments and products that are right for your goals and objectives.
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