Most people know to save as much as possible while working in an effort to prepare for those golden retirement years. As you continue to save, be sure to take into account those financial risks you might encounter once youâre actually retired.
The easiest way to save for retirement is to increase and maximize your 401K or 403c contributions, according to Carol Gyton, senior vice president, Consumer Market Leader, Bank of America in Detroit. âIf you have a company match, by all means contribute enough to take advantage of the match,â she said.
Those who donât have a retirement plan through their employer should open an IRA and automatically contribute to the account. Rethink your spending as well. âEvery time you get a raise, tax refund, bonus or any funds on top of your current income, save it for retirement right away,â she said.
Eliminate debt, learn from retirees, get advice from financial experts, and be flexible. Supplement your retirement income by earning some extra money doing something fun.
Since 1900, the stock market has done really well over the long haul. However, if you break it up into five-to-10-year segments, there has actually been some pretty serious volatility (not to mention the awful, wild swings weâve seen lately). To understand how to prepare for stock market volatility as you retire, it may help by answering two key questions:
What does volatility mean to my retirement?
For the sake of argument, letâs imagine weâre sitting in a bull market and youâre retiring in five years. History has shown, however, that a bear market â a sustained loss to the stock market â will come. Thatâs why when we retire can be as important, or more important, than how much we actually save for retirement.
Focusing on strategies that avoid those bear market times is the first step in dealing with volatility; smooth out the volatility so you donât experience those large losses.
What happens if I invest in the stock market and it tanks?
Letâs say you were to invest $100,000 into the stock market. The first year you lost 30 percent. How much do you think you need to earn the following year to get back to your original $100,000 or break even? Isnât it the same 30 percent?
Nope. Itâs 42 percent. The reason is because youâre earning income on less money.
In this example, you only had $70,000 in that second year to invest rather than $100,000, so you need to earn 42 percent rather than 30 percent to get back to your original amount.
The moral: try to invest more than you think you need to, and diversify well among stocks and bonds, so youâll be better prepared for inevitable stock market drops.
Prepare for the risk of living a long time. As you think about longevity as a risk, have you considered the probability that youâll need long-term care, and the expenses of this care? Most people donât, but itâs a significant issue and the risk is only magnified with our increased chances of living longer.
The average annual costs today of nursing-home care is $83,950. In 10 years, it will be $136,746 per year â assuming only 3 percent inflation. Once you hit 65, though, the odds of needing long-term care at some point are about 70 percent.
The reality is that long-term care costs have tended to increase at a higher rate than the general cost of living. Thatâs why longevity, with the inclusion of inflation and long-term care, is a huge risk to consider during retirement. Youâll want to either have long-term care insurance or enough in savings to cover the possibility of long-term care expenses.
With the challenge of longevity in mind, the idea then, is to not only accumulate the maximum amount of wealth, but also to distribute those resources in the most tax-efficient manner so you can make it to the âbottom of the mountainâ safely. A consideration of inflation also factors in to how you distribute your resources. The average has been 2 to 3 percent per year â or higher.
This leads to the third biggest risk most often overlooked by those heading into retirement: taxes. It helps to think of your retirement money in the three ways (or buckets) it might, or might not, be taxed:
Taxable money This includes liquid accounts that are taxed on an annual basis as a result of earned dividends or recognized capital gains. They could be savings accounts, interest-earning checking accounts, stocks, bonds (other than municipal bonds) and mutual funds (other than tax-free municipal bonds).
Tax-deferred money (taxes postponed) This is where most of us accumulate wealth, outside our homes. Tax-deferred money is a great option because postponing taxes allows money to grow faster through uninterrupted compound interest. When it comes to investing with tax-deferred money â such as a traditional Individual Retirement Account or a 401(k) â the question really becomes: Do you think tax rates will be higher, the same, or lower in the future? History tells us that taxes will go up.
Tax-free money This could be municipal bonds or a municipal bond fund, It can also be in the form of a Roth IRA, where you earn a dollar, pay taxes on it, contribute and grow that money and then access it tax-free in retirement. But there is a catch: If your income exceeds $135,000 in 2018 or $135,000 in 2019 (filing single) or youâre married and file jointly and your income exceeds $199,000 in 2018 or $203,000 in 2019, you canât contribute to a Roth IRA. And even if you can contribute to a Roth IRA, there are annual limits. In 2019, the maximum you can put into a Roth IRA will be $6,000 if you are under 50 and $7,000 if you are 50 or older.
Youâll want to ensure your portfolio is diversified, from a tax standpoint, across all three of those buckets â taxable, tax-deferred and tax-free â with an emphasis on having as much as possible in that last one, the tax-free bucket.
Debra Kaszubski, vitality special writer, contributed to this report.