REWIREMENT

REWIREMENT

Rewiring The Way You Think About Retirement!

Second Edition

JAMIE P. HOPKINS

Copyright © 2021 Jamie P. Hopkins

All rights reserved.

I dedicate this book to my family. My parents who gave me opportunities to succeed in life. To my sisters that encouraged me through the years. To my wife, Kathy, who is the light in my life, and to my wonderful children that always put a smile on my face and represent hope for the future.

Contents

I. Introduction to Rewirement

II. Retirement Basics

What is Retirement?

Behavioral Biases: Getting Out of Your Own Way

Magic Retirement Savings Number

Retirement Savings Vehicles

Saving Versus Investing

Proper Insurance Coverage

Housing in Retirement

III. Retirement Risks

Don’t Risk Your Retirement

Risk of Undersaving for Retirement

Longevity Risk

Inflation Risk

Overspending Can Ruin Your Plan

Health Care Expenses

Long-Term Care Expenditures

Frailty and Old Age

Stock Market Risks

Unexpected Early Retirement

Unexpected Financial Responsibility

IV. Putting a Retirement Plan into Play

When to Begin Retirement Planning

Building a Retirement Income Plan in Ten Steps

Step 1: Evaluate Your Current Situation

Step 2: Determine Your Retirement Goals

Step 3: Estimate Your Retirement Income Needs

Step 4: Identify Your Sources of Retirement Income

Step 5: Calculate Financial Preparedness

Step 6: Develop a Strategy to Address Any Shortfalls

Step 7: Develop a Tax-Efficient Withdrawal Strategy

Step 8: Understand the Risks Facing Your Plan

Step 9: Convert Assets Into Income

Step 10: Retire and Put the Plan in Motion

V. Concluding Thoughts

VI. Index

VII. About the Author

Acknowledgements

I want to acknowledge a number of financial services professionals who have guided me, taught me and, in other cases, just helped me become a better person.

Professor David Littell, my first real mentor, who helped bring me into and guide me in the retirement planning field. Dr. Wade Pfau for all of his fantastic research on income planning.

I want to thank Sonya Dreizler and Tyrone Ross for being wonderful leaders in the financial services profession and for helping me see new perspectives.

I also want to acknowledge the editorial help and guidance in this book from John Whitham and Cameron Carlow.

FOREWORD

By Wade D. Pfau, Ph.D., CFA, RICP®

It has been my great pleasure to watch Jamie’s career blossom from being a new graduate fresh from law school into an assistant professor at the American College of Financial Services, and then quickly becoming one of the country’s leading experts and coaches on retirement income topics.

We joined the American College within a few months of one another at a time that retirement income planning was taking off as a distinct and essential part of financial planning. With the recognition that risks change in fundamental ways after retiring, it was clear that retirees need to start looking at matters differently than they had during their careers. This process of thinking differently about retirement is what Jamie has neatly captured with the idea of “rewirement.” It is what makes this book so important.

That idea of needing to think about retirement differently became clear to me when I first stumbled into financial planning from the field of economics. I had obtained access to a data set that provided financial market returns from a variety of countries extending back to 1900. I had also come across what we know today as the 4 percent rule-of-thumb for retirement spending, and I was curious how the 4 percent rule would have performed in other countries. The answer was that it did not work so well in other countries, and the basic ideas for building investment portfolios when saving for retirement do not always neatly align with the realities after retirement. There was real interest in this article, which is unusual for academics, and I quickly found a home in this newly expanding field.

When I wrote that article, I was still working as an economics professor in Japan. In Spring 2013, I was ready to return to the United States, joining the American College and meeting Jamie for the first time. He had been brought in to help Professor Dave Littell develop the Retirement Income Certified Professional (RICP) designation for financial advisors, which helped make the American College the go-to source for information on retirement topics. The American College pioneered the RICP designation for financial advisors with its rollout in 2012. It provides fair and comprehensive coverage to the different schools of thought and philosophies about retirement income planning. It takes a broad view and is not wedded to just one approach.

This agnostic approach continues today with my work at RetirementResearcher.com. I was part of an effort to develop the Retirement Income Style Awareness™, which helps participants understand their own underlying preferences about retirement income regarding tradeoffs between contractual protections and the potential for growth, commitment and optionality, growth and income, and so forth.

It continues for Jamie as well, as he expanded the reach of the RICP, was instrumental in helping to grow and transition the Funding Longevity Task Force into the Academy of Home Equity in Financial Planning at the University of Illinois, and now through his role as Managing Director of Carson Coaching.

In Rewirement, Jamie shares many important insights. As just a few examples, readers will take away an understanding that half of the population lives longer than life expectancy numbers indicate; sequence of returns risk in retirement means you cannot rely on average portfolio returns, though stocks can still play an important role; even low inflation rates can have a large impact over retirement; housing wealth is too important for many retirees to ignore in their planning; it is worth putting some thought into Medicare and Social Security choices; and tools like annuities and reverse mortgages can make more sense once the full range of retirement risks is fully understood.

You will come away from this book with a much better understanding of how to rewire the way you think about retirement. Retirement requires different thinking. Strategies that may not make sense when viewed from an accumulation mindset can suddenly show their value in a broader retirement framework. This is especially important today as a global pandemic threw so many plans for a loop and as low interest rates continue to hamper the growth potential for retirement portfolios. Jamie describes the basics of retirement, the various risks you need to manage, and the step-by-step approach to building a retirement income plan. His Rewirement Alerts highlight some of the key insights about this process, leaving readers better prepared to make the most of this wonderful phase in life.

I hope you will enjoy and learn much from Rewirement.

Dr. Wade D. Pfau is the Retirement Income Certified Professional Program Director at The American College of Financial Services and the founder of RetirementResearcher.com.

Preface

When I set out to write the first edition of Rewirement in 2018, I had one simple goal in mind: Get more people to think differently about retirement income planning. As a lifelong student of the retirement income planning profession, I continue to learn and refine the planning techniques. As you will hear from me in this book, planning is dynamic; it must give us a blueprint for success but at the same time be flexible enough to bend or change course.

Well, fast forward to 2021 and the world has seen plenty of changes. 2020 was a hard year for many. We saw volatility in the markets like never before, a global pandemic, loss of life, tremendous government spending, and numerous tax changes that impacted retirement planning. It was due to these changes that I knew an update to the book was needed. There is new behavioral research; new tax laws, including the SECURE Act, which was the largest change to retirement planning legislation in almost two decades; and a global pandemic that has reshaped some aspects of retirement income planning.

Rewirement was my first real book, a place where I could put down my own thoughts on income planning, behavioral finance, and financial literacy. Since I originally wrote this book, my world view has expanded, and the second edition reflects this broader view of income planning and behavioral finance. I have added timely changes based on laws and the pandemic, along with more behavioral finance research. I also added practical thought-provoking questions after each chapter as a way to further the discussion and aid you in your planning.

I don’t pretend to have all the answers, but my hope is that this book can help add value to your life or simply change the way you think about retirement planning. If it can positively impact one family, one set of lives, then in my view it is a success.

I. Introduction to Rewirement

“Retirement planning is like hitting a moving target in the wind.”

– Me

Can you visualize your retirement? Most people cannot, yet they still retire cold turkey, with no plan in place. Just answering some simple questions can drastically improve your happiness and finances in retirement, but it likely requires to you “rewire” the way you think about retirement. Rewirement is the process of changing the way you think about retirement to overcome mental and behavioral hurdles holding you back from a more financially secure future.

Rewiring your mind to improve your retirement starts with a fairly simple exercise. Before you can do any planning, you need to visualizing how you plan on spending your time in retirement. Do you know where you want to be? What you want to be doing? Whom you want at your side? Are you sinking into a faded blue beach chair on a white-sand beach while discussing your grandchildren’s latest success stories with your spouse? Or perhaps you are with your friends on the back nine of your local golf course, gearing up for an eagle putt? Once you can visualize what you want in retirement, the next important question is How will you attain these goals? Retirement planning is like hitting a moving target in the wind. Your retirement goals will continue to evolve throughout your life, while retirement tools, laws, risks, and techniques will also continue to change over time. If you want to accomplish your goals, no matter how simple or complex, you need planning.

Now let’s think about what the past few years have brought us in terms of wind. In 2020, we experienced a global pandemic due to Covid-19. The impacts were wide-ranging and have reshaped society. In some positive ways, certain technologies were adopted much faster, including video conferencing. In other ways, it will reform how information is delivered and how comfortable others feel around crowds. It has changed the way the government looks at benefits and tax cuts, and how the Fed deals with monetary policies. For individuals in retirement, it has made some more conservative with their spending and others more fearful of nursing homes, actually delaying care in some instances.

In short, many people had to shift course in 2020. For some, it was a devastating year. For others, it was a year of learning and adjusting. For me, I learned a lot about human behavior and the importance of planning. No plan should remain static forever. Planning is about providing a framework for encouraging positive decisions towards your goals.

The prolonged period of low interest rates also needs to be addressed when it comes to retirement planning. Many people want to be conservative with their investments in retirement, putting money in cash, CDs, bonds, and other fixed income sources. However, we need to be realistic on what the market pays today for fixed income. The 1980s aren’t here right now, we don’t have government bonds paying 15 percent a year and it is probably not coming in the near term. This puts pressure on investment portfolios and individuals to try and chase yield without fully understanding the implications.

Perhaps one of the single biggest misconceptions I run into, and I without a doubt will get an email about this from a reader, is that dividend-paying stocks replace fixed-income sources in retirement for income. I will be clear on this: That is not true. Do not think that fixed income sources can be replaced by dividend-paying stocks. The reality is that dividend paying stocks act like stocks, not bonds or fixed-income sources. Can dividend paying stock be a great part of a retirement plan? Of course! Should you think of them as a replacement of your bonds altogether in retirement? No! According to Morningstar Research, dividend-paying stocks tend to have a lot of risk in the form of volatility. Simply put, when dividend paying stocks cut their dividends, the stock price often drops too, creating a double impact on the individual’s portfolio.

Simply put, this is a great example of how people need to change their view on retirement income planning. Yes dividend paying stocks can be a good accumulation investment, and yes they can provide a stream of cash flow, but it presents a lot of risk and shouldn’t be viewed as pure bond or CD alternative of safe income.

If you are sailing, you cannot change the direction or the strength of the wind. In fact, you can’t control when or if the wind will change directions. But you do know that it will eventually occur. Instead, you can only change the direction of your sails. By doing this, you can either have the wind help get you to where you want to go, or you can allow the wind to blow you off course and into the rocks.

In addition to planning, you will need to overcome significant personal hurdles, misconceptions, and detrimental behavioral biases that derail you by taking proactive steps to rewire the way you think and act. You will need to set goals, save money, and understand the risks and roadblocks ahead of you. These behavioral hurdles or misconceptions can be just as dangerous as the wind. Failure to identify them or address them can spell ruin in retirement as we might overspend or be too conservative with our actions, which can leave you in line for greater harm. Often people think if they are conservative and stay on the course they will be fine. The classic “stay the course” adage. However, stay the course only works if you are still on a good course. If you were headed to the rocks due to inaction, staying the course ends in disaster. You need a positive framework, informed action, and a plan to navigate turbulent and uncertain times.

People are messy. Many of us are overconfident and underprepared to plan for our own retirement. In fact, most people are their own biggest roadblock to a financially secure and happy retirement. This is because a lot of the human aspects of decision-making and self-protection that work so wonderfully throughout our everyday lives actually backfire when it comes to retirement planning. These behavioral finance biases can cause you to make irrational financial decisions. So to help ourselves, we often need to get out of our own way. And to get out of our own way, we need to set up a plan that takes us to where we need to go—a secure and happy retirement.

Retirement is a new phase in your life, something you have not lived through before. It takes a new mindset. But, no matter how daunting the challenges are, you need to remember that you are in control—as long as you take the time to develop a comprehensive retirement plan. Research shows that those who proactively plan for retirement significantly improve their finances, retirement satisfaction, and overall happiness. An HSBC study called The Future Of Retirement showed that people with financial plans accumulate nearly 250 percent more retirement savings than those without a financial plan in place. Good planning starts with good information. In order to meet your retirement goals, you need to have accurate information so you can make informed decisions about your future. This often means overcoming misconceptions or hang-ups you might have towards a variety of financial concepts.

One way to avoid personal mistakes and improve your retirement is to automate your plan as much as possible, which will help you avoid those behavioral finance biases that can get us off course. But what you automate, and how much, depends on where you are in your work career. Those early in their career need different investment tools and strategies than those in their mid-sixties. For younger individuals, automating savings is more important than for those nearing or already in retirement. For those in retirement, automating withdrawals and investment allocations can be more important.

It is also important to acknowledge that moving from the workforce into retirement can be financially, mentally, and emotionally challenging. It presents change and a new life phase never before experienced. This move requires you to rewire the way you think about life. You must prepare yourself for the unknowns ahead and be proactive to improve your quality of life. There is power and success in planning! Research I have conducted and published in the Journal of Financial Planning shows that those who plan for retirement end up with more money and are happier in retirement. If you want less money and less happiness, then plan on not planning. But for everyone else, a retirement plan is essential for this portion of your life. In fact, part of retirement planning is all about figuring out what to do when you can no longer make decisions and take care of yourself. If you plan on retiring and living to an extended age, you will need to be able to take care of yourself. If you do not engage in retirement planning, do not expect anyone else to do it all for you. In order to have a successful and enjoyable retirement on your own terms, you need to be proactive and take charge of your planning to set yourself up for the secure future that you want.

It is no secret that the United States is on the brink of a retirement crisis. The baby boomers are retiring in droves, nearly 10,000 a day, and will continue to do so for years to come. This workforce exodus is just the tip of the retirement crisis iceberg. The baby boomers, as a group, are wholly unprepared for retirement. They do not have the financial assets needed to retire and maintain their current quality of life. Perhaps even scarier is the fact that many soon-tobe retirees have no retirement income plan in place and have not sought out the help of a professional retirement planner. The lack of planning and savings will become even more evident in future years when these already financially unprepared retirees will face tremendous expenses for their health care and long-term care. By then it will be far too late to save additional money for retirement or to plan for these risks. Instead, retirees and people approaching retirement need to understand the strategies and tools available to make their limited accumulated savings and assets stretch out over a lifetime—and to manage the risks they face along the way. The good news is that this can be done by making smarter choices with regard to Social Security, Medicare, IRAs, and taxes by being proactive and executing a comprehensive plan. Planning will improve your retirement security and prepare you for the future so you can retire on your own terms.

Remember, retirement planning is complex and can take decades of saving and coordination, so it is never too early to start planning. The sooner you start, the more likely you are to be successful in meeting your retirement goals. People who create a retirement plan tend to be more successful, worry less about their finances, and report a higher satisfaction with their lives.

There is a lot you can do on your own, but don’t be afraid to ask for help as well. Take the time to find a retirement advisor with solid credentials, like a Retirement Income Certified Professional (RICP) or a CERTIFIED FINANCIAL PLANNER (CFP). You wouldn’t trust a doctor who hasn’t had surgical training to perform surgery on you, so don’t get a financial advisor who hasn’t had retirement income training. Remember, you are in control of your retirement. As long as you make well-informed and carefully planned decisions, you can improve your retirement income security without saving even a dollar more.

This book will highlight the major risks, mental hurdles, and behavioral biases that can derail your retirement and provide a process to follow to create a well-developed plan. Whether you are just getting started in your first career, or you can see the finish line, this book can help you live a more successful financial life and will help you become better prepared for what lies ahead. Specifically, for those of you in the front half of your working career, it will discuss essential saving, investing, and planning strategies to ensure that you can grow and obtain the investment portfolio nest egg that everyone wants. For those closer to retirement, just saving isn’t enough. You need to turn your savings into a monthly paycheck. This book will provide the tools and techniques necessary for you to make more informed retirement planning decisions from this point forward, including how to turn your nest egg into sustainable retirement income.

This book will also explain some of the best investment tips, products, and retirement tools available today. Those preparing for retirement need to understand the tools available to them and how to use those tools in a systematic and efficient manner in relation to their retirement plan. For example, if you are planning for a long-term care event, the tools and techniques would likely be very different than if you are planning on purchasing a second home in retirement.

In the end, your retirement will be unique. By reading this book, you will become better informed about where to begin your own retirement plan and equipped to utilize tools and techniques tailored to your goals. Most importantly, this book will help you rewire the way you think about retirement. The reality is that most people want a financially secure future, and that is achievable, but it requires change and planning. While retirement and financial planning can be daunting, a proactive and intelligent approach can improve your life and the lives of your family members. Filled with expert tips, this book will clearly explain the various risks that can thwart a successful retirement plan. By better understanding the risks you face, you will be better able to visualize the steps you need to take to prepare yourself for retirement security!

Rewirement Mindset Questions

How well do you think you understand retirement income planning?

What was your first experience creating income from a set amount of savings?

How do you want this book to influence your life in a positive way?

II. Retirement Basics

What is Retirement?

“The trouble with retirement is that you never get a day off.”

– Abe Lemons, Basketball Coach

I love the former University of Texas Basketball head coach Abe Lemons’ quote about retirement planning. While whimsical, it also conjures feelings about how retirement takes over your life. But retirement does not mean the same thing to everyone. Even the term retirement is not easy to define. While most people view retirement as a period of time when they are no longer working and do not plan on returning to work, others continue to work in retirement.

Retirement is a time period full of various challenges and opportunities. For many, retirement offers the freedom to engage in activities that were unattainable while working, but it also means leaving behind those consistent paychecks that everyone has grown accustomed to for the past few decades. As such, life in retirement can be fundamentally different from other phases of your life. In a lot of ways, I see retirement as the time of your life when your employment is no longer the primary income source used to fund your day-to-day expenses. Instead, you are going to be your own boss, and you will need to supply the income and paychecks for yourself from savings, part-time work, Social Security, and other income sources.

Although you may no longer be employed in retirement, there is still work to be done. You need to have an actionable plan in place to turn your financial assets into a steady stream of income to meet your day-to-day expenses as well as your goals and long-term needs. Perhaps the most challenging part of retirement income planning is that you will need this income to last for an uncertain amount of time.

One way I do not see retirement is the accounting way. In accounting, an asset is counted as retired when it is completely removed from service, meaning that its useful life has passed and should be disposed due to obsolescence. I don’t know how you feel, but hopefully when you are retired you still have some useful life ahead of you.

All joking aside, it is important to note that many people do want to continue working in retirement. Some people look at retirement as an opportunity to do volunteer work, while others want to continue employment in the form of a phased retirement, a bridge job, part-time employment, or even a whole new career (a so called “encore career”). If you are someone who plans to work in retirement, that’s great! However, I also want to caution you. Many more people plan on working in retirement than actually end up working in retirement. This is important to understand, especially if part of your plan is to rely on continued employment to fund your retirement. Your company may downsize, you may become physically unable to work, or you may just change your mind. Regardless, you will still want to have sufficient savings and income sources to handle a full departure from the workforce.

The answer to when and how to retire is not definitive for each individual, either. Some people choose not to retire but are forced into retirement due to caretaking responsibilities, company downsizing, health-related issues, or other life events. Other people retire when they feel they are financially capable of meeting their lifestyle goals without continued employment. For some, retirement may begin simply due to social norms or other anchor points. Anchor points can be socially or legally created. For example, if you see your family and friends all start to retire around age sixty-two, you might feel some pressure to join them. Following others into retirement without your own plan in place can be like following them off a bridge. Maybe the water will be fine, but shouldn’t you check first? The fact is that far too many people retire prematurely—meaning they are still able to work but do not yet have sufficient funds to meet their retirement income needs. Whether or not your decision to retire is voluntary, you should first have a retirement plan in place. Before you leave the workforce, you need to understand how you are going to fund your retirement and whether you can afford to do the things you want.

I recently discussed this topic with an amazing academic, Dr. Teresa Ghilarducci from The New School for Social Research. She has researched the area of working in retirement and found that to some degree this is a fallacy. The opportunities for everyone to keep working late into life just aren’t there. Additionally, health plays a major factor in one’s ability to work, which might not hold up into your late 60s or 70s in order to stay in the workforce. while you might want to keep working, the opportunity might not be there. So, when doing planning, it is often prudent to not rely on continued income from work as part of your long-term retirement income plan. This is also why Dr. Ghilarducci has been a proponent of pension plans in order to create a paycheck of sorts in retirement.

So even the best drafted retirement plans might have to change along the way. This even goes to the fact that defining retirement for everyone can be a challenge, as it is not one neatly organized thirty-year period that looks the same on day 1 as it does on day 10,957. Retirement is a continuum of life phases. Your life at sixty-five and your life at ninety-five will undoubtedly look very different. At sixty-five, you might still be very active—playing sports, running marathons, swimming, golfing, and traveling. While it is not impossible to run a marathon at age ninety-five (Fauja Singh of India has completed a number of marathons after age ninety and even after age one hundred), most people will likely experience declining health and activity levels over time.

On a personal front, my grandfather has been an amazing retirement case study for me. He is in his mid-90s and still is playing tennis a few times every week. Honestly, he runs better than a lot of people in their 50 which, is amazing because he didn’t even pick up tennis until his 60s! But on the other hand, he has had a 30-plus year tennis career. Think about that, if you pick up a hobby or sport in your 60s you could be doing that for longer than your entire work career. That is one of those notions that shakes the framework of how I view the world. Retirement can be a long period of time, in some cases longer than you actually worked!

Another one of my favorite notions is about predicting the future. Do you want to know the single best way to predict the future? Create it! If you want something, go build it. If no one has handed you your success so far in life, don’t expect them to in retirement or at any point in the future. To have the future you want, you need to do the work, put in the effort and build what you want. Don’t let others dictate your retirement, control it by putting in the work day in and day out to create the future you want.

Rewirement Alert

Don’t think you have to adhere to traditional notions of retirement. Climb mountains, run, volunteer at a charity, or start a business. Define retirement the way you want to live!

In some ways, retirement is better defined by dividing it into three distinct phases: the early, active “go-go” years; the aging but healthy “slow-go” years; and the end-of-life “no-go” years. Many people feel fine discussing and planning for the early phases of retirement. The go-go years are often the most expensive because every day is like a Saturday. And what day of the week do you spend the most money today? For most, the answer is Saturday.

However, discussions about the late years of retirement are far more challenging. Failing health, long-term care, nursing homes, Alzheimer’s, and death all force us to look at our fears about aging and our own mortality. For some, it is far more comfortable to avoid these discussions at all costs, even if it means placing their retirement plans and financial wellbeing at greater risk of failure. In retirement planning, ignorance is not bliss; it is a risk exaggerator.

Behavioral Bias Alert

Superman Syndrome: When an individual believes they will remain healthy and active their whole life.

Avoiding the bias: No one is immune from aging, even if some are affected less harshly than others. Your retirement plan must account for the risks associated with aging (long-term care, Alzheimer’s, physical injuries, becoming a caretaker, etc.) as much of it is out of your control.

By failing to educate yourself on the risks you face in retirement, you increase the risk of future unhappiness and financial ruin. By learning about the common risks, setting up a plan, and executing it, you can maximize your happiness, your financial success, and your quality of life in retirement.

Rewirement Mindset Questions

How would you personally define the word retirement?

Do you expect to “work” in retirement?

What is your first memory of someone retired in your life?

II. Retirement Basics

Behavioral Biases: Getting Out of Your Own Way

“Investing is simple, but not easy.”

– Warren Buffett, Investor

Warren Buffett is widely regarded as one of the greatest investors and financial gurus of our time. His short but sweet quote about investing is very telling. In reality, a lot of retirement planning and investing techniques are not complex. However, that does not make it easy. Why, you ask? Well, the biggest hurdle for a financially secure and happy retirement for many people is themselves. You can even go so far as to say that you are both your own biggest risk and biggest asset in retirement. So do yourself a huge favor and get out of the way!

But how do we do this? Mostly, it’s planning ahead and recognizing our shortfalls. It’s learning, and it’s hiring others to help us when we can’t help ourselves. Rewiring the way we think about investing and financial planning is crucial. You might have heard about efficient markets and that people are generally rational. But a lot of new research in a growing field of behavioral science and, more specifically, behavioral finance shows that people are people—we are messy and don’t always make decisions in a manner that supports our best long-term interests. Remember, casinos are open all across the world and they are very busy, so people must not be that rational! Rewiring the way you act, plan, and think will help you have a more successful retirement.

A lot of our behaviors are shaped by our experience, our natural tendencies, and our awareness. Our first money memories are so important to our life. I recently discussed this topic with Dr. Brad Klontz, and one interesting takeaway was how money experiences two generations before us could be impacting our decisions today. If your grandparents felt a particular way about money, that could have informed your parents’ belief system and experiences, which now informs your decisions.

Take some time, reflect back on your first money experience. Was it a positive one? Was it built from trauma or from a place of abundance? How did your first experiences with money inform your life decisions and perhaps how you feel about money today?

The more we can reflect on our experiences and understand how we react to money, the better prepared we are to overcome behavioral or psychological hurtles around money that could negatively impact our future.

When we make decisions, we can only make them with the information that we have. So we often prioritize the newest information because it is top of mind. This can lead to irrational and narrow-minded decisions. For instance, we often make irrational decisions like valuing short-term gains over long-term gains or going to extraordinary measures to avoid losses at the expense of gains. For many of us, we are also our own favorite expert—reading, learning, and absorbing information in a manner that only supports our current view of the world. Because people also like the known and familiar, we tend to over invest in companies near us, in our home state, or in our own professional arena. This is called home bias, and has been found in the behaviors of consumers all the way through large investment fund managers. This is a problem because it can mean an investor is taking on more risk than needed to achieve their desired rate of return in their investment portfolio.

Vanguard research has found that individual consumers exhibited this home bias more than institutional investors. When you start working with an advisor, the overweight to certain investments due to home bias is generally significantly reduced. But this is just one example of a behavioral bias that can unknowingly impact your financial future. Let’s look at a few behavioral biases that can harm us as we plan for retirement.

Behavioral Bias Alert

Home bias: Selecting investments that are near you, either regionally or professionally, over investments that you may be less familiar with.

Avoiding the bias: By giving preferential treatment to investment options closer to you, more suitable options may be ignored or treated less favorably. Working with a professional financial advisor has proven to greatly reduce this behavioral risk.

First, there is the concept of anchoring, which we want to avoid. Anchoring is the irrational way we attach our thoughts and beliefs to a reference point. For example, we know others retire at age sixty-two, so we then think that is a good time to retire. This is not based on any rational review of our own finances or even the other person’s situation. We also might see a stock hit fifty dollars a share, so we think that stock is worth fifty dollars. Then, when we see it trading at twenty-five dollars, we think that is a good deal because it used to be fifty dollars. But it might not be a good deal; the twenty-five dollars probably reflects its current actual value.

So what can we do about anchoring? We can challenge our perspectives, seek other viewpoints, and search for that devil’s advocate position. Ask yourself why you are doing something or why you hold that belief. Sometimes you might just realize it’s because someone told you or you think you read it. So take the time to look it up, and do some research to see if your belief holds true. With retirement two of the biggest anchor points we need to avoid are that ages sixty-two and sixty-five are the “correct” retirement ages and that you should take Social Security as early as possible. Everyone’s retirement age is different, and Social Security, more often than not, should be claimed past sixty-two.

Behavioral Bias Alert

Anchoring: The irrational way we attach our thoughts and beliefs to a reference point.

Avoiding the bias: Your retirement plan is unique to you. When you attach your plan or beliefs to certain anchor points—like public perception, word-of-mouth, social media or unverified sources—you risk making a decision that is against your best interests. If it worked for someone else, that doesn’t necessarily mean it will work for you.

Next, many people use mental accounting as a way to separate their money into separate accounts or uses. So you might think this savings account is for vacation, and another is for credit card payments. Mental accounting is essentially a form of budgeting that allows people to assign assets to different needs. However, it is not all that logical or rational. Money is fungible. If you have two savings accounts, they are not really two separate piles of money that can only be used for two different expenses. Instead, you should try to use all your money in the most efficient manner. For instance, if you have a savings account earning 1 percent that you have mentally accounted as your vacation fund, but you have ongoing credit card debt, you should use the savings account to pay off the credit card debt. That is the rational decision.

The main way to break away from this bad financial behavior is to realize that money, regardless of its account or intended use, is still just money. Money is money. So use money in the most efficient way possible, not just how you thought you wanted to use the money.

Behavioral Bias Alert

Mental accounting: A form of budgeting where we assign assets to different needs or wants, often defying logic or rational.

Avoiding the bias: When you compartmentalize your assets, you can often lose sight of the big picture. A dollar is worth a dollar. But that dollar on a credit card is not the same as a dollar in your checking account. Your budget should consider all aspects of your money to create financial efficiency, including interest, purpose, and when you plan on using it.

We also need to avoid overreacting to short-term changes. The stock market is too volatile to be fully rational. This is because far too many people overreact to changes in the market, whether the market goes up or down. Instead, most of us should show patience and just ride out our plans.

If we have a sound investment and income plan in place, we shouldn’t have to dramatically change our investments due to market changes. So this usually means we should put our investments on autopilot. Individual investors do worse than indexed funds and target date funds because individuals overreact. Instead of buying low and selling high, individuals panic and sell when the market drops and buy when the market goes up. So if you can’t leave your investments alone, get out of your own way. Hire an investment professional to handle your investments, or pick investments like target date funds, managed accounts, or manage payout mutual funds that reallocate and manage your investments for you.

Behavioral Bias Alert

Overreaction to short-term changes: Making impromptu decisions without full consideration of the long-term effects.

Avoiding the bias: Financial planning accounts for market volatility. If you make reactionary changes amid volatility, the plan can get off track quickly. In other words, buying high and selling low is not meant to be reactionary, because if you are reacting, you’ve already missed the top or bottom of the fluctuation.

Another irrational behavior that can damage your retirement is called prospect theory. The idea is that losses have more emotional impact on us than gains do. So we are more upset by a 20 percent drop in our investments than we are happy by a 20 percent gain. This can lead to us avoiding short-term losses, payments, taxes, or other financial “pain” that might be otherwise good for us in the future. For instance, selling a stock at a loss can be a good thing, in some cases, to offset gains on other stocks; this is called tax-loss harvesting. Or it might be a good idea to pay extra taxes today in order to convert a traditional IRA to a Roth IRA. But in both of those situations we might be hesitant because it causes us to pay more or lock in a loss today, despite the fact that both could be good for our long-term financial stability. This can be hard to overcome.

It really requires a fundamental mindset change. You need to visualize the future value or benefit of the decision. As such, having a plan in place that shows the future value or benefit to your life can be helpful. The more we can visualize the future benefit, the more likely we will be able to suffer that short-term pain for a long-term gain.

Behavioral Bias Alert

Prospect theory: The understanding that losses have a greater emotional impact on an individual than gains do.

Avoiding the bias: Realizing that losses hurt more than the joy behind gains can help you make better decisions in the short-term, which will compound to long-term benefits.

Most Americans also suffer from low financial literacy and retirement planning literacy. As such, many people just do not possess the knowledge to properly plan for retirement. In these situations, it can also be hard recognize what we don’t know and to come to terms with it. In fact, there is a lot of research that shows overconfidence in one’s ability leads to bad financial and investment decisions. Overconfidence is hard to overcome alone. The reality is that the more an individual trades investments, the lower the returns become. You cannot beat the market, so just embrace it. Buy and hold. Don’t get into daily management and investment trading. Overconfidence is a great reason you should consider hiring a financial advisor.

Behavioral Bias Alert

Overconfidence: Making decisions with an assumption that you are better at making that decision than others.

Avoiding the bias: Investment managers spend 40-plus hours a week studying the markets and the investment landscape. They are professionals. You are not, and you cannot beat the market. Overconfidence in your abilities can be detrimental to your financial plan.

This is by no means a comprehensive list of the behavioral biases that we might encounter. You’ll find even more of them sprinkled throughout this book, but even then, there are hundreds of others that exist and are being studied. Many of the biases and negative behaviors can be overcome by a few different techniques. First is getting a plan in place. If we have a plan for how we will save, invest, and live in retirement, we are more likely to stick to it. Secondly, we want to automate as much as possible. Behavioral scientists have shown automation is one of the best ways to overcome our negative biases. So automate your savings, debt payments, and investment strategy. Set up automatic payroll deductions for your 401(k), have your credit card bills paid automatically, buy a house and pay the mortgage, consider whole life insurance, and pick investments that don’t need constant monitoring like mutual funds and target date funds.

Rewirement Alert

Overconfidence, risk aversion, and anchoring can lead many people down a path of financial ruin. Instead, rewire how you think about investing by automating as much as possible by hiring an advisor, using target-date funds, indexed funds, or manage investment accounts.

Rewirement Mindset Questions

What was your first experience with money?

What financial lessons would you like to pass onto your children, grandchildren or community?

What is one behavioral bias that you exhibit around money that you want to overcome or reduce the impact of on your future financial goals?

II. Retirement Basics

Magic Retirement Savings Number

“Money is numbers and numbers never end. If it takes money to be happy, your search for happiness will never end.”

– Bob Marley, Musician & Activist

One of the most popular questions I get asked is, “How much do I need to have saved for retirement?” The reality is there is no one answer to this question. Really, what we need is income in retirement.

For many people, their savings will be what supplies most of the income. So, you might hear numbers like one million or two million dollars. Realistically, the latter amount is much more money than most people need in investable assets for retirement. Nonetheless, for some, it’s not nearly enough. Perhaps you have heard that people need a multiple of ten to twenty times their current income? While these rules of thumb can be helpful in bringing attention to retirement savings, the focus cannot be on accumulating a set amount of money on a specific date, as that is not realistic or doable due to market volatility and fluctuation.

The focus of savings should really look at the individual retiree’s unique goals, needs, risks, and income sources. In order to figure out how much you need for retirement, you first need to be able to visualize retirement and come up with realistic retirement expenses. Once you can estimate your expenses, you can then start figuring out how much income you need in retirement.

But visualizing of your future self is not as easy as it seems. Studies show that the way people think about their future self is similar to how they think of other people. It’s a lot harder to save for retirement if you think of the future version of yourself as a different person.

Conversely, those who perceive a closer continuity or connection with their future selves were more likely to set money aside for their future needs. A study by the Institute for the Future found that the majority of Americans (53 percent) rarely or never think about what life will be like in thirty years. As such, these individuals are not all that likely to feel a sense of connectedness with their future self.

To find the inspiration to save, try connecting with your future self. Visualize what you want your retirement to look like. You can even use facial recognition software to see your future self. The more you can connect your current self with your future self, the more likely you are to make the best choice for both of you, not just the current you.

Behavioral Bias Alert

Separating your future self: When you think of your future self almost as though they are an entirely different person, thus making it more likely that your decisions will favor your current self.

Avoiding the bias: If you can visualize your future self and your future retirement, you are more likely to make decisions in the best interest of your future.

While savings can be a major part of retirement planning, meeting your income needs and generating a steady paycheck is really the goal for retirement income planning, not just wealth accumulation. Furthermore, you need to consider all of the assets at your disposal to meet your income needs, not just your investable assets. This means considering how you will use Social Security, your home equity, your pension, your 401(k), and your life insurance, and whether you will keep working part time in retirement.

Someone who works part time in retirement and has Social Security and a pension will often need far fewer investable assets to meet their retirement income needs than someone with the same income needs who only has Social Security and a 401(k). Remember, when saving for retirement, you should focus on all the income sources you have available to meet your retirement needs and not just your accumulated investable assets. So how much you should save is really tied to how much you want to spend in retirement.

Rewirement Alert

Remember that there is no magic retirement savings number. Far too many people get focused on retiring when they hit a specific investment amount. Instead, remember that a secure retirement is all about reliable income not a “magic” savings number.

When we are saving for retirement, we are really saving to replace our income to meet our needs at some future date. So, how much we need to save depends on our retirement expenses, how much investment returns we expect to get in retirement, and how long we expect to be retired. For those who expect to work longer, invest more aggressively (in higher-yield investments like the stock market as compared to CDs and bonds) or have a shorter retirement so you can save less. For those that start saving earlier, in their twenties as opposed to thirties or forties, you can save a much lower percentage of your income each year and still meet your retirement goals. For those that start saving in their early twenties, they might only need to save 6 percent a year if they invest aggressively. However, for those that wait until their thirties, that number might jump to around 10 to 12 percent a year. And for those that wait until their forties, you might need to save more than 25 percent of your annual income for retirement.

Retirement income expert Tom Hegna has been speaking and writing on the topic of secure income for decades and often he goes back to as simple point: happiness. Think about it, we can create vastly complex savings, investing, and tax optimizing strategies for retirement income but will that make you happy? Research has shown that those with secure income sources like Social Security, pensions, and annuities are happier in retirement. Additionally, as you age, managing a complex portfolio and income plan might become challenging or just stressful. So there is a strong argument for simplifying your planning as you get older. Annuities or other simple income techniques could create an almost auto-pilot income plan. This can help increase the longevity of your retirement income plan, add a feeling of security, and improve happiness because you know what you can spend each month.

So try visualize your future self, start saving as early as possible, automate your savings, and invest heavily in the stock market at an early age. Most importantly, while savings is crucial to a secure retirement, retirement planning is all about generating secure income streams to meet your needs.

Rewirement Mindset Questions

Are your retirement planning decisions today looking out for your future self as much as your current self?

What secure income sources will you have in retirement?

Do you think annuity income would make you happier in retirement?

II. Retirement Basics

Retirement Savings Vehicles

“A simple fact that is hard to learn is that the time to save money is when you have some.”

– Joe Moore, TV Personality

Retirement planning can start with your first job. As soon as you start making money, start putting some aside for the future. Really what you are doing is consumption smoothing. When you are earning money while working, you need to save money for when you can no longer work. For most workers, the best place to save for retirement is in a 401(k), SEP IRA, SIMPLE IRA, defined-benefit pension plan, traditional IRA, or Roth IRA. Many of these are sponsored by your employer, like a 401(k) or defined benefit plan.

I also want to point out that there has been a growing amount of bad information out there on retirement plans. I see articles and videos on social media saying that IRAs or 401(k)s are bad investments. Well, they are not investments, they are tax advantaged savings vehicles with tremendous benefits. However, it is important to remember that there is no retirement savings vehicle that was created to be an entire retirement savings and income plan. What do I mean by this? You cannot rely solely on one saving vehicle to create your retirement plan. You need think about diversifying and other ways to create long-term security, but retirement plans can and should play an important role.

The 401(k) plan has become the most popular employer-sponsored retirement planning savings vehicle. Typically 401(k)s are set up to allow employees to defer their own salary into the account on a pre-tax basis, allowing you to receive a tax deduction for what you put into the account. A 401(k) account allows for investments to grow tax deferred, meaning you don’t have to pay income taxes on these accounts and investments until the money is withdrawal later in retirement. The employer also matches some of what the employee puts into the account, and the employer’s contribution is also tax deductible, meaning the employee does not pay income tax on it until money is withdrawn from the 401(k).

For most, the single thing you must do with a 401(k) is always take full advantage of any employer-matching contribution. This means you need to defer money into your 401(k) each year. However, the percentage you must defer to take full advantage of a company matching contribution differs from plan to plan, so talk to your HR department to figure out how much you need to defer. Most people should not stop here and will need to save more than just what the match requires, as it is often between 6 to 8 percent of your income, not enough to save for a financially secure retirement. Also, remember that the 401(k) is really just a tax-advantaged savings account; you also need to invest inside of it. So pick investments that offer you a good opportunity to grow your wealth for retirement. Again, if you feel uncomfortable with doing this, hire an advisor or pick a target date fund that matches the year you might retire.

Your employer might also offer a Roth 401(k). This is still just a traditional 401(k) profit-sharing plan, but with the ability to defer some of your compensation on an after-tax basis into the Roth account. The salary deferral can still trigger any company matching, however, the match will go into a traditional tax-deferred account – not the Roth account. So, if you put in $10,000 into a Roth 401(k) account, your company can match it, but that would go into a tax-deferred account on a pre-tax basis. Roth 401(k)s are growing in popularity and it can be a good idea to mix your savings between Roth and traditional tax-deferred in order to create tax diversification with your investments.

If you are self-employed, saving for retirement is a bit different. You will need to be more proactive in setting up a tax-advantaged savings vehicle that you can put money into for retirement. Consider setting up or talking to a professional about setting up a SEP IRA or SIMPLE IRA. If you run a fairly large company, you could even consider a 401(k) or defined benefit plan, but they are much more expensive plans to run. So for most companies with fifty or fewer people, SEPs and SIMPLEs offer the best savings vehicle from a cost and time standpoint. One downside with both SEPs and SIMPLEs is that they have strict coverage rules, meaning that most employees will be covered by the plan. As such, they work best with small companies. Additionally, you often cannot save as much in a SEP or SIMPLE as you can with a 401(k). However, SEPs and SIMPLEs are cheap to maintain and run. They also have simple documents and almost no annual filing requirements.

In addition to SEPs and SIMPLEs, traditional IRAs and Roth IRAs are great retirement savings vehicles. Traditional IRAs are funded with tax-deductible contributions, and then you can pick almost any investment option you want. But IRAs have served more as a rollover vehicle rather than a savings vehicle. When you retire from work, you will likely transfer your employer savings in the 401(k) to an IRA. IRAs are great for savings and retirement, but they are subject to required minimum distributions at age 72 and have lower contribution limits compared to other retirement plans. As such, they typically can’t be your only savings vehicle.

Rewirement Alert

Just because you are using a 401(k) does not mean you cannot use a Roth IRA or traditional IRA also! Remember, depending on your income, you can save in a 401(k) at work and set up your own IRA to set aside additional money.

Most people are somewhat familiar with traditional IRAs, but fewer people are familiar or comfortable with Roth IRAs. I think Roth IRAs are a vastly underutilized retirement savings and investment vehicle. I actually blame tax professionals in part for the underutilized Roth IRA. Tax professionals often look to minimize taxes today (falling into classic behavioral finance biases). They may not realize that a Roth IRA can offer tax benefits, access to funds, ease of use, and retirement income benefits that are too attractive to ignore when compared to traditional IRAs and 401(k)s. Roth IRAs allow you to save for retirement and receive tax-free investment returns, while retaining access to your funds if and when you need them. A great bit of advice for younger savers is to use the 401(k) to get the match and then save in Roth IRAs next.

Behavioral Bias Alert

Present over future: Making decisions that will benefit you now, even if the opposite might benefit you more in the future.

Avoiding the bias: Investing in a traditional retirement account rather than a Roth account means you are lowering your tax burden now vs. when you withdraw the money. If you expect your annual retirement income to be more than you currently make each year, you should favor Roth accounts. Make sure to consider the full picture when deciding which account type is right for you.

A Roth IRA is a tax-advantaged savings vehicle designed for retirement investments. A Roth IRA is funded with after-tax contributions, meaning you do not get any tax-deduction for contributing to the account. Your contributions are then invested in an investment that you select, such as stocks, bonds, or mutual funds. Once these investments grow in value, you can receive the investment gains tax free, which is an attractive benefit of the Roth. According to the 2021 tax rules, you can invest up to $6,000 a year in a Roth IRA; if you are over age fifty, you can put an additional $1,000 into a Roth IRA for a total of $7,000. This amount can be contributed for both you and your spouse, even if only one of you is working, assuming you are filing a joint return. Setting up a Roth IRA can be accomplished rather quickly. It can be started online with companies like Vanguard or Fidelity, or initiated with a financial advisor through most large financial institutions.

While you cannot contribute to a traditional IRA after age 72, there is no age limitation on contributing to a Roth IRA, meaning you can contribute after you are age 72. Additionally, Roth IRAs can be set up for minors who have some earned income of their own. If you have a child who is working during summers, you could help them set up a Roth IRA and sock away some investments. While you do need income to contribute to a Roth, there are some limits. If you earn too much money in a particular year, you might not be allowed to contribute to a Roth IRA for that specific year. In 2021, for single filers, your ability to contribute to a Roth phases out once you hit $125,000, and completely maxes out at the $140,000 level. For those married and filing jointly, the phase-out range for Roth IRA contributions is $198,000 to $208,000. Also, you can contribute to a Roth IRA in addition to your 401(k) each year, it’s not an either-or decision. But remember if you want to save in a Roth account, Roth 401(k)s are not subject to the income limits that a Roth IRA are subject to. However, most working Americans earn under those limits and are eligible to contribute to a Roth IRA.

What are the benefits of a Roth IRA?

- Tax-Free Growth: The main benefit of a Roth IRA is that your investments grow tax free. However, you do need to meet a few conditions to receive the investment growth income tax free. First, you need to have had a Roth IRA in existence for at least five years. Second, for a tax-free and penalty-free distribution of investment gains, one of the following conditions needs to be met: reach age 59.5, death, disability, or $10,000 of qualified first-time home-buying expenses.

- Access to Funds: While tax-free growth is fantastic, there are additional benefits of a Roth IRA. One of these benefits is the easy access you have to your own contributions to the Roth IRA. For instance, if you put $5,000 dollars into a Roth IRA, invest it in stocks, and the value grows to $10,000, you can still withdraw your initial investment of $5,000 at any time without paying income taxes or penalties. This is because Roth IRA withdrawals allow you to withdraw your contributions first before having to tap into any of the investment gains. This is a great feature that does not exist with a 401(k) or traditional IRA, because withdrawals of contributions to deductible accounts typically generate income taxes owed and a penalty tax of 10 percent if the withdrawal takes place before age 59.5. This Roth IRA feature gives people more access to their own money, more liquidity, and more flexibility. In fact, a Roth IRA can serve as a type of emergency fund because you have immediate and tax-free access to your savings.

- Lower Taxes in Retirement: Roth IRAs also offer great tax savings in retirement. Because Roth IRA withdrawals of both contributions and investment gains are income-tax free when taken in retirement, they do not increase a retiree’s tax liability, tax rate, Medicare premiums, or Social Security taxes. The tax-free nature of Roth IRAs can be very beneficial.

- No RMDs: Another benefit of a Roth IRA is that the account balance is not subjected to required minimum distributions after the owner of the account reaches age 72. Most other retirement accounts, like the 401(k) and traditional IRAs, are subject to required minimum distributions. A Roth IRA means that seniors have more control over when they spend their money and are not forced to take withdrawals. This also allows the money to remain invested and to continue to grow in a tax-free vehicle for a longer period of time.

Roth IRAs offer a number of tax benefits, retirement savings opportunities, and liquidity benefits that often go underappreciated. Remember, you can still set up a Roth IRA each year by contributing before the tax return due date in April (in other words, you have until the tax deadline in 2021 to set up a 2020 Roth IRA). Don’t think it is too late to start using this valuable savings vehicle. If it all feels a bit overwhelming, find a good financial advisor who can help you set up a plan and invest for your future with a Roth IRA.

In essence, there are three ways to get money into a Roth IRA. First, you can make annual contributions to the Roth IRA. Roth IRAs have the same contribution limits as traditional IRAs. Additionally, you cannot contribute more than your taxable compensation for a year. So, if you only earn $4,000 this year, you cannot put more than $4,000 into an account. However, this is an exception for the compensation limit if you file a joint tax return. If your spouse had enough taxable compensation, you can still contribute to a Roth IRA as long as the combined contributions for both spouses are not more than the taxable compensation listed on the joint tax return.

In addition to contributing directly to a Roth IRA, money can be rolled over from a Roth account into a 401(k) or 403(b) plan. There is no limitation as to how much can be rolled over from a 401(k) or 403(b) Roth account to a Roth IRA in a given year. However, there are other limitations that could apply inside the plan that could limit your ability to roll over money while still working, as many plans do not allow for in-service distributions.

Lastly, you can get money into a Roth IRA by way of a conversion. Traditional IRAs and qualified plans can be converted into a Roth IRA. By converting a traditional IRA to a Roth IRA, any untaxed amounts that are rolled over or transferred to the Roth IRA are subject to income taxation.

To convert money to an IRA and have the taxable income included in a given year, the conversion must take place by December 31. So if you want to convert an IRA to a Roth IRA for 2021 and have that income included for 2021, the conversion must take place by December 31, 2021. However, you might not know your full tax liability for months. As such, under the previous tax laws you could essentially undo this transaction with something called a recharacterization if the conversion subjected you to unfavorable tax consequences. With a recharacterization, you could undo the transaction and not owe the income taxes on the conversion by having any converted money sent back to the original IRA or account. However, the tax reform bill at the end of 2017 removed the ability to recharacterize Roth IRA conversions.

Recharacterizations were not completely removed in the new bill, as the tax planning technique is still available for rolling out excess contributions to a Roth IRA. This is typically used if you contribute early in the year to a Roth IRA but then earn too much over the phase-out limits, thereby disqualifying you from being able to contribute to a Roth IRA for the year. As a result, you can undo the contribution without being subject to an excess contribution penalty tax by recharacterizing the contribution to an IRA. You can do the recharacterization of excess Roth IRA contributions up until your tax return date plus extensions for a year, giving you time to figure out if you hit the phase-out limit.

Rewirement Alert

Don’t be afraid of paying taxes today! Convert money from a traditional IRA to a Roth IRA when you are in a year of lower taxes. Look for those years when you lost your job, switched jobs, went part-time, or retired, as they can cause you to earn less and be in a lower income tax bracket.

Roth IRA contributions and conversions remain valuable planning options. In fact, if your tax bracket is lower than normal, you should talk to an advisor or accountant about Roth conversions as they are more valuable when you are in a lower tax rate environment.

As you might have realized, I spent a lot of time talking about Roth IRAs. This is because I think they are vastly underutilized retirement savings vehicles. Biases against paying taxes today often hold people back from taking full advantage of Roth savings. Rewire the way you think about taxes. Sometimes it can be a good idea to pay taxes today to get tax free growth like in a Roth IRA!

Rewirement Mindset Questions

What can you do to save more money into a tax advantaged retirement account?

What is and is not appealing about a Roth savings account for you?

Do you have tax diversification with your retirement savings?

II. Retirement Basics

Saving Versus Investing

“How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.”

– Robert G. Allen, Author & Investor

Setting money aside in IRAs and 401(k)s is just one part of preparing for a financially secure future. But, you need to invest this money in assets that will provide you solid returns over time. This often means taking risk.

When you set money aside or cut back expenditures after budgeting, you are saving money. However, saving money is very different than investing money. First, we need to save money so we can invest it. So Save! Save! Save! which enables you to Invest! Invest! Invest! which allows you to Spend! Spend! Spend! in retirement.

Without saving, we do not have money to invest, and without investments we won’t have the money to spend in retirement. When investing for retirement, automate as much as possible by hiring a financial advisor. Research shows that the most valuable reason to hire someone is actually to act as a less emotional third party. The financial advisor keeps you from engaging in those damaging behavioral biases when markets take a downturn. I know very few people want to hire someone else to keep them from making bad decisions, but in a lot of ways that is what you are doing. There is tremendous value in having a third party assist you in your planning.

Research also shows that the more transactions or investment trades an individual makes, the lower his or her total returns are compared to those who do not trade. So the more you mess with your own investments, the worse you make them. Consider using indexed funds, mutual funds, and managed accounts to automate your savings. While they might not be the absolute most efficient investments, they will most likely far outperform what you will do on your own.

Remember, there is a difference between investing and savings. Furthermore, speculating is entirely different. You can do some speculating with your funds but it should be limited. For instance, if you want to buy Bitcoin or another crypto-currency, this is really speculation. It is not investing in the true sense. There is no way to model or project returns. Instead, you are just speculating that the value of the asset will increase over time. Speculating can provide huge rewards but comes with great risk. As such, you should keep speculating in your portfolio to a small amount, typically between 1 and 5 percent of your assets. Really, when speculating you need to ask yourself, can you stomach the asset becoming worthless and losing all your money in it? If you can’t, then you shouldn’t be buying it. We save (set aside money) so that we can invest it! And eventually spend it in retirement!

Think of what happened in early 2021 as an example. Individual stocks like GameStop showed tremendous gains because individual investors on an online forum, Reddit, committed to buying the stock in an attempt to “short squeeze” hedge funds who betted the stock would go down in value.

Basically, these individuals banded together to hold GameStop stock and force hedge fund managers to buy the stock at much higher prices than they originally borrow and sold the same stock for at much lower prices. As the Reddit investors held, they made national headlines, which prompted more and more investors to get involved. Soon not only GameStop stock was on the rise, but other recently shorted stock, various crypto currencies and precious medals. All from internet speculation.

However, the trading became so intense that many online brokers had to pause trading because they needed capital to cover any sales. It not only froze the rising stock prices, but left many at jeopardy of losing their initial investment. Soon these individual stocks came back to earth, and those who tried to get in after the initial rise faced significant losses.

The moral of the story here is that trading individual stocks is not a retirement plan. One false move and you can lose decades worth of potential retirement savings. Again, can you handle that investment losing all or most of its value and not have it affect your retirement plan? If not, then stick to your long-term strategy!

Rewirement Mindset Questions

What is your investment philosophy?

Do you think you are a risk taker when it comes to investing?

What is the best investment you have made in your life?

II. Retirement Basics

Proper Insurance Coverage

“Fun is like life insurance, the older you get, the more it costs.”

– Frank McKinney, Journalist & Cartoonist

Saving and investing at an early age are beneficial, but all of our good work can be undone if we do not have the proper risk management tools in place. I will cover different insurance products throughout the book, but a brief discussion of having the right amount of insurance is worth the time.

While not all risk management tools are insurance products, many of the most popular and useful risk management tools are insurance products. Most people are forced to get car insurance, health insurance, and homeowner’s insurance.

Interestingly, many people will pay for insurance for things like a cell phone but not for their own life! In reality, the insurance is not really for the underlying item, but is usually to protect something else in your life. For instance, cell phone insurance is not really for the phone itself, but to help protect you against a painful and large out-of-pocket expenditure if the phone breaks. (I also do not really support insurance on most “smaller cost” electronic items – but that isn’t the focus here.) Simply put, insurance is about security and caring for others. Life insurance is about taking care of your loved ones.

Research has shown that people who believe they have the right type and amount of life insurance feel more secure about their future. Additionally, these investors tend to see more value in their advisors.

Furthermore, behavioral finance research shows that people gravitate to full insurance over partial insurance. For instance, if you could get 50 percent insurance coverage for $100 or 100 percent coverage for $200, you are likely to believe that the $200 coverage is a more appealing and better deal, even though they are the same. So keep this in mind when looking for the right type of insurance. Start with your plans and goals, then get the right insurance to protect the things you hold close.

While you may be paying for required insurance, there are two types of insurance you might not be forced to get that you should look into. You should make sure you have the right type and amount of any insurance, but with life insurance and disability insurance, you are likely to have more of an onus on yourself to go out and get the policies.

Life insurance: Life insurance is an extremely valuable risk management tool that can pull double or even triple duty with your planning. Life insurance, especially term insurance, is an extremely valuable tool to protect your family. If you have kids, a spouse, or other dependents, you should speak with a professional about life insurance. Life insurance, at its core, is really about taking care of others. It is about replacing your value, at least monetarily speaking, when you pass away to provide for someone else. If you get married, have kids, or run your own business, life insurance is a must. Nonworking spouses should not be ignored either. Often it is a good idea to get insurance on both spouses. Once you get further down your planning path, you might also want to consider a more complex life insurance product like a variable or whole life product. Permanent life insurance products can also come with a feature called cash value. Cash value can be a helpful way to build up some savings that can be accessed income-tax free at different periods throughout your life.

Disability insurance: You might have some disability insurance while working. So first thing to do is always check and see what is available. Social Security also provides disability insurance to most Americans. However, many people should consider purchasing their own individual disability insurance while working. Premiums (costs) vary significantly based on the policy, person, and area of the country. As such, it is always worth shopping around. There are both short-term and long-term disability policies available.

Probably the most important thing about insurance is talking to a professional to do an insurance review of your situation. This will include life insurance, disability, long-term care, and property and casualty insurance. One tip for everyone is once you get married and have kids, life insurance is a must! Start off by considering term insurance as it is the most affordable when you are young. Permanent insurance has a place and can help build up a tax free cash flow source in the policy’s cash value. So consider permanent insurance if you think you have a permanent life insurance need or are interested in the special tax treatment of cash value. Insurance really is about protecting you and your family. It can feel expensive, but it gets a lot more expensive if you don’t have it and need it.

Rewirement Mindset Questions

Do you view insurance as part of your investing?

Do you think you have the right types and amounts of insurance?

What is the single most important thing in your life that you believe you should have more insurance around but do not?

II. Retirement Basics

Housing in Retirement

“There is nothing like staying at home for real comfort.”

– Jane Austen, Author

Owning a home has traditionally been a sign of financial stability throughout the world. Homeowners also tend to develop a strong sentimental attachment to the home. This makes sense, we spend a lot of time there. But, this is one area where retirees need to rewire their thinking. The home is an asset and can be used to support your retirement. But it often requires the homeowner to take some affirmative action that might be uncomfortable at first, like downsizing or considering a reverse mortgage.

Housing and retirement is probably my favorite retirement planning topic. Why? Because owning a home has always been part of the American dream. It is also where you spend the majority of your time and resources. For many people, where to live in retirement is perhaps the biggest decision to make. And housing wealth is often the largest asset many Americans have by the time they retire. However, behavioral biases sneak in when it comes to housing-in-retirement decisions, often causing people to be irrational. The home represents a sentimental asset that people are often unable to part with willingly.

When buying a home, you have probably heard the widely used phrase “location, location, location.” What realtors mean by this is that identical homes may have very different prices depending on location. What this often means to home buyers is that they may have to pay more to live close to work or to be in the best school district. The right location may also mean the most potential for capital appreciation, an important consideration when the home is a long-term investment. In retirement, however, many of these considerations move to the background. In fact, retirees need a new mantra when making housing decisions, “cash flow, cash flow, cash flow.” Cash flow is king in retirement. Without it, you cannot meet your retirement income needs.

However, many people are unwilling to tap into their home equity to support their retirement. It feels like a risk to people. And if you have Social Security income, Medicare covering your medical bills, and a home, you can probably make it through retirement. But I don’t want you to just make it through retirement, I want you to thrive in retirement. This means changing the way you view the home. The home is a savings vehicle that also provides housing services. It is, though, a bad investment that generally just keeps pace with inflation. That does not mean buying a home is a bad decision, but from an investment return perspective, it’s not a good or competitive investment.

Before focusing on cash flow, the place to begin is with what people want, since that drives spending needs in retirement. The reality is that most people want to age in place. A 2017 research article published in the Journal of Financial Planning, “The Effect of Low Reverse Mortgage Literacy on Usage of Home Equity in Retirement Income Plans,” showed that the vast majority of homeowners, roughly 83 percent, wanted to age in place in their current home for as long as possible. People feel a deep emotional attachment to their homes. This emotional aspect of homeownership cannot be ignored in retirement, but it also cannot be the only consideration. In many cases, the current home is not financially or functionally appropriate for the homeowner to live in throughout retirement.

In addition to wanting to age in place, homeowners do not want to “backtrack” in retirement from owning to renting. Only 5 percent of the survey respondents in the aforementioned study indicated a desire to rent if they were to move out of their home in retirement. Once an individual owns a home, most want to keep owning a home. Home ownership evokes a real sense of achievement and is still viewed as part of the American dream. Even in today’s increasingly partisan world, homeownership remains a shared value across party lines. In a 2017 Zillow Housing Aspiration Report, roughly two-thirds of both Republicans and Democrats reported that owning a home is essential to living the American dream.

Behavioral Bias Alert

Over sentimentalism: Having an emotional attachment to an asset that prevents you from making wise decisions.

Avoiding the bias: Most commonly, people are overly sentimental about their home, which makes sense. It’s typically one of the largest assets you own, you spend a lot of time there, and often there are family ties and memories attached. But it’s also one of the biggest potential sources of income in retirement! Don’t forget that your retirement goal is cash flow!

Since most homeowners want to age in place and not rent, let’s take a look at why “cash flow, cash flow, cash flow” should replace “location, location, location” in choosing retirement housing. Cash flow can be improved in three ways: moving to free up cash flow, restricting debt obligations, or supplementing retirement income by tapping into home equity through a reverse mortgage.

The first housing strategy to improve cash flow is to move in order to free up equity or to reduce costs. Downsizing is probably the most common housing decision made in order to free up cash as many retirees are living in homes that are too large, too expensive, and not fit for senior living. Downsizing to a more economical home that allows for aging in place can be a viable strategy because it helps reduce ongoing costs and, at the same time, frees up home equity to support a more comfortable standard of living in retirement.

Closely related to downsizing is relocating. Relocating might mean moving to a more expensive house but in a less expensive area, perhaps even to a new state or country. When selling a house and relocating to a new area, it is important to look at the total cost associated with moving, including changes in taxes. Some states, like Pennsylvania, provide good tax incentives for seniors to relocate by not taxing pension and Social Security income, which can increase cash flow. However, a relocation decision needs to be carefully examined because it is almost impossible to reverse. If you sell your home and move to a new state, it is unlikely you will be able to repurchase your old home and move back if you don’t like the new area.

The second cash-flow factor for retiree housing is debt management. While freeing up cash flow and equity can be achieved through downsizing and relocating, taking strategic measures to deal with an existing mortgage can also improve a retiree’s financial situation. Every year, an increasing proportion of retirees are entering retirement with a mortgage; the required mortgage payments throughout retirement put a serious strain on cash flow. These mortgage payments can cause a substantial financial burden and risk for the retiree. To address this problem, some people try to make extra payments and prepay the mortgage several years before or early in retirement. Most research shows, however, that this is not the best way to handle a mortgage and actually can be worse for a retiree than just continuing to make normal mortgage payments throughout retirement. One option is to lower monthly payments by refinancing at a lower interest rate. Another option is to embrace the mortgage and spread out the payments over a longer period of time. While getting a longer mortgage for a retiree might seem counterintuitive, it can actually improve cash flow by lowering monthly payments and, in many cases, increase the longevity of the homeowner’s retirement portfolio.

With the home being the largest asset for many Americans, it needs to be used strategically to support a retirement, but retirees also need a place to live. While there are a variety of ways to strategically maximize your home equity, there are six main ways to tap into this equity in retirement, including downsizing, a sale-and-leaseback, a traditional home equity loan, a special-purpose loan, home sharing, and reverse mortgages. All of these strategies have different benefits and can be used to support different retirement objectives.

First, you can downsize in retirement. While it is a very emotional decision to leave your own home—especially if it is where you raised your family and lived most of your life, it can be a very good financial decision. Downsizing can help you move into a more economically affordable home. It could reduce a variety of home-related expenditures like heating, cooling, cleaning, and property taxes. Additionally, downsizing can free up home equity if you move into a cheaper home. You can now put that money to work for you by investing it or spending it to meet your retirement income needs.

Rewirement Alert

Don’t think of your home as an asset of last resort. Put your home equity to work for you early in retirement by downsizing or setting up a reverse mortgage.

If you decide you want to live in place, there are a variety of other ways to tap into your home equity without moving. You could engage in a sale-leaseback agreement. This type of agreement is often entered into with family members whereby the children buy the home, providing the parents with an influx of cash, and still allow the parents to remain in the home. There can be benefits to the children also, as they receive payments from the parents for rent and possible tax deductions.

If you do not want to move or sell your home, you could consider home sharing. This is a Golden Girls-type scenario. You can essentially rent out your home to other retirees, perhaps friends or family members. This can create an influx of cash to you, help cut down on certain expenses by sharing them, and provide companionship. If you need help, there are home-sharing companies that can help facilitate the agreements and find roommates in most states.

Another way to tap into your home equity without relocating is to engage in some type of home equity loan. There are a variety of ways you can take out a loan against your home. First, there is the traditional home equity loan. These can be useful for short-term expenditures in retirement. The downside of taking out a traditional home equity loan in retirement is that you have now just built in a new expense—the loan repayment—that must be met or you could lose your home.

Another option could be a special-purpose loan. These are not available to everyone and are very state-law specific. However, some states offer special-purpose home equity loans to be used for things like paying off property taxes or long-term care. You will need to look at your local laws to determine if these are available.

Rewirement Alert

You probably have a negative view of reverse mortgages. I implore you to change your thinking about them. Reverse mortgages are not just for cash-poor, house-rich people. They can benefit millions of retirees.

Lastly, and perhaps most importantly for retirement income planning, is the reverse mortgage option. Let me preface this by pleading with you to continue to read and not give in to your urge to skip the discussion of reverse mortgages because you have heard negative things about them. While there are risks with utilizing a reverse mortgage, if properly used, it can be one of the best features of your retirement income plan. A reverse mortgage is in some ways very simple. The lender gives you a payment in the form of a lump sum, tenure option, or line of credit. That amount is the debt that you owe the lender and will begin to grow at the applicable interest rate at the time, similar to a traditional mortgage. However, with a reverse mortgage, no payments are required while you are alive and still living in the home. Instead, the reverse mortgage continues to grow over time, essentially paying back the loan with your remaining home equity.

In the past, many people used reverse mortgages incorrectly by relying upon them as a last resort in retirement. In fact, you have probably heard people say to only use a reverse mortgage as a last resort. However, research has shown that using a reverse mortgage as a true last resort, once all other assets are gone, is the worst way to use your home equity. In many cases, this use of reverse mortgages just makes a bad situation worse—people run out of money, poorly spend the reverse mortgage payments, cannot meet their property and insurance taxes, and lose their homes. With a reverse mortgage, no mortgage, or a traditional forward mortgage, if you can’t pay your bills or taxes, you can lose your home. Instead of being used as a default, last-resort option, reverse mortgages should be used near the beginning of your retirement, either as a buffer against bad markets or as the first source of your retirement income. Research shows that these are the two most effective uses of reverse mortgages and can substantially improve your retirement security.

I see that reverse mortgages can be used in a number of ways in retirement. It can be used to help cash flow for a retiree with limited income sources, can be used as a tax efficient cash flow source because the reverse proceeds are not taxed at time of distribution, and can help someone fund Roth conversions. Additionally, a reverse mortgage can be used strategically in a coordinated withdrawal fashion with a retirement income portfolio. The idea is to utilize your home equity in down market years so to not exacerbate the spend down of your retirement assets. There is also a program called the HECM for Purchase, which allows seniors to purchase a home with a reverse mortgage. This can be good way to buy a home for a senior as they do not have to take out a traditional loan with a monthly required mortgage payments. With a HECM for Purchase, the homeowner would put down about 50 percent cash and fund the other half with the HECM for Purchase loan.

I think there are three clear situations when a homeowner should consider a reverse mortgage. First, anytime someone over age sixty-two is relocating and buying a new house. I think looking at the HECM for Purchase program in comparison to other options is prudent. It might not be the right solution, but it could be. Second, for anyone carrying a traditional mortgage into retirement, a reverse can be a good way to pay off a traditional mortgage and create flexibility in cash flow. The reverse mortgage essentially allows you to make monthly mortgage payments if you want, and in months that you don’t want to make a payment, you don’t have to. Lastly, anyone doing a systematic withdrawal strategy in retirement should at least consider home equity as asset.

Now there are more complex and coordinated strategies out there, too. For example, a reverse mortgage option can help you defer Social Security. If you need income at sixty-two when you retire but don’t want to take Social Security early, you could take a payment option from a reverse mortgage to provide you with the same amount of income. The reverse mortgage will likely be charging a rate around 4.5 percent in today’s market, while Social Security gives you guaranteed increases of 7 to 8 percent per year when you defer benefits. You can run the math. It’s fairly simple. If I can borrow at 4.5 percent and get 8 percent increases elsewhere, it works out. Now as interest rates rise, borrowing from your home equity to support Social Security deferral won’t be an effective strategy.

While many people find it mentally and emotionally difficult to use a reverse mortgage early in retirement as their primary income source, more people feel comfortable using the line of credit option as a protection against bad market returns. The idea is somewhat simple. At age sixty-two, you can set up a line of credit. At this point, you have not withdrawn anything from your home equity so the loan does not continue to grow. However, your line of credit will continue to grow. If the market suffers a bad year, and your investments plummet, you can take an immediate withdrawal from the line of credit, avoiding a large withdrawal from your investments when they are at a low point. This can significantly improve your retirement income security. In fact, if the market rebounds in a year or two, you can always repay your reverse mortgage (the amount you borrowed from the line of credit plus interest) and still keep the line of credit open. Using your home equity strategically early in retirement through a reverse mortgage can help you defer Social Security and avoid withdrawals from your investments in bad markets.

The best use of home equity and a reverse mortgage line of credit is to diversify your home equity. While you might think your home was a great investment—and it might have been—most U.S. homes only keep pace with inflation and offer no other real investment growth. Furthermore, your home is a very illiquid asset, as it can take months to sell, with a lot of your savings and wealth tied into it. This is an amazing phenomenon—that most people put their money in an illiquid and low-growth asset. However, if you use a reverse mortgage line of credit, you have now diversified your home equity into your house and a line of credit. The line of credit really creates liquidity in your home value at a very low cost. You don’t have to use it if you don’t need it. Borrowing always comes with a cost, and you will usually want to avoid debt if at all possible. But once you have your reverse mortgage line of credit set up, you can use your home equity to support your spending and income needs—especially if a market crash occurs as it did in 2008 and 2020 (April to May). Would you rather borrow at 4.5 percent from your line of credit for a year or sell when your stocks just crashed downward of 40 percent? The math again is simple. All you are doing is avoiding losses by using your assets to generate income in the most efficient manner possible.

Your home is a great source of pride and financial savings. Do not let your home just sit through your retirement without putting it to work for you. Whether you want to relocate or age in place, your home can be one of your most strategic retirement income assets, allowing you to reduce market risk, reduce longevity risk, and improve your overall retirement income security. Break that bias and think about the home as a strategic asset. Put your home equity to work for you, not the other way around.

Rewirement Mindset Questions

Have you thought about where you want to live in retirement?

Do you want to use home equity to be an income source in retirement?

What are two things that are appealing about reverse mortgages?

III. Retirement Risks

Don’t Risk Your Retirement

“People need to understand the psychology of risk more than the mathematics of risk.”

– Paul Gibbons, Economist

A secure retirement income plan really starts by ensuring that your income needs and retirement goals can be achieved. During this process, you need to account for all of the pitfalls and roadblocks that could derail an otherwise well-developed plan. While it may be incredibly daunting to evaluate every risk you could face in retirement, it must be done. By ignoring even one major risk, you could completely undermine your plan, leaving you without sufficient income to retire with financial independence and dignity.

To aid your planning, you need to have at least a basic grasp of the risks you could face in retirement and be aware that you can beat back these risks with proper planning. However, the solutions offered will not necessarily fit into every plan, nor will they always be suitable for your specific situation. You need to personalize the risks and reevaluate how they impact your unique circumstances and plan. The most important part of reviewing risks is to show that active planning can help, which can assist you in getting over that mental block that you can’t do anything to improve your situation.

Behavioral Bias Alert

Decision paralysis: Delaying, over-analyzing or not making a decision altogether even when it leads to a better outcome.

Avoiding the bias: Often we can underthink or overthink our decisions. Both can create an inability to make decisions that can lead to better outcomes. Decision paralysis, or analysis paralysis, is an insidious enemy to our future financial security as it leaves us unguarded and unprepared. Remember, an object not in motion will not move unless something moves it—whether that is you or an outside force.

In addition to personalizing, you will also need to prioritize the risks. For example, if you have a history of health conditions, then your health-care risk will be higher than that of some other retirees. As such, you would want to focus on making the correct Medicare coverage decisions and properly utilizing tax-preferred savings vehicles like health savings accounts (HSAs), which can help fund your out-of-pocket medical costs in retirement. If, on the other hand, you are more worried about how long people live in your family and about ultimately outliving your money, then you would be more interested in deferring Social Security benefits and purchasing longevity insurance.

Ultimately, a good retirement income plan will prioritize and then address your risks. However, before you can do this, you first need to understand the risks unique to your situation.

Remember, we only get one shot at retirement, so we need to get it right the first time.

Rewirement Mindset Questions

Do you make decisions easily or do you get overwhelmed and struggle to move forward?

What is the process you go through before making a decision?

Who do you rely on for guidance or ideas when you have a big decision to make in life?

III. Retirement Risks

Risk of Undersaving for Retirement

“The question isn’t at what age I want to retire, it’s at what income.”

– George Foreman, Boxer

The Baby Boomer Generation is facing a massive retirement savings and income shortfall. A large part of the issue is due to a lack of savings and a lack of good overall retirement income planning. The good news is, even if you haven’t saved enough to meet all your needs, you can still significantly improve your retirement security by setting out a retirement income plan and by making good decisions now.

If you are still a good number of years from retirement, you have time to save up money and improve your situation. The earlier you start saving the better off you will be for retirement, as this gives your investments and money time to grow. Consider saving 10 percent of your salary for retirement. Also, make sure you roll over your employer-sponsored retirement accounts when you switch jobs, even if the amounts do not seem like much.

Unfortunately, as you start to near retirement, increased savings will have little impact. Instead, you will need to focus on other areas of your planning, such as making good Social Security decisions, selecting the correct employer-sponsored plan-distribution option, avoiding early retirement, maximizing home equity, and taking advantage of some of the numerous tax benefits available for retirement planning.

While additional savings can never hurt, staying employed and continuing to work can have a much bigger impact for those nearing retirement. Consider using your vacation days and spending some money in the last few years before retirement to avoid burnout. If you can avoid retiring early, or if you can continue to work for a year or two more than planned, this will improve your retirement security far more than simply saving a few thousand dollars one year before retirement.

For those who still have time to save, make sure you take advantage of contributions to your 401(k). If your 401(k) allows for salary deferrals, consider putting money aside for retirement. These contributions will be tax deductible, meaning you can defer taxes and the taxes on any investment growth inside your 401(k) until you take a distribution from the account. However, there are more things to consider. If your employer offers a matching contribution, make sure you are deferring enough of your salary to get the full employer match. Not taking advantage of the match is akin to leaving free money on the table. Also, pay attention to the investment options you choose inside of the 401(k), and do not be too conservative. Many people fear market risk, but you need to be invested in equities to generate good returns in your 401(k).

In addition to employer-sponsored retirement plans, you can always create your own retirement plan with either a traditional or Roth IRA. You can put money into a traditional IRA in three different ways. First, you can roll over another account like your 401(k) balance into an IRA.

Second, you can make a deductible IRA contribution. A deductible IRA contribution is limited to $6,000 in 2021 (an indexed number that can change from year to year—you will see a number of these indexed numbers in the book—we will note them, but you will need to check the current year numbers before making any planning decisions), plus an additional $1,000 for those ages fifty and over. However, your ability to make a deductible IRA contribution is determined by your status as an active participant in an employer-sponsored retirement plan, your adjusted gross income, and your filing status. As such, if you participate in a 401(k) and earn too much money, you cannot make a deductible IRA contribution.

The third way to put money away in a traditional IRA is to make a nondeductible IRA contribution that is subject to the same contribution limits. Anyone who has earned income can make a contribution. While a nondeductible contribution will not help you reduce this year’s taxes, there is still a benefit to making the contribution, because any growth on the investments will be tax deferred. You can make a nondeductible contribution every year that you have earned income, regardless of age. Previously you could not make a contribution to an IRA after age 70.5, but the SECURE Act of 2019 eliminated this restriction, which means you can save in your IRA or a spousal IRA if one spouse keeps working and has earned income past age 70.5. However, there is an offset rule that could reduce the effectiveness of qualified charitable distributions (QCDs) if you deduct IRA contributions past age 70.5. We discuss this charitable giving technique later in the book.

Rewirement Alert

Too many self-employed people think it’s too complicated or costly to set up their own retirement plan. In fact, the government created the SIMPLE IRA and SEP IRA for small business owners. These can be set up with little out of pocket cost and have minimal ongoing plan reporting and maintenance requirements. Consider using a SEP to shelter more of your income than you could each year in a traditional IRA or Roth IRA.

Another option to help you build your own retirement income savings plan is to use a Roth IRA. A Roth IRA offers different tax advantages than a traditional IRA. A traditional IRA is all about deferring taxes into the future. As such, the government requires you to start taking distributions after age 72 so that it can get some taxes from you. However, a Roth IRA is all about paying taxes upfront and allowing tax-free distributions later on in life. As such, there are no required minimum distributions from the account after age 72 because you will not owe the government any additional taxes. A Roth IRA can be a powerful planning vehicle. Similar to a traditional IRA, there are three main ways in which you can get money into a Roth IRA. First, you can roll over money from a qualified plan or another Roth IRA into the Roth IRA. A rollover can be a good way to move Roth savings or after-tax employee contributions in a 401(k) out of an employer-sponsored plan.

Secondly, you can make annual contributions of $6,000 and the additional $1,000 after age fifty. As long as you have qualifying income, you can continue to make Roth IRA contributions. All Roth IRA contributions are after tax and nondeductible. You pay taxes on your income and put it into a Roth IRA. The tax benefit is that all income you generate from your investments comes out tax free, if you meet certain trigger and holding-period requirements.

Remember that, before age 59.5, there is a 10 percent penalty tax, often referred to as the 72(t) penalty tax, on distributions from your tax-advantaged retirement accounts, such as your 401(k) and IRAs. While there are a variety of exceptions to this 10 percent tax, be sure to consult a tax expert before taking any withdrawals from your tax-advantaged retirement plans, because the exceptions to the 10 percent tax are different for IRAs than they are for 401(k)s and other accounts. For instance, you can avoid the 10 percent tax on a distribution from an IRA for college education costs or $10,000 for first-time home-buying expenses. However, these exceptions do not apply to 401(k) distributions.

In order to withdrawal Roth IRA investment gains tax free, you need to keep investments in a Roth IRA for five years from the start of your first Roth IRA account, and also you must hit age 59.5, die, become disabled, or be using a Roth IRA withdrawal for first-time home-buying expenses. However, you will still be able to access your retirement contributions without the 10 percent 72(t) penalty tax or ordinary income taxes. So, your money is your money in a Roth, but investment growth might be taxed if you don’t wait long enough.

Rewirement Alert

Your money is fungible. Roth IRAs and 401(k) loans can serve as good ways to access money to pay for emergency expenses without being subject to penalty taxes. Think about your financial situation as a whole and don’t get stuck into mental accounting when you can use funds to reduce high interest debt or other detrimental financial burdens.

Third, you can convert money from a qualified retirement plan or IRA into a Roth IRA. Conversions can be incredibly powerful retirement planning tools. In fact, you can improve your retirement security and have more money for retirement—without saving a single dollar more—just by doing conversions at the right time.

While we briefly mentioned Roth conversions earlier on, let’s take a look at how it works. First, you need to have money in an account that you can convert. Savings in an IRA can always be converted to a Roth, and so can distributions from a qualified retirement plan. When you engage in a Roth conversion, the money you are converting from the IRA or qualified plan is treated as income. You then pay income taxes on that amount as if it were ordinary income. However, you are not subject to the 10 percent early-withdrawal penalty tax even if you do this before age 59.5. The money then goes into a Roth IRA and can grow income tax free. There are no age limits or income limits to a Roth conversion, which means anyone can do it!

While Roth conversions are not only about taxes, the tax-savings elements are often the driving factor. Because you have to pay taxes on what you were hoping were tax-deferred savings in an IRA or employer-sponsored plan, there is a painful aspect of a conversion. Many people do not like the idea of paying increased taxes today. In fact, some accountants will steer you away from Roth IRAs and conversions altogether, not fully grasping the value of a conversion. For most people, a Roth IRA conversion is a good tax technique if you can pay taxes at a low rate today. For instance, if you are let go from work halfway throughout the year, it might be a good year to consider a Roth conversion because your income and marginal tax rate will likely be lower. In some cases, you will just want to do a partial conversion and take advantage of whatever range is left in your low marginal tax bracket.

Another benefit of a Roth conversion or Roth savings is tax diversification. Many people have some tax-deferred savings and some taxable savings. However, far fewer have any Roth savings. By adding some Roth savings via a conversion, you can limit the risk of rising or falling tax rates in the future and better protect your savings.

A Roth IRA is also not subject to the required minimum distributions that start for tax-deferred accounts at age 72. This enables the Roth IRA to continue to grow well past age 72 without being minimized by RMDs. Additionally, any qualified distribution from the Roth IRA will not impact your income taxes. This can be very helpful later in life if you are trying to keep the taxation of your Social Security benefits at a minimum.

A Roth conversion can be very helpful in getting more money into tax-advantaged savings. The reason is that you can pay the taxes on the converted money from an outside account and often should do this if possible. This allows you to roll over the full amount from the converted account into the Roth IRA. This essentially works as a massive Roth IRA contribution. If you had a $100,000 IRA and converted it to a Roth IRA at a 25 percent tax bracket, you would expect to have a $75,000 Roth IRA. However, you can roll over the full $100,000 to the Roth IRA and pay the taxes from your bank account. That essentially allows you to make a $25,000 Roth IRA contribution for that year by paying the rollover taxes from outside funds. This can help someone with a lot of money saved in the bank get that money into a tax-advantaged savings vehicle.

A Roth IRA conversion can also create peace of mind for a retiree. When you have $500,000 in a 401(k) or IRA, the government owns part of it and part of any future earnings. Furthermore, it is hard to tell how much the government really owns because you don’t know what the future taxes on it will be. However, with a Roth IRA, you own the whole account, so if you see a balance of $500,000, you can rest assured that you own 100 percent of that account and do not have to share it with the government in the future. You have already paid your taxes on this account. The removal of uncertain future taxes can be a nice benefit to increase your peace of mind when planning for retirement.

A Roth conversion can be used as a back-door way to contribute to a Roth IRA. You cannot contribute directly to a Roth IRA if you make too much money. However, you can always make a nondeductible contribution to a traditional IRA if you are generating income. Then you can convert that contribution over to a Roth IRA immediately. This is often referred to as the back-door Roth. Beware that this strategy does not work as effectively if you have tax-deferred money in an IRA, as all of your IRAs will be counted together when you do the conversion, and you will likely owe additional income taxes on the conversion. While Roth IRAs can be effectively used to increase your savings to avoid required minimum distributions and to improve your retirement security, these strategies can be difficult to properly utilize. For example, if you choose to convert to a Roth IRA at age 72, you must take your full required minimum distribution before the money is converted. A back-door Roth is not a way to get out of an RMD. You should consider speaking with a retirement specialist to best maximize the advantages of a Roth IRA.

Take full advantage of Roth IRA or Roth 401(k) savings opportunities. If I could, I would have all of my investment assets in a Roth IRA. Roth IRAs offer amazing benefits to young individuals with tax-deferred and likely tax-free growth. Ask your employer if they have a Roth 401(k) option, and take full advantage of it.

Take advantage of Roth IRA conversions. By converting money from a 401(k) or IRA into a Roth IRA early in retirement, you take back control of your money. You no longer have to be subject to required-minimum distribution rules throughout your retirement. As such, you can spend your money when you decide you want to, instead of when the government tells you. Talk to a CPA or tax professional before doing a conversion so you can take maximum advantage of tax-bracket bumping strategies and so you don’t wind up paying more taxes than you need to. I don’t like paying taxes, and I certainly don’t want to pay more than is required.

Rewirement Mindset Questions

Why might you want to pay taxes today instead of in the future?

Do you think tax rates will be higher in the future than they are today?

What is the biggest risk you worry about when it comes to taxes?

III. Retirement Risks

Longevity Risk

“The 2,000 year old man’s secrets of longevity. (1) Don’t run for a bus – there’ll always be another. (2) Never, ever touch fried food. (3) Stay out of a Ferrari or any other small Italian car. (4) Eat fruit – a nectarine, even a rotten plum is good.”

– Mel Brooks, Comedian & Film Maker

I have always been a fan of Mel Brooks’ movies, and his guide to longevity isn’t bad either. Eat well and don’t overspend on cars. Honestly, I think one of the biggest financial missteps people make is buying cars that they can’t afford.

Did your parents and grandparents live for a long time? If so, you might be worried about outliving your money in retirement. This is often referred to as longevity risk, which is really the risk of living longer than you expected to and potentially outliving your assets. While longevity risk is a common term, and I will use it in this book, remember longevity is not a risk. Longevity is actually a great thing! It means you get to live a long time. Really, longevity is a risk exacerbator. The longer you live, the more money you will need and the more impact other risks will have on your life, like inflation and public policy changes.

No one can predict with 100 percent certainty what their life span will be. This uncertainty creates serious planning issues as your retirement income plan must be built to provide income for an uncertain amount of time. The average life expectancy for someone alive at age sixty-five is eighty-four for males and eighty-six for females. But remember that an average life expectancy is really just the midpoint here. That means that about half of people will die before these ages, and half will live past the average life expectancy, so if you just plan to live to the average life expectancy, you only have a 50 percent chance of being right. This means there is a serious likelihood that you may live past the average age and need income for a longer period of time. In fact, many people underestimate their life expectancy. Nearly 25 percent of people alive at age sixty-five will live to age ninety, and 10 percent will live past age ninety-five. There is a serious risk that you might need your retirement income assets to last twenty-five, thirty, or even thirty-five years. Additionally, with advances in medical treatment, it is no longer surprising to see people live past age one hundred. If medical treatment continues to improve, this could soon become the norm.

The uncertainty of your life expectancy cannot be fully eliminated. A good plan will customize a realistic life expectancy for you, taking into consideration your health, your family’s health history, your socioeconomic status, and life expectancy tables. It is often a good idea to add a few years to the projection to build in a buffer zone to help protect against longevity risk. However, too long of a buffer zone could substantially reduce your quality of life in retirement because you earmark too many assets for a time period that you are not alive to enjoy. The buffer zone could be longer if you are a conservative, risk-averse person. However, less risk-averse people might feel comfortable with their own projected life expectancies. This does not mean that you should just pick age one hundred to be on the safe side. Remember, if you overestimate your life expectancy and decrease the amount of money you can spend while alive, you will be leaving assets unspent when you pass away. Keep in mind that an average life expectancy is just a midpoint; it means that half of the retirees will live past that age. You only have one life and one life expectancy, so make sure you are prepared to live until a very mature age.

There are many effective strategies to reduce the risk of outliving your retirement assets. One good way to protect against longevity risk is to transfer the risk. This can be accomplished through different sources of guaranteed lifetime income. First, Social Security will provide you with a lifetime income stream. This means that making the correct claiming decisions and maximizing the lifetime value of your Social Security benefits are crucial. To help protect against longevity risk, it is often advised that you defer claiming Social Security benefits as long as you continue to be eligible for a benefit increase, which is age seventy. By deferring benefits, you will receive a larger monthly benefit for life, and the longer you live, the more valuable this benefit will be for your retirement. So don’t fall into the trap of taking Social Security as soon as possible. Instead, figure out your life expectancy. If you think it is likely you’ll live for a long time, consider deferring your benefits.

Another option would be to select a life annuity form of distribution from your employer-sponsored retirement plan. This would also help provide you with a guaranteed source of lifetime income that would continue payments no matter how long you live. Far too many people take the lump-sum distribution option from their employer-sponsored plans. In fact, the annuity options offered inside of your 401(k) or defined benefit plans might be far superior to anything that you could purchase on the open market. Additionally, annuities are insurance products that are often specifically designed to make lifetime payments. As such, the longer you live, the more payments you get. Review your distribution options, and make sure you are making the correct decision.

To reduce the risk of running out of money in retirement, consider deferring Social Security benefits to age seventy, pick the annuity distribution option from your 401(k) plan instead of a lump sum, buy a deferred annuity, and add a few buffer years to your projected life expectancy when planning how long your retirement will last.

Rewirement Alert

Most people underestimate their own life expectancy. Don’t plan on dying young, but prepare for it. Plan on living a long time and build a plan that supports it. Also, remember that 50 percent of people live past an average life expectancy!

If your employer does not offer a life annuity distribution option, or if you decide you want the lump sum for control, you could purchase a life annuity on the open market to provide you with lifetime income. Additionally, you could consider longevity insurance, a deferred annuity that annuitizes and begins to pay monthly income payments at a future date, say at age eighty-five.

A type of longevity insurance called a qualified longevity annuity contract (QLAC) can be held inside your IRA, allowing you to purchase deferred income and not be subject to required minimum distributions up to age eighty-five. There are limitations on how much QLAC you can purchase inside your IRA, as the value of the QLAC is excluded from required minimum distributions that start at age 72. This annuity can be coupled with your other income streams to make sure you maintain your purchasing power and income needs if you begin to outlive your other assets. The downside is that many of these lifetime income products end when you die. However, you can purchase lifetime income annuities that either continue for the life of your spouse or another third party or provide a return of your premiums upon your death. Such options are add-ons and will make the annuity more expensive and reduce the amount of monthly income you will receive.

Lifetime annuities are perfectly designed to address longevity in a way that is unlike any other financial product or strategy. However, annuities can be complex and not all are designed to maximize lifetime income. While annuities can be used for a number of different investment and risk management purposes, the existence of mortality credits in lifetime income annuities give them strategic advantages when looking to deal with running out of money due to longevity risk.

A reverse mortgage can also reduce longevity risk, as it offers a tenure payment option. Essentially, this distribution will pay you monthly payments for as long as you live in the house. The concern would be if you live for a long time and eventually need long-term care in a facility. Since you are no longer living in the house, the monthly payments would cease. Reverse mortgages can be an effective retirement income tool to help reduce the risk of outliving one’s money. In addition to a tenure option, reverse mortgages can be used to create income as a bridge early in retirement to help defer Social Security benefits, reduce sequence of returns risk, and to help with Roth conversions.

Reverse mortgages and annuities can be powerful tools. However, both suffer from lower than expected uptake due, in part, to some behavioral biases that hinder people from adopting the products. People like control of their money and assets. As such, people are often hesitant with any strategy that is perceived as giving up control. Additionally, the products can be complex. This complexity can lead to misinformation. I don’t think there is a more misunderstood product in existence than reverse mortgages. Consumers and regulators alike do not understand the product. This lack of understanding also inhibits usage. Lastly, the home is about the last great vestibule of wealth for many in retirement. As such, people cling to it and hold onto it, despite the fact it might not be a good financial decision.

Behavioral Bias Alert

Lost control: Turning away a better option to maintain full control of your money or assets.

Avoiding the bias: Remember that the goal of retirement is to meet your retirement income needs, not just to have a large savings in place. Guaranteed income sources like annuities or reverse mortgages have negative perceptions, but can be incredibly valuable tools when needed.

There are also minor planning changes you can make to generate more income, especially early in retirement. If you decide to engage in a systematic withdrawal strategy, discussed in detail later on, you could lower your withdrawal amount to make your investment portfolio last for a longer period of time. For example, if you plan on taking out 6 percent of your investments each year to live on in retirement, you could drop that number to 5 percent in order to make the assets last longer. In fact, a reduction in spending and your withdrawals for just a few years early in retirement can have a big impact on the longevity of your portfolio.

Additionally, you would also take a distribution as a percentage of the account every year. For example, you could withdraw 5 percent of your account balances each year and you would never run out of money. However, your withdrawals would not be consistent and there is no guarantee that you would have enough money to meet your expenses each year. Extending the life of your retirement portfolio to help make sure you don’t run out of money starts with reducing your spending and reducing portfolio withdrawals in down markets. Ultimately, picking a sustainable distribution strategy is crucial.

Lastly, you could create a contingency fund and set aside money specifically for later in retirement. A Roth IRA can be a good place to keep your contingency fund as it will grow tax free and not be subject to required minimum distributions. Additionally, if you don’t end up needing the money, a Roth IRA serves as an efficient estate-planning vehicle, as your heirs can inherit the account and take distributions from it without having to worry about income taxes. Using Roth IRAs for estate planning became even more important after the passing of the SECURE Act in 2019, which requires most retirement accounts inherited by a non-spouse to be withdrawn within 10 years. These requirements apply to Roth accounts, but your heirs won’t have the major tax hit that comes tax-deferred accounts like traditional IRAs.

Making sure you don’t run out of money in retirement is not easy. The uncertain timeframe creates challenges. However, you can address these challenges by making smart decisions with your money. Don’t be afraid to defer Social Security, use annuities, and reduce your withdrawals to make your money last longer!

Rewirement Mindset Questions

Do you know anyone that lived past 100?

How are you going to deal with making your savings last a lifetime?

Do you consider the life expectancy of you and your spouse when planning for longevity risk in retirement?

III. Retirement Risks

Inflation Risk

“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.”

– Ronald Reagan, President

My grandfather always reminds me that a hamburger used to cost him only ten cents when he was young and not the few dollars it costs today. While this is a familiar story to many, the hidden lesson is the impact of inflation over a lifetime.

While inflation typically only slightly increases the cost of goods and services from year to year, it represents a serious risk and challenge for retirement income planning, as its impact is magnified over an extended period. For example, if an item costs one dollar today, after one year of 5 percent inflation, it would cost $1.05. However, after ten years of 5 percent inflation, that one-dollar item would cost nearly $1.63. The impact of inflation is often referred to as a decline in purchasing power, as one dollar will not buy as much in ten years as it does today. If a retirement income plan does not take into account inflation and the potential decline of purchasing power, it could meet your needs early on but fail to meet those needs ten to fifteen years down the road. However, there are strategies that can be leveraged to better insulate a retirement income plan against inflation.

The average U.S. inflation rate from 1913 to 2013 was a mere 3.22 percent. However, international rates over this time were much higher. Furthermore, inflation rates in the United States have varied drastically over this period, with the highest thirty-year average being 5.44 percent and the lowest thirty-year average being 0.78 percent. While the cumulative impact of an average annual inflation between 0.78 percent and 5.55 percent over thirty years is huge, the United States has managed to avoid prolonged periods of hyperinflation over the past century, an issue that has plagued other countries like Brazil, which experienced annual inflation in 1990 of 30,377 percent. (And no, that is not a typo!) Hyperinflation can have a tremendous impact on retirees, rapidly evaporating their purchasing power and leaving them without sufficient retirement income to meet their required expenses. While it is difficult to protect against hyperinflation because it would cause widespread shock to the entire financial system, inflation must be accounted for when planning for retirement.

Rewirement Alert

Don’t underestimate the power of inflation. Even average inflation of roughly 3.5 percent per year will double your expenses over the course of retirement. So make sure you use an appropriate inflation projection when determining your expenses throughout retirement.

Just as inflation varies from country to country, inflation will also vary from state to state and across goods and services. For example, the cost of medical care over the last ten years has risen at a significantly faster rate than average inflation, while food and clothing costs have risen at a slower rate. This distinction is incredibly important because retirees often spend more of their income on health care and living expenses, two areas that have seen higher than average annual inflation. To account for this retiree demographic inflation difference, an experimental inflation price index, the CPI-E, was created to monitor the impact of inflation on goods and services for the elderly.

Certain retirement income sources are better protected against inflation than others. For example, Social Security has an annual cost-of-living adjustment based on the consumer price index (CPI). This allows Social Security benefits to remain relatively immune to inflation. However, there have been proposed amendments to the current system to allow for cost-of-living adjustments based on the CPI-E index instead of the CPI, which would better protect retirees from inflation on items that directly reflect their spending habits. Delaying Social Security as long as possible is also a good way to protect against inflation risk because, as benefits increase up to age seventy, a larger percentage of an individual’s retirement income plan will be inflation protected. Consider using up your non-inflation adjusted retirement assets first and deferring Social Security as long as possible to ensure that more of your retirement income is inflation protected.

Many financial products also offer an option to purchase inflation protection. For example, annuities often allow you to either purchase a set inflation increase in benefits—for example, 5 percent per year—or allow inflation protection based on an index, like the CPI. Long-term care insurance also offers inflation protection to ensure the benefits do not lose their purchasing power over a long retirement. However, purchasing too much inflation protection can create an added cost that can end up reducing the total returns on the insurance or investment product for the retiree.

One of the best ways to reduce the potential risk of decline in purchasing power in retirement due to inflation is to delay retirement as long as possible by continuing to work. Salaries typically adjust quickly due to high levels of inflation, and many jobs offer annual increases in pay to adjust for changes in the cost of living. If you are in a defined benefit plan, working as long as possible can help protect your benefits, since they are often tied to your average highest three years of salary. You could potentially see a significant increase in benefits if inflation rises and your salary adjusts accordingly. Profit sharing and 401(k) account benefits will not adjust as rapidly if inflation increases during the last few years of employment.

Additionally, bonds, CDs and other “safe” investments that guarantee a certain level of return can be significantly impacted by inflation. For example, if a bond offers 3.5 percent annual returns nominally, but inflation is 4 percent per year, the bond’s real interest rate is actually negative because the returns are not keeping up with inflation, resulting in a decline in purchasing power. Additionally, in recent years bond rates have been historically low, increasing the risk that inflation could erode the purchasing power of the investment over time.

Bonds used to provide two main benefits: a positive inflation adjusted return and diversification from market returns. Today, the return is all but gone with real rates in 2021 for government bonds at essentially negative across the board. However, in 2020 bonds were still a strong investment diversification vehicle. If you want more return, you could increase risk by taking less highly rated municipal and corporate or international bonds or by extending duration. However, if you are looking for inflation protection, the government does offer Treasury Inflation-Protected Securities (TIPS), which are CPI-adjusted bonds designed to keep pace with inflation. TIPS can be used to create an inflation-protected retirement income plan. Inflation remains one of the great retirement risks, so having a plan to deal with it is important.

There are also benefits of investing in bond funds because they can produce better long-term returns than individual bond ladders. However, one downside is that they can drop in value, whereas if you let a bond mature, you know how much you are getting at that time. Bond funds tend to recover fairly quickly from drops overall, but if you need income in a one- or two-year span, you could be taking risk that the bond fund will be less than you need if the value drops and you have to liquidate it.

Equities are often mentioned as the investor’s most reliable hedge against inflation. Historically, equities have performed well over long periods of time, such as a thirty-year period, when compared to inflation. However, the performance of equities as a hedge against inflation begins to suffer when inflation exceeds 5 percent. Even in times of high inflation, equities still tend to perform better than traditional bonds as inflation protection. While equities are not a perfect hedge against high short-term inflation, over the long run a well-diversified stock portfolio that includes consideration of international stocks can provide inflation protection.

Rewirement Alert

Many people think it’s a safe investment choice in retirement to pull their money out of stocks and put their savings into CDs and cash. This can be a very risky strategy because cash loses money every day when there is inflation. Instead, keep a well-diversified investment portfolio and consider using TIPS (Treasury Inflation-Protected Securities) if you want a safe investment that will keep pace with inflation.

There are other options to limit inflation risk in retirement, such as investing in dividend-paying equities, investing in commodities, or purchasing inflation-linked savings bonds. I-Bonds are government-issued debt securities and are particularly well-positioned to handle inflation because they earn interest through a mix of inflation and fixed rates. However, the government does limit the amount of I-Bonds an individual can purchase.

Additionally, home prices and rental income often adjust well for inflation. Tapping into home equity during retirement or having rental income as part of one’s retirement income plan can help offset some inflation concerns.

Inflation risk has been top of mind lately as the government poured trillions of dollars into the economy in 2020. The Federal Reserve has stated they want to see a roughly 2 percent average inflation rate moving forward, which would be well below historical levels but higher than recent levels. Changes in government policies and a long-term trend towards lower levels of inflation might start to change the way people approach inflation, but we cannot forget about it when looking at long-term financial horizons like retirement.

Inflation risk and the decline of purchasing power is a serious risk for soon-to-be retirees, as future inflation rates remain unknown. As such, when planning for retirement, consider the long-term effects and the uncertainty of inflation over the expected period. For example, if someone plans to be retired for twenty years, it would be helpful to see the highest and lowest cumulative impacts of inflation rates for a twenty-year period in the United States. While inflation risk is a major concern, it can be mitigated through proper planning and by including inflation-protected investments in a retirement income plan.

Rewirement Mindset Questions

What goods or services can you think of that have had a meaningful price change in your life due to inflation?

Do you think about inflation each year?

Name two or three ways you would deal with the impact of inflation in your retirement plan?

III. Retirement Risks

Overspending Can Ruin Your Plan

“I spent a lot of money on booze, birds, and fast cars. The rest I just squandered.”

– George Best, Irish Footballer

Don’t overspend your income! We are back to the human element again. Overspending can easily undo even the best laid retirement plan. Overspending can occur for a number of reasons. Two main reasons cause people to overspend. First, the person can just lack self-control with spending. Second, the person can misunderstand how much he or she can actually spend in retirement. It is the second one that we can rewire.

Many people think if their stocks average 8 percent returns they can withdraw their average returns from their retirement portfolios and not run out of money. However, if you withdraw 8 percent per year, adjusted for inflation, you will run out of money. In fact, the safe withdrawal rate in the United States is only 4 percent for thirty years, even though the average returns are much higher. This rule says that with a 50 percent stock and 50 percent bond investment portfolio, you can only withdraw 4 percent of the portfolio each year adjusted for inflation if you do not want to run out of money in thirty years. Pay attention to the latest research on sustainable withdrawal rates, understand how the 4 percent rule works, and understand how sequence of withdrawals works. Understanding those factors will better prepare you to develop a sustainable withdrawal rate. Even a well-designed retirement income plan can be quickly ruined if you pull out too much money, especially early in retirement.

The reason you can’t spend your average returns is because of an investment risk that has huge implications for retirement income planning; it is called “sequence of returns risk.” Investment returns are unpredictable and variable from year to year. The order of returns actually has a huge impact on the sustainability of a retirement portfolio that must be spent down in order to provide income. Large drops in the value of your investments in the first few years of your retirement can significantly add to the possibility of running out of money. Withdrawing money from an account while it is down can lock in the losses, and you may never be able to recover.

Let’s take a look at a simple example here that shows the impact of sequencing of returns risk. We will look at a $500,000 investment portfolio in the S&P 500 from 2000 to 2019. We will take 6 percent ($30,000) out of the starting value at the start of each year. Comparatively, we will show the exact same returns but flipped around, starting with 2019 and counting back to 2000. What you see is that they have the same average rate of return, but one person runs out of money and the other ends up with an ending balance of $781,600. The difference between the two scenarios is $845,719.28. Remember, one was not smarter or better than the other. If you had $500,000 invested in both situations and taken no withdrawals, you’d end up with essentially the same amount of money. But with distributions, it created an entirely different outcome based on when you had good returns, early vs. late.

2000-2019 Distributions

Year

S&P Returns

Balance

Distribution

Starting Balance

$500,000

$30,000

2000

-0.091

$454,499.95

$30,000

2001

-0.1189

$374,026.90

$30,000

2002

-0.221

$267,996.96

$30,000

2003

0.2868

$306,254.48

$30,000

2004

0.1088

$306,310.97

$30,000

2005

0.0491

$289,877.84

$30,000

2006

0.1579

$300,912.55

$30,000

2007

0.0549

$285,785.65

$30,000

2008

-0.37

$161,144.96

$30,000

2009

0.2646

$165,845.92

$30,000

2010

0.1506

$156,304.31

$30,000

2011

0.0211

$128,969.33

$30,000

2012

0.16

$114,804.43

$30,000

2013

0.3239

$112,272.58

$30,000

2014

0.1369

$93,535.69

$30,000

2015

0.0138

$64,412.49

$30,000

2016

0.1193

$38,517.90

$30,000

2017

0.2183

$10,377.35

$30,000

2018

-0.0438

($18,763.17)

$30,000

2019

0.3149

($64,118.70)

$30,000

Total Time

Average Return

Ending Balance

20 years

7.6810%

($64,118.70)

2019-2000 Distributions

Year

S&P Returns

Balance

Distribution

Starting Balance

$500,000

$30,000

2019

0.3149

$618,003.00

$30,000

2018

-0.0438

$562,248.47

$30,000

2017

0.2183

$648,438.31

$30,000

2016

0.1193

$692,218.00

$30,000

2015

0.0138

$671,356.61

$30,000

2014

0.1369

$729,158.33

$30,000

2013

0.3239

$925,615.71

$30,000

2012

0.16

$1,038,914.22

$30,000

2011

0.0211

$1,030,202.31

$30,000

2010

0.1506

$1,150,832.78

$30,000

2009

0.2646

$1,417,405.14

$30,000

2008

-0.37

$874,065.24

$30,000

2007

0.0549

$890,404.42

$30,000

2006

0.1579

$996,262.27

$30,000

2005

0.0491

$1,013,705.75

$30,000

2004

0.1088

$1,090,732.94

$30,000

2003

0.2868

$1,364,951.15

$30,000

2002

-0.221

$1,039,926.94

$30,000

2001

-0.1189

$889,846.63

$30,000

2000

-0.091

$781,600.59

$30,000

Total Time

Average Return

Ending Balance

20 years

7.6810%

$781,600.59

Rewirement Alert

Most people think if they average 8 percent returns they can spend 8 percent each year. However, you need to realize this is not the case due to the sequence of returns and inflation. Bad investment returns and losses early in retirement can substantially lower how much you can spend.

You can reduce the risk of excess withdrawals due to a poor sequence of investment returns early in retirement by reducing the volatility of your investment portfolio. By diversifying your investments, you can minimize the risk of large losses in the first few years of retirement. This means picking a well-diversified set of stocks and bonds that are not correlated with one another, so if one goes up, the other goes down. This can help normalize your returns over time. Additionally, adding in foreign stocks can help reduce your volatility and increase your allowable withdrawal rate. In many cases, you will not need more than 10 percent invested in international stocks, which can usually be accomplished through a mutual fund.

Another way to generate more sustainable income is to set aside cash, bonds, an annuity, or home equity that can be utilized during the first few years of retirement in the event that the stock market drops significantly. Diversify your investments between large-cap stocks, small-cap stocks, bonds, and international stocks to increase the amount you can safely withdraw from your investment each year. This allows you to avoid withdrawing money from your assets while their value is down and helps you extend the lifespan of your investments. A reverse mortgage line of credit is well designed for this task, as you can tap into your home equity early in retirement if the stock market drops. However, if the market doesn’t drop, you don’t have to access the home equity and can save it for later in retirement.

Spending too much money is one area that you have a lot of control over. While you might want some flexibility to take additional withdrawals for unexpected expenses, maintaining the plan is important in the long run. This means you must pay careful attention to your spending. You might not have a lot of control over the market, and you might have only a limited ability to increase your income, but you always have the opportunity to reduce how much you spend.

Another way to avoid excess-withdrawal risk is to engage in a flooring approach to retirement income planning. A flooring approach attempts to secure guaranteed income sources not impacted by stock market ups and downs. By switching your assets away from systematic withdrawals to guaranteed monthly payments, you will have limited your ability to access money each month, reducing the excess-withdrawal risk, but also reducing your overall access to liquid funds. Remember, you have control over excess-withdrawal risk, so set a good plan, and stick to it.

Social Security builds in a natural floor for most retirees. However, annuities can be another source of flooring and guaranteed monthly income payments. There are thousands of variations of annuity products on the market. There are deferred annuities that begin payments at a future date and annuities that begin payments immediately. Furthermore, there are variable annuities that do adjust to market conditions and annuities that are locked in at the time of purchase. Annuities can also last for one life, a set period of time, or for joint lives (for as long as either you or your spouse is alive). There are also hundreds of riders that can be attached to annuity products, allowing for inflation protections and guaranteed lifetime withdrawals. Make sure you know how the annuity works and fits into your overall plan. All annuities are not created equal. So shop around and compare prices. If you are trying to buy monthly income payments, make sure you are getting the best deal you can. This is a way to maximize your income!

You will likely hear or have heard negative things about annuities. Some of this is due to misinformation, and some of it is due to the fact that annuities can be complicated products that are not suited for everyone’s retirement plan. Make sure an annuity fits your goals and overall plan. Annuities have a place in retirement income planning and can make your retirement much more secure, as they can provide you monthly income and take market risk off the table.

Annuities can be confusing because they come in many varieties. If your goal is a predictable income stream for life, here are your primary options:

1. Income annuities: The simplest annuity product promises a regular (usually monthly) payment in exchange for a premium. For lifetime protection, you buy a life annuity that pays as long as you are alive. Couples may consider a joint annuity that pays as long as one person is alive. Those who are concerned about an early death can get a death benefit, but it will reduce income payments. The deferred income annuity allows for the purchase of a specified income amount that begins in the future. Since investment risk becomes more dangerous as retirement approaches, removing some risk by pre-purchasing a specified income can make sense. The income annuity locks into the strategy of converting an asset into income—and it is not reversible. This has advantages (simplicity and elimination of market risk), but it also has disadvantages (loss of liquidity and the flexibility to change strategies later). Income annuities will be combined with other strategies. So locking in is not a problem if flexibility is available elsewhere in the plan.

2. Deferred annuities: Another option for building an income stream in the future is a deferred annuity. During the deferral stage, the annuity value is based on the account balance, which is tied to underlying investment experience. Deferred fixed annuities promise a return described in the contract, and variable contracts allow from a selection of investment alternatives. The owner of a deferred annuity can choose to “annuitize,” which means the annuity becomes an income annuity at that point. With today’s low-interest-rate environment, older deferred annuity contracts may have more favorable contract terms for converting the account into monthly income than a new contract—meaning that if you have an older contract, hang on to it. An important innovation with deferred annuities is the development of the guaranteed withdrawal benefit rider. The rider provides a guaranteed lifetime payment without having to lock in as you do when annuitizing. When the income rider is turned on, you get a promise of lifetime income, but the account remains intact. If there is an early death or a change of heart, the remaining account balance can still be accessed. If the account value becomes zero, the rider continues to pay the promised income amount for a single or joint life.

Consider purchasing an annuity to take market risk off the table, and set yourself up with monthly guaranteed income payments. When choosing an annuity, (1) be clear about the primary purpose of the annuity, (2) consider all available product options, (3) pay attention to price, and (4) look at the ratings of the insurance carrier.

Rewirement Alert

Many people dislike the idea of purchasing an annuity because they feel like they are giving up control of their money to an insurance company. But in reality, when you have more guaranteed income in retirement you have more freedom to spend because you do not need to self-insure against your longevity.

It can be challenging to decide when to purchase an annuity. Annuity income can be purchased prior to retirement, at retirement, or in retirement. There are good arguments for buying at each point, so a prudent alternative may be to continue to purchase income over time, starting well before retirement. Maybe the best reason to buy early is that you have met your goals and have the resources to buy the income you need.

Both income annuities and deferred annuities with withdrawal benefit riders allow you to know with certainty the cost of income. Buying income by purchasing an annuity prior to retirement allows the value of the annuity to grow during the deferral period. This helps you reduce the cost of buying that income for retirement. You can reduce risk and build an income stream prior to retirement at the time that volatility can have the largest negative impact on retirement security. Some products, specifically deferred annuities with a guaranteed withdrawal benefit rider, provide the ability to build an income stream without having to lock in a start date, and the owner can even decide not to exercise the income option.

On the other hand, there are real benefits to buying annuity income throughout retirement. The primary argument for deferring the purchase of income is that your health status may change, and deferring allows you to maintain liquidity and flexibility. Buying income over time allows for building an income stream without locking in with too high a percentage of assets. Annuity income generally becomes less expensive with age, as payments are expected to be made for a shorter period of time, so deferring retains flexibility and allows for purchases at a reduced cost. Annuity income prices vary with interest rates, and buying income over time allows for protection from buying all the income at a time when interest rates are low and the income cost is too high. This is sometimes referred to as timing risk. As such, you should consider buying any product or investment over time instead of buying everything at once. By buying over time, you reduce the risk of buying at a bad time. With investments, this strategy is often referred to as dollar-cost averaging, but it can be used with other financial products like annuities as well.

In addition to these factors, there are some other factors relevant to the timing of a purchase. If the market has been up, purchasing income allows for locking in gains in the market. If medical advances extend life expectancy, the cost of income will increase. While buying an annuity is not for everyone, there are clear benefits when setting up a retirement income plan.

Hiring a financial advisor can really help with excess-withdrawal risk and help you pick the right type of annuity for your retirement plan. By placing some boundaries and a third party between you and your retirement assets, you can also help protect your assets from rash decisions and excess spending. People often see the stock market drop in value and immediately try to sell their investments, locking in losses. Instead, the best strategy is to ride out the storm in most cases. A good advisor can help you maintain the value of your assets and keep your income flowing. Additionally the advisor can help manage the sustainability of your plan over time and let you know if you need to change your spending habits.

Be careful when helping out your family members. While you might want to help your children, if you give away too much, you might jeopardize your own retirement. This could also create an expectation from your children that you will always provide for them.

Lastly, beware of buying things like a boat or vacation home. Such purchases involve costs that go well beyond the original price tag. These items could create phantom expenses for the remainder of your retirement years, taking away assets that you need for more important things like health care. Ultimately, just make sure your expenses fit your retirement plan and budget. Don’t overspend—make sure you know what you can spend! Determine a reasonable withdrawal rate at the beginning of your plan, budget for expenses (including family gifts), and stick to the plan throughout retirement.

Rewirement Mindset Questions

Do you tend to change your spending behaviors in down market cycles? How so?

How would you like to manage investment risks in retirement?

What are a couple ways that you could deal with the sequence of returns risk in retirement income planning?

III. Retirement Risks

Health Care Expenses

“Medicare and Social Security have created the healthiest and most financially secure generation of senior citizens in American history.”

– Jim Walsh, Politician

One of your biggest expenses in retirement will be health care-related costs. Out-of-pocket health care costs for an average sixty-five-year-old couple are often in the hundreds of thousands of dollars in retirement. Most people think they will need far less money saved up for health care because of Medicare. While Medicare is an incredible insurance program for retirees, it is not without its issues. For instance, Medicare has deductibles, co-pays, coverage limits, and no cap on out-of-pocket expenses, meaning you could spend $100,000 in a year on medical expenses. For most people, the biggest planning issue is just not realizing that Medicare requires some annual planning and review throughout retirement.

If you have employer-sponsored retirement health insurance coverage, it can go a long way in helping you meet your health-care needs. If you can get retiree health-care coverage from your former employer, you should look into it and see how it works with Medicare; however, such coverage is decreasing and is no longer common. Instead, once you hit age sixty-five, you will likely be eligible for Medicare Part A, as long as you worked for ten years and are eligible for Social Security. You will still need to choose the appropriate insurance for yourself and your spouse, as there are other areas of Medicare that are not automatic. This means you need to understand your options under Medicare and how the insurance helps you meet your specific health-care needs.

For most people, Medicare coverage ends up consisting of a few major decisions. Medicare Part A primarily covers hospital bills and is paid for during your years of employment. There are no additional premiums for Part A when you retire, as long as you are eligible for coverage. If you are not eligible for Part A, you can still pay annual premiums and get coverage. However, Medicare Part B, designed to cover doctor bills, does have a monthly premium. When signing up for Part B, there is an initial enrollment period. This period starts three months before your sixty-fifth birthday and continues for three months after, for a total of seven months. However, if you miss this window, you will have to wait until the next general enrollment period, January 1 to March 31, and your coverage won’t start until the next July 1. Missing this enrollment period will also cause you to have a higher premium and a gap in insurance coverage.

Rewirement Alert

Many people do not realize that if you miss your Medicare enrollment period you can be without insurance and be subject to penalty fees. Missing your open enrollment period can also cause existing insurance you might have through COBRA or work to become secondary and not pay out.

In addition, you will need to decide if you want to pay for Medicare Part D, which provides coverage for prescription drugs. When picking a Medicare Part D plan, you can choose from a variety of private plans in your area. Be sure to look at the premiums and what is covered under each plan. A plan with higher premiums might be more expensive, but it also might offer far more comprehensive coverage. One planning point on selecting a Medicare Part D plan is to talk to your local pharmacy. Find out what plans they see used in your area, what plans are easy to work with, and what plans would best cover the prescription drugs that you need. Buy on total benefits and not just on price!

Be aware of Medicare coverage gaps. There are copays, deductibles, and the dreaded Part D “donut hole,” where you are required to pay 25 percent of your prescription drug costs for a period of time. The Part D “donut hole” coverage gap has been reduced over the next few years, but it still can cost you thousands of dollars.

Rewirement Alert

Many people do not realize that certain Medicare decisions require annual review. For instance, if you have Part D coverage for drugs, you should pay close attention to your plan each year and switch during the open enrollment period if your plan stops covering or increases the costs of the drugs you need.

In addition to getting Medicare Parts A, B, and D, you might also want to consider a Medigap insurance policy to supplement your Medicare coverage. Medigap or Medicare Supplement Insurance can help fill the gaps in coverage that exist in traditional Medicare. While the policies sold have to cover standard benefits, the premiums can vary from company to company, so shop around. One company in your area could offer the exact same benefits and coverage as another company but charge a much higher premium.

If you still have time before retirement, consider taking advantage of a high-deductible health care plan. Having a high-deductible health care plan can allow you to save money in a health savings account (HSA). The HSA can be a very tax-efficient way to fund your health-care costs because contributions are tax free, and withdrawals are tax free as long as they are used for qualified health-care expenditures. In 2021, the HSA contribution limit is $3,600 for an individual with self-coverage and $7,200 for family coverage. These limits are indexed annually to reflect cost-of-living changes. HSA funds can be used to help pay for Medicare premiums, long-term care premiums, and out-of-pocket expenses.

Fund an HSA if you are still working and have a high-deductible plan. This can lower your taxes for this year and give you a tax-deferred savings option to help meet your retirement health-care costs. For young individuals, use an HSA as a savings vehicle. Think about it as a retirement health-care account. With the tax-free investment growth and tax-deductibility of contributions, there is almost nothing better in the entire U.S. savings system than an HSA. However, watch out for HSA fees, and pick a high-growth investment option if possible.

Planning for health-care costs in retirement doesn’t just start at age sixty-five when deciding on Medicare. Instead, it is a lifelong planning opportunity to make sure you have the right insurance leading up to Medicare, to put aside money for out-of-pocket costs, and to understand your Medicare benefits when it is time to enroll.

Rewirement Mindset Questions

How important is your personal health as it relates to long-term retirement planning?

What health insurance benefits do you review when making plan decisions, or are you only focused on the premiums?

What are you doing to improve your health this year?

III. Retirement Risks

Long-Term Care Expenditures

“Aging is out of your control. How you handle it, though, is in your hands.”

– Diane Von Furstenberg, Fashion Designer

Too many people think that long-term care planning is just a decision about whether or not to purchase long-term care insurance. Long-term care planning, however, is so much more. It is a discussion about how you will fund this expense, where you will receive long-term care, and who will provide the care.

Unfortunately, very few people are prepared to deal with this risk, as less than 8 percent of people have long-term care insurance and only 10 percent of people in the United States have a long-term care plan in place. This lack of planning is extremely troubling because long-term care is a very real and very expensive risk. It is estimated that nearly 70 percent of people will need long-term care at some point. Don’t fall into Superman Syndrome, the behavioral bias where an individual believes they will remain healthy and active their whole life. No one knows if they’ll be able to age in place with no additional care. Further, while you may expect family-provided care in retirement, plans can change rapidly that require nursing home care.

The need for long-term care planning became even more apparent as the Covid-19 pandemic erupted in the United States. There was a tremendous amount of attention given to nursing homes and the potential for these facilities to be incubators of the disease, and residents of nursing homes did prove to be disproportionately affected, both because of the ease of exposure from communal living and the fact that the disease took a larger toll on individuals who were elderly or had pre-existing conditions.

The question is, did this change human behavior when it comes to retirement planning? We now see fewer people move into nursing homes, and although fear of disease is probably a factor, another is that many people who might need nursing home care don’t have a long-term care plan in place. That’s a problem that pre-dated the pandemic.

Consider that about 1.5 million people live in nursing homes in the U.S., but they represent only a fraction of the more than 10 million Americans, mostly older than 65, that the Kaiser Family Foundation has identified as needing long-term services and support to help them get through the day. That figure represents about 3% of the current U.S. population and it is likely to increase in the coming years along with the median age.

Needs vary from person to person and over time, but according to HHS’s Administration on Aging, someone turning sixty-five today is close to 70 percent likely to need some kind of long-term care in their remaining years. And while one-third of today’s sixty-five-year-olds may never need long-term care support, 20 percent will need it for longer than five years.

A recent survey by the American College of Financial Services found that only about one-third of retirees have any type of long-term care plan—and this in the midst of a global pandemic that disproportionately affected older Americans!

Meanwhile, Genworth has been tracking the cost of care since 2004 and has found that the cost for facility and in-home care services has risen on average between 1.71% and 3.64% per year. Here are some of the median yearly costs as noted by Genworth:

Private nursing home room

$102,200

Assisted care living facility

$48,612

In-Home Care Homemaker

$51,480

In-Home Care Health Aide

$52,620

Adult Day Health Care

$19,500

Long-term care is often the largest unfunded retirement liability, but it shouldn’t be. It can often be one of those topics people want to avoid because it requires them to imagine a time and situation that they would rather not think about—like you or your partner being seriously ill.

Most people think long-term care is all about nursing homes and insurance, but long-term care insurance is not designed to cover healthcare costs. Rather it is designed to cover custodial care, which is more accurately defined as needing assistance with basic daily functions like eating and dressing.

Despite the widespread notion that when elderly people need assistance they move into a nursing home or other facility, in reality the vast majority of care is provided at home by unpaid family members. But that care is not free. According to an AARP report from a few years back, family caregivers spend almost $7,000 annually in out-of-pocket expenses. For long-distance family caregivers, the price tag can be as much as $12,000 a year. And over half of all long-term care insurance claims actually start while the individual is receiving care at home. So, your planning considerations should start with home care and involve the entire family.

For some, long-term care insurance will be a great solution. For others, a hybrid insurance policy that mixes both long-term care benefits and life insurance or an annuity payment may be a better option. Others may want to self-fund their plan or need to rely on government funding through Medicare. Every situation will be somewhat different, but everyone needs a plan.

Individuals who work with a financial advisor and have a long-term care plan in place tend to be more satisfied with their advisor than those who do not have a plan in place. In fact, the majority of clients with a long-term care plan (81 percent) say they are highly satisfied with their advisor, as opposed to 68 percent without a long-term care plan. Why? Remember, long-term care planning entails considerably more than nursing homes and long-term care insurance. It’s not about products, it’s about planning.

Long-term care planning can be done early in life, directly before retirement, and in some cases, during retirement. Ideally, it should be done before care is actually needed. In many cases, the best time period to begin planning for long-term care is in your forties and fifties as part of your overall retirement plan. Long-term care insurance becomes significantly more difficult to acquire in your late sixties and seventies.

Financing long-term care expenditures can be done through the purchase of long-term care insurance. However, even insurance is not always a complete solution for financing these expenses. In some cases, it might be too expensive, not available, or just not right for your needs. However, you will need to consider how much long-term care risk you want to pass on to an insurance company and how much you want to self-insure or rely upon the government. Long-term care insurance can be used to defray expenditures or provide almost comprehensive coverage. As such, it is important that you understand that you can purchase insurance to cover just a portion of your projected expenses if you believe higher levels of long-term care insurance coverage are too expensive.

Rewirement Alert

Many people have the misconception that Medicare pays for long-term care expenses. It does not. But, if you don’t have a lot of money saved for retirement, Medicaid might be your best long-term care financing option. Otherwise consider getting insurance.

Remember that if you want to purchase long-term care insurance, you should consider doing it in your forties and early fifties as part of your overall retirement plan. Long-term care insurance becomes significantly more difficult to acquire later in life, and many people are denied coverage by insurance companies at that point. In addition, purchasing a long-term care insurance policy earlier in life can lock in lower premiums.

Behavioral Bias Alert

Narrow framing bias: When an individual focuses on one attractive option, ignoring other options that may be more suitable.

Avoiding the bias: Long-term care insurance, Medicaid, or a large health savings account are not the only available option to paying for long-term care. Consider a combination of planning solutions, a hybrid life insurance product, certain annuities, or even a reverse mortgage if it better fits your needs.

While long-term care insurance is one way to fund long-term care expenses, it is not the only option. Policies can be expensive, unavailable to those who are not healthy enough to purchase them, and often considered objectionable because of their “use-it-or-lose-it” nature. Long-term care expenses can also be financed through a variety of newly developed “hybrid” or so-called linked-benefit products. One such product seeing tremendous growth and adoption is the life insurance policy that offers a tax-qualified long-term care rider. In fact, the sale of life insurance policies with long-term care riders has increased dramatically over the past few years. These hybrid life insurance and long-term care policies give the policy owner access to the majority of the death benefit if long-term care services are needed. If long-term care services are not needed, or if not all of the death benefit is used up to pay for long-term care expenditures, the remaining death benefit is paid out to the beneficiaries upon the death of the policy owner.

Life insurance policies can also be used to fund long-term care costs in a variety of other manners. First, if the policy has a cash value, this amount can be accessed through withdrawals and policy loans to pay for long-term care expenses. Secondly, the policy could be sold (referred to as a life settlement option) to help pay for long-term care expenses. In some cases, a life settlement can give the policy owner up to three times the amount of money as the cash value option. A third option is a viatical settlement, which also involves selling the policy but is done when the policy owner is terminally ill. With this approach, proceeds from the sale are generally income tax free. The sale price of the policy is determined by the future life expectancy of the terminally ill policy owner and the policy benefits.

In addition to life insurance and long-term care insurance hybrid policies, annuities have also been linked to long-term care benefits. For example, some annuities now offer tax-qualified long-term care benefits. Companies like OneAmerica offer fixed annuities with long-term care riders, which enable you to invest the money you might have saved for long-term care into a product that provides a fixed income, but it also will provide higher payouts if you need long-term care benefits. In some cases these types of products will double or triple the annuity payment when long-term care is needed.

Additionally, hybrid products usually are purchased with a single lump-sum payment. This can be an attractive feature for someone who does not prefer to pay annual or monthly long-term care insurance premiums that can rise significantly over time (which has occurred with some policies over the past few years). While most long-term care insurance policies try to keep premiums level, they can change, and in some cases have doubled, in cost. As such, some people like the certainty of a single-pay option because they reduce the risk of rising premium rates in the future. Lastly, both life insurance and annuity hybrid products solve the “use-it-or-lose-it” problem with long-term care insurance. If the long-term care benefit is not needed, benefits are available for other purposes.

If you own an existing life insurance or annuity product, you might be able to exchange that policy for a hybrid product that offers a long-term care benefit or for a stand-alone long-term care insurance policy. The Pension Protection Act of 2006 allowed for Section 1035 exchanges of traditional life insurance and annuity products for hybrid long-term care policies.

For example, the life insurance policy could be Section 1035 exchanged tax free for a long-term care insurance policy, despite the buildup of value inside of the life insurance policy. Ultimately, like-kind exchanges under Section 1035 eliminate the taxable gain inside the annuity or life insurance policy because the qualified long-term care insurance policy allows for tax-free payouts for qualified expenses. If you have an outstanding life insurance policy, consider exchanging it tax free for a hybrid life insurance and long-term care policy. This new policy can do double duty for you, and you can take advantage of some of the value built up in your old policy to help reduce your long-term care risk.

Before purchasing either a life insurance or annuity and long-term care hybrid product, it is crucial that you shop around, as products and prices vary considerably. Also, make sure you are buying the product that best fits your needs and goals, since not every product will work for every person and situation. Additionally, ensure that you can afford the investment before you make the purchase, because some products do not offer any return of premiums and the decision will be final. Each person’s situation is different and you need to see if any of these solutions fit your situation.

Another potential funding source for long-term care expenditures is a traditional income annuity. Income annuities have the advantage of paying out income, whether or not long-term care is needed. Life annuity income can be purchased over time during retirement to build an income source later, when long-term care needs are likely to occur. The advantage of buying annuities over time is that you do not have to lock into the strategy entirely if your health or economic status changes. Another option is the deferred income annuity, in which a specified monthly annuity amount is purchased at a younger age (fifties or sixties) with the intention of beginning benefits later in retirement (ages eighty to eighty-five). This type of annuity can provide significant income at a relatively low cost because of the extended deferral period and the fact that annuities that begin at a later age have a much higher payout rate due to the shorter payout period.

Reverse mortgages can provide another option to pay for long-term care expenses. Reverse mortgages can pay out in the form of a lump-sum benefit, monthly payment, or a line of credit. The loan does not have to be repaid until the last homeowner borrower leaves the home. As such, a reverse mortgage does not necessarily help someone who ends up in a nursing home, as the home will likely need to be sold to pay off the reverse mortgage. However, if an individual needs long-term care services in the home, a line-of-credit reverse mortgage might be an appropriate way to pay for this care and remain in the home.

For the foreseeable future, self-funding long-term care insurance, Medicaid, and family-provided care will all continue to be primary sources of long-term care funding. However, the market is changing and more people are becoming aware of new and alternative solutions to pay for long-term care. Whatever avenue you decide to take, having a plan in place is crucial. Even if you plan to rely on Medicaid, you will still need to spend down your assets before you can qualify. Furthermore, as new financing opportunities develop, and your circumstances change, your long-term care plan will likely need continued monitoring and adjusting.

Rewirement Mindset Questions

Have you or do you act as a caregiver? Will someone act as a caregiver for you?

Where would you like to receive long-term care if you needed it?

Have you had a candid conversation about long-term care with your loved ones?

III. Retirement Risks

Frailty and Old Age

“Cherish all your happy moments, they make a fine cushion for old age.”

– Booth Tarkington, Author

Aging brings with it a variety of retirement risks, including escalating healthcare expenses and possible long-term care expenses. While these represent significant financial risks for aging retirees, there is another risk, one often misunderstood and overlooked, lurking in the shadows—frailty risk.

Frailty risk can pack a powerful punch to the security of your retirement plan and open you up to the risk of elder abuse. This is an unpleasant topic for people to talk about, which is the biggest hurdle. Many people don’t plan for incapacity and frailty because they simply just do not want to address the elephant in the room. We all get older. This is a part of life.

Behavioral Bias Alert

Self-related bias: As we age, there is some evidence that people become more self-related and struggle to see the world through others’ eyes. Additionally, we become closer to ourself, our family, and our friends, but become further removed from strangers.

Avoiding the bias: People can become more and more isolated as they age and mobility decreases. In essence, there is evidence that self-bias can kick in as we age, which means we need to be aware that it is happening. Try to remain open-minded and empathetic toward others.

Too often people lump frailty risk in with long-term care and health-care concerns. However, frailty risk results from deteriorating mental or physical health, creating a variety of issues for the retiree. These include financial problems, planning challenges, lifestyle changes, and additional threats to physical health. Frailty is not always easily defined but can loosely be characterized as that gradual loss of energy, strength, physical capability, and mental sharpness often associated with aging. Frailty is not simply aging, though it is highly correlated with aging. A University of Michigan study shows that nearly one-third of people age sixty-five and older suffer from some degree of frailty. While many people manage to remain active throughout retirement, many others go through different phases of activity, decreasing over time due to frailty issues. Frailty can spell unanticipated financial risk to a retirement plan.

An individual suffering from frailty during retirement might face significantly higher expenses. As you grow older and continue to live in place, the family home, once a crowded, four-bedroom house full of children, has now become a large burdensome property to maintain. Each weekend, you clean, mow the grass, and perform other maintenance chores such as cleaning the gutters to keep your home up and running. However, as you age, you might not be able to get out the ladder, climb up onto the roof, and clear the leaves out of the gutters. Maybe this only costs you a few hundred dollars a year to get a company to do it for you. The next year, you are no longer able to mow the lawn every week nor shovel the snow during the winter. Again, another few hundred dollars are needed to hire someone to perform yard work.

As frailty risk sets in, more and more home, personal, and other tasks become financial strains, and you need to hire someone else to do it, forgo the tasks, or rely on others for help. If these maintenance jobs are left undone, your property could diminish in value and no longer be the financial asset you were counting on to tap into later in retirement.

At some point, frailty might become an even costlier issue if you are no longer able to drive. If you live in an area that requires driving and lacks good public transportation, this can represent a significant challenge and additional financial strain. The costs of private drivers, taxicabs, or ride sharing services like Uber or Lift may be prohibitive, seriously curtailing an otherwise active and health-conscious lifestyle and further compounding the frailty factor. It should come as no surprise that, in some cases, frailty has been shown to decrease one’s ability to remain independent in retirement.

In addition to living independently, you might decide you want to purchase a new life insurance policy or obtain long-term care insurance coverage. However, the onset of frailty could be a factor in the underwriting process, possibly prohibiting you from being insurable. In some cases, you might be insurable but at a much higher cost. This is a good reason to purchase long-term care insurance and life insurance at an early age, preferably in your early fifties when the likelihood of being uninsurable is much lower.

Frailty will also impact other retirement income risks such as long-term care and health-care costs. For example, research out of the University of Arizona shows that those suffering from frailty are more likely to have more severe injuries and develop complications when receiving treatment in the hospital. Furthermore, the research suggests that patients suffering from frailty experience both longer intensive unit stays and longer overall lengths of stay in the hospital. The increased severity of injuries, additional complications, and extended stays in the hospital all add up to increased health-care costs as a result of frailty.

Frailty does not have to ruin your retirement. In fact, proactive steps can be taken in order to reduce the risk of frailty and its potential impact on your retirement. Not all people suffer from frailty as they age. As a planning point, if you keep working even part time and stay active in retirement, you can help hold off frailty and age-related diseases like Alzheimer’s. Retiring early can have a detrimental impact on both your retirement savings and your health. As such, maintaining job skills, avoiding burnout, reducing work hours, and other measures can help keep you in the workforce longer, decreasing the risk of frailty.

In addition to working longer, some other steps can be taken to minimize the likelihood of suffering from frailty risk. Planning ahead of time is very important. For instance, setting up a trust and a trustee to make decisions for you can be a good way to deal with the decline in mental ability over time due to frailty. Planning ahead for the additional costs that result from frailty in maintaining a home, paying for health care, affording long-term care, and facilitating travel are also important. Downsizing early on in retirement or moving to a continuing-care community to reduce the physical demands of homeownership can also be a good idea. Hiring others to maintain your home and perform tasks can be done but do so with caution. There is an increased danger of financial elder abuse as more outsiders are introduced into the frail individual’s life at the time when he or she may be most vulnerable.

The risk of elder abuse can be physical, emotional, and financial. Financial elder abuse is a huge risk and often goes unreported. It is estimated that the financial cost of elder abuse in the United States is in the billions of dollars a year. Often financial elder abuse is accompanied by emotional abuse. Perhaps the most upsetting part is that it is typically family members, friends, and caregivers who engage in elder abuse. This can spoil a retiree’s happiness and overall experience of retirement, even if the financial loss does not ruin his or her plan. Putting a third party in the way of your money can be a good way to protect against this risk. Establishing an intermediary, such as a financial advisor or an independent trustee, could help protect your money against theft and misuse due to financial elder abuse.

Consider setting up a special power of attorney called a “durable springing power of attorney,” health-care power of attorney, and a living will to help manage end-of-life issues such as incompetency. These legal documents can help you ensure you get the care and quality of life you want later in retirement. An estate-planning attorney can help you coordinate these with your overall retirement and estate plan.

Let’s not lose sight of how your retirement plan will impact your estate planning. Estate planning is about how you will pass your assets to your heirs at death. This requires thoughtful planning and updating throughout life.

Everyone’s heard the stories of celebrities who died without a proper estate plan in place. It’s been a hot topic in the last few years with Prince and Aretha Franklin serving as unfortunate faces of the phenomenon. But it’s not just freewheeling entertainers. Abraham Lincoln – a lawyer by trade – didn’t have one, which leads me to say something you’ve probably never heard anyone say: Don’t be like Abraham Lincoln.

Most people want to plan for a good life and a good retirement, so why not plan for a good end of life, too? Let’s look at four ways you can refine your estate plan, protect your assets and create a level of control and certainty for your loved ones.

1. Review Beneficiary Designations

Many accounts can pass to heirs and loved ones without having to go through the sometimes costly and time-consuming process of probate. For instance, life insurance contracts, 401(k)s and IRAs can be transferred through beneficiary designations, meaning you determine who you want to inherit your accounts after you die by filing out a beneficiary form. You can often name successors or backup beneficiaries, and even split up accounts by dollar amount or percentages between beneficiaries with these forms.

A good rule of thumb is to update and review these forms and designations every couple years, especially after major life events like divorce, marriage or the birth of children or grandchildren. In some situations, divorce might wipe out a beneficiary designation for an ex-spouse. Accounts like 401(k)s require that you change the designation or your ex-spouse could inherit it – even if you remarry in some situations.

Take the time and make sure all of your retirement and investment accounts have beneficiaries attached and are updated to ensure your assets pass to the right people when you die.

2. Have Proper Life Insurance

As we discuss in other sections of this book, one of the primary uses of life insurance is to protect against the loss of income in the event of an individual’s untimely death. The most important time to have life insurance is typically while you’re working and supporting loved ones with your income.

This can still be the case in retirement. If one spouse creates most of the retirement income through Social Security, continued work, a pension, an annuity, or another income source, it makes sense to keep life insurance in order to provide for the surviving spouse or dependents after the death of the individual.

In addition to protecting against lost income in the event of death, life insurance can also provide a means for passing on income tax-free to the next generation. If one goal of retirement and estate planning is to pass on a legacy, life insurance can be a very efficient vehicle to accomplish that goal.

Furthermore, life insurance can provide much needed cash flow and liquidity for estates that might be subject to estate taxes or that have lots of illiquid assets like family businesses, farms or collectibles. With an irrevocable life insurance trust, funded with a life insurance policy, the trustee could purchase assets from the estate with the life insurance funds in order to provide liquidity to the estate.

3. Avoid Probate with Trusts

Part of effective estate planning is having the correct will and trusts in place. While almost everyone will need a will at some point, the same is not always true about trusts. In some cases, setting up a trust to shelter or control assets is not worth the cost if the individual has very limited resources. However, as an individual’s estate planning needs and assets increase, the value of a trust as part of the estate plan also increases.

There are two main types of trusts: revocable and irrevocable. For general estate planning needs, a revocable trust covers most issues. Often this means a simple estate plan can consist of a will, a revocable trust, a power of attorney document, and up-to-date beneficiary designations. For most people, you don’t need much more.

Someone can fund revocable trusts with assets and still use the assets today without changing their income tax nature. These types of trusts function as a more effective way to pass on assets outside of probate and allow a trustee to manage assets for their beneficiaries.

On the flip side, an irrevocable trust can be a way to provide creditor protections, separate assets from the annual tax liability of the original owner, and even help reduce estate taxes in certain situations. However, irrevocable trusts can be more complex and expensive. Before you move assets into an irrevocable trust, understand the complexities and restrictions that could be placed on them.

4. Incorporate Charitable Giving

Many Americans give to charities on an annual basis—it’s part of achieving true wealth. True wealth is about having the freedom to achieve your goals, and for many that means being able to leave a legacy to their church, alma mater, charity, or another organization or cause they care about.

Charitable giving is a more comfortable way to donate money as you might need the assets to support your income during retirement, but upon your death the money is no longer needed and can be passed onto a charitable goal.

With charitable giving as part of an estate plan, you can give outright gifts to charities or set up a charitable remainder annuity trust (CRAT) to provide income to a surviving spouse or heir, with the remainder going to the charity. Interestingly, you can even set up a CRAT at death by passing along your IRA, which can be an effective way to both generate income for a loved one and give to charity in a tax-efficient manner. Honestly, CRATs and CRUTs are even more valuable after the SECURE Act passed as vehicles to pass on wealth and have a charitable impact.

Another retirement driven charitable giving technique to look at is a qualified charitable distribution (QCD). IRA owners who have reached age 70 ½ (even though the new RMD beginning age is 72) can make QCDs. A qualified charitable distribution must be a direct transfer from an IRA account to a qualified charity, meaning that the check is written directly to the charity by the trustee or custodian. Total annual qualified charitable distributions from all IRAs for an individual cannot exceed $100,000. For married couples, each spouse can make up to $100,000 of QCDs. These transfers have two important consequences:

1. They count toward satisfying the required minimum distribution requirements each year.

2. The distributions are excluded from the taxpayer’s income.

Qualified charitable distributions can only be withdrawn from traditional IRA accounts, and only distributions to qualified charities count. Private foundations and donor-advised funds are excluded. The IRA owner must also receive a written acknowledgement of the gift from the charity.

There can be significant tax benefits to QCDs. All IRA owners who have reached age 72 have to start taking required minimum distributions. Retirees who do not need the entire distribution for living expenses may choose to give some of the distribution to charity. The charitable contribution generally—but not always—results in a charitable tax deduction. Individuals who do not itemize their deductions (because their total deductions are less than the standard deduction) do not benefit from the charitable contribution. In addition, charitable deductions are limited to a percentage of the adjusted gross income (this percentage depends upon the type of charity receiving the gift). Those who give away substantial amounts may exceed the limit.

There is another more important difference. When an IRA owner takes a distribution from the IRA and then later makes a charitable contribution, the distribution counts in the calculation of adjusted gross income (AGI). If a QCD is elected, the distribution is excluded from income and it does not count as part of AGI. This is a big advantage because taxpayers can now avoid a higher AGI for a year. A higher AGI could mean:

- A larger percentage of Social Security benefits are taxable

- Higher premiums for Medicare Part B and D

- A loss of itemized deductions when adjusted gross income exceeds certain limits

Additional exposure to the 3.8% investment income tax and the 0.9% additional Medicare tax that apply to high income individuals

The first of these issues, increased taxation on Social Security benefits, is an issue that affects middle income retirees. For single taxpayers, a portion of Social Security benefits become taxable when provisional income is $25,000 or more ($32,000 for married filing jointly). Provisional income not only includes AGI but also includes half of Social Security benefits plus tax exempt interest. Those with higher income are not affected by the first issue (they have to include the maximum of 85 percent of Social Security into taxable income) but they are affected by the other issues.

Charitable planning is a very important part of financial planning and your own values. If you are charitably inclined, make sure you are maximizing your charitable impact by being purposeful in your actions and giving. Many people are reactive when giving to charity, like giving when asked, instead of being proactive about giving. Using CRTs and QCDs or donor advised funds (DAFs) can all be ways to give, achieve the same outcome we are achieving today, and increase our effectiveness by reducing our total tax bill.

In the end, your estate plan is unique to your situation. Everyone will pass away at some point and you need to have an estate plan in place at that time. A good portion of an estate plan isn’t about money—it’s about protecting family, making sure assets pass smoothly to the heirs you want, and removing complexity for your loved ones. But taxes and liquidity are issues that need to be addressed, too.

Take the time to plan for a good end of life and update your estate plan. For instance, in 2019 the SECURE Act substantially changed the rules around inherited IRAs and 401(k)s. This means many trusts need to be updated and you need to review your beneficiary designations in accordance with the new changes.

It’s long been common practice to stretch IRA and 401(k) distributions over the life of the beneficiary. A smart strategy for two reasons: (1) It allows the tax-advantaged nature of retirement accounts to continue for years, even decades, as investments continue to grow tax-deferred inside of the IRA or 401(k). (2) It spreads out the taxable distributions, which helps reduce the tax burden.

The SECURE Act mostly went into effect on January 1, 2020, creating new rules for people who die after this date. Many beneficiaries will have to fully distribute taxable accounts within ten years of the account holder’s death. That could push your loved ones into a higher tax bracket. Surviving spouses will still be able to stretch their distributions over their own life expectancy in most cases, however, children and others can be required to distribute faster under the new rules.

So, instead of allowing beneficiaries to stretch out RMDs over their own life expectancy, the beneficiary must distribute the entire balance of the inherited account by the end of the tenth year following the year of the account owner’s death.

Exceptions to this new rule include: the surviving spouse of the deceased account owner, individuals who aren’t more than 10 years younger than the deceased owner, a minor child of the deceased, and a disabled individual or a chronically ill individual. These individuals will still be able to stretch out distributions.

Minor children can stretch out distributions until the age of majority in their state (typically age eighteen, but not always) and in some cases until age twenty-six if they’re still in school. They have to finish distributions by the end of the tenth year following the age of majority. Additionally, certain beneficiaries for trusts and estates will still be subject to a five-year distribution period.

Lastly, if the owner died before the end of 2019 (or the end of 2021 as it relates to government retirement plans), the old stretch rules will continue to apply. However, if a beneficiary of an inherited IRA or retirement account dies after 2019, the grandfathering rules will no longer apply and the beneficiary of the beneficiary (often called a successor beneficiary) will now have only ten years to distribute the account.

The stretch strategy’s undoing is no surprise; It’s been proposed for years because it will generate tax revenue. The SECURE Act is expected to raise roughly $16.4 billion in revenue over the next 10 years. Almost all of it—$15.7 billion—will come from the elimination of the stretch option.

Is there a viable alternative to the soon-defunct stretch strategy?

We can’t fully replicate the tax-deferred nature of the IRA or 401(k) on inherited accounts. But charitable remainder trusts and insurance products could provide similar benefits. Focus on more tax-efficient strategies as part of your retirement and estate planning.

For example, bracket-bumping Roth conversions is the strategy primed to give beneficiaries a boost in the SECURE Act era. Roth IRAs will still be subject to the 10-year distribution period under the SECURE Act, but distributions from the Roth won’t impact the beneficiary’s taxable income. Roth conversions require the account owners to plan in advance. If done correctly, they can cancel out the taxes that come with a shortened distribution period.

Let’s look at a quick example of how these new IRA beneficiary rules could impact your heirs. Let’s say you leave $1,000,000 in an IRA to your child—a 40-year-old, single professional who earns $120,000 a year. Under previous rules, they could stretch out distributions over 44 years. The first-year distribution would be about $22,727.27. This wouldn’t push them into a higher tax bracket.

Under the SECURE Act, your child will have to distribute the account over 10 years. They decide to spread it out evenly, taking out $100,000 in the first year. This pushes them up to $220,000 of income with roughly $40,000 of the distribution into the 32% tax bracket and roughly $16,000 of the distribution into the 35% tax bracket. This significantly increases the taxes they’d pay on the IRA.

Instead of leaving the money in an IRA, you can start doing strategic Roth conversions to alleviate that tax burden before you die.

Let’s say one parent was in the 24% tax bracket with $100,000 of income. They could start doing Roth conversions early in retirement to take advantage of their full tax bracket, up to roughly $160,000, without going to the next tax rate.

There are a lot of strategies out there to reduce the impact of the SECURE Act on your own retirement, but you need to be proactive in reviewing your plan regularly and adjusting for any changing legislation.

Rewirement Mindset Questions

How did your parent’s or another loved one’s life change as they aged?

How has your life changed as you get older? What things do you not do today that you would have done in the past?

What estate planning or beneficiary designations do you need to review every couple of years, or follow major life events?

III. Retirement Risks

Stock Market Risks

“Fasten your seatbelts, it’s going to be a bumpy ride.”

– Bette Davis, Actress in All About Eve

Part of your retirement income plan will likely include a significant amount of stock market investments due to their long-term growth potential. Typically, higher-risk investments tend to offer higher rates of return. This is essentially a tradeoff between certainty and uncertainty. But remember that all types of investments come with certain risks, not just stocks. For instance, bonds and other guaranteed income sources often suffer from liquidity issues, and their returns could be outpaced by inflation. Additionally, even bond and annuity payments could falter under the right catastrophic conditions.

When investing in stocks, there is a degree of uncertainty, as the average growth has varied a lot historically in the United States. Even though there is a risk that you could suffer a financial loss in the market, research shows that most people need to be invested in the market to help their portfolio sustainability. Investing in stocks can also help deal with inflation, as stock prices and dividends tend to adjust somewhat for inflation over time, allowing you to maintain your purchasing power throughout retirement.

Instead of avoiding the market completely, you just need to be smart about investing. This means dollar-cost averaging, diversifying investments, and holding stocks for long periods of time. First, avoid purchasing all of your investments on one day. Instead, buy stocks over time and give them plenty of time to grow. This also means resisting the urge to overreact when the market has a bad week, thus selling your stocks at a loss. Instead, be patient and try to ride out down parts of the market. Try to overcome those detrimental behavioral biases that drive people to buy high and sell low.

Behavioral Bias Alert

Loss aversion: Making unwise decisions in order to avoid a loss or in an attempt to avoid a loss.

Avoiding the bias: No one likes watching an investment lose value. But investing comes with ups and downs. Build a well-diversified portfolio that fits your comfortability with risk, then hold on through the down moments. If the market drops and you sell at a loss, then stocks bounce back, you’ll have to repurchase those same shares at an even higher price than you sold for.

Secondly, make sure you are diversifying your investments between asset classes, such as stocks versus bonds, and within asset classes. This means you shouldn’t own too much of any one company as a long-term investment strategy. You need to deal with the risk that one company’s stock is very volatile over time. It is better to buy a lot of unrelated company stocks to help reduce volatility. However, remember that if you are invested in the market, you cannot completely avoid market risk, even when properly diversified. When the market drops, it drops, even if you are diversified.

To reduce investment risks early in retirement, consider a collar strategy to hedge your investments during the first few years of retirement. A collar is an options trading hedge that is created by buying protective puts (protection against the stock falling too low) by selling a call option (which gives someone else the ability to buy the stock if the stock goes up a lot) on shares of stock you already own. It costs you nothing out of pocket and limits your upside and downside. It can be effective for a few years in early retirement but should not last the entire retirement—it will severely impact your long-term gains, as it is a hedging technique against risk.

Rewirement Alert

Don’t leave the stock market entirely in retirement. While stocks are volatile and carry some risk, they also provide excellent returns in the long run to help fund a lengthy retirement.

When picking your investments, it is also important to take a look at the liquidity. This is really a measure of how fast you can turn an investment into cash. For example, real estate or business ownership investments might seem like a good opportunity, but if you cannot easily sell the property or business interest for years, the lack of liquidity needs to be considered. Stocks tend to have a lot of liquidity, as you can often sell them within days.

Now to make everyone mad. Dollar cost averaging is one of the most discussed investment strategies out there. The idea behind dollar cost averaging is that you should spread out your investments over time to reduce the impact of market volatility on your portfolio. However, in most situations, dollar cost averaging does not help. In fact, on a risk-adjusted basis, it has been shown to not reduce risk. Yes, dollar cost averaging can improve total returns or reduce risk during market drawdown periods, but in most investing time horizons, it actually reduces returns significantly.

If you can accept some volatility and risk, most investors are better off investing in lump sums when you have money rather than dollar cost averaging. However, if you are afraid of the market dropping right after an investment, you can dollar cost average to help reduce this concern, but don’t expect dollar cost averaging to increase your returns on average over time.

In the end, I prefer simplified investing strategies. I like simple, low-cost index- or industry-driven investments. I stay away from stock picking and day trading. Overall, research shows that active management does not outperform the market as a whole over the long-term. Yes, you can build wealth by taking risks and focusing on a single stock or company. But to hold and mange wealth you need to diversify. When you are young and can handle risk, take it. Once you have built wealth, focus on protecting it with your investment philosophy.

It is also increasingly important to lay out your investment values. What do you want to accomplish with your investments? Remember, you are in essence giving or lending your money to support a company’s growth. Do you want to help that industry or company grow? If not, you might consider investing elsewhere. The growth of ESG and value-based investing helps align people with their society, their impact, and the purpose behind their investments.

As you approach your retirement plan, be aware of assets that can be quickly turned into cash to meet expenditures. The stock market and investments are your friends. Be smart and don’t panic, because your investments are crucial to the success of your retirement plan.

Rewirement Mindset Questions

Do you contemplate selling your stocks when the market is down in fear that it will continue a downward trajectory?

Do you currently engage in dollar cost average investing and why?

What are the three most important values you want to demonstrate when you invest?

III. Retirement Risks

Unexpected Early Retirement

“If you change the way you look at things, the things you look at change.”

– Wayne Dyer, Philosopher

While you will have some control over the time and manner in which you leave the workforce, many people are forced into retirement earlier than they expected. Nearly 45 percent of retirees say they retired earlier than expected, approximately 45 percent say they retired when they planned to, and 10 percent say they retired later than planned. For those retiring early, declining health was the primary reason for early retirement. This will be one area that might be hard to fully control. However, leading a healthy and active lifestyle can help you remain fit enough to continue working and retire on your own terms.

The second-most cited reason for early retirement is to fulfill family caregiving responsibilities, whether it is to care for elderly parents or a spouse. These responsibilities often fall on full-time working women and can create emotional, physical, mental, and financial issues for the caregiver, even impacting her own health and career. So how can you manage this risk? First, talk to your parents and family about having a long-term care plan in place. If they have a plan, all of the burden might not fall on you. Additionally, you can limit the impact on your spouse and children by having a long-term care plan in place for yourself. Long-term care planning is not just a financial decision, it is about protecting the family unit. In fact, you can even consider purchasing long-term care insurance for your parents, or at least have a discussion with them about their long-term care plans. Purchasing long-term care insurance for a parent or spouse can improve their retirement security and your own by reducing the caretaker burden on yourself. If you don’t want to purchase long-term care insurance for both spouses, consider purchasing it for the female spouse only, as she will likely need care for a longer period of time.

Rewirement Alert

Many people fall into an anchor-point trap and retire too early. Don’t worry about when your friends or relatives retired. Instead, pick a retirement date that works for you. Age 62 or 65 is not a magic retirement date. Ignore those numbers and figure out what works in your situation.

The third-most cited reason for forced early retirement is corporate downsizing. Losing a job just a few years before you were planning to retire could severely impact your retirement security in a variety of ways. You might have to start spending your retirement assets earlier than expected, you will be subject to inflation for a longer period of time, you will most likely have a reduced rate of savings, and you may have to collect Social Security earlier than anticipated. In order to avoid these situations, you need to keep yourself employable until you choose to retire. Stay engaged at work, continue to develop your marketable skills, keep up with continued education, and maintain your professional networks. All of these are really investments in yourself. Spending the time and money to continue your professional growth, even into your mid-sixties, can provide a lot of value, since you can better control your retirement and your future security. These activities are investments in your human capital or lifetime earning potential. Continue to invest in yourself so you can maintain employment and find new employment, if necessary, to ensure that you can retire on your own terms.

Early retirement means a longer retirement period, which means you will need more money. Many people who retire early feel the need to collect Social Security before their full retirement age. If your full retirement age is sixty-seven, and you begin to collect benefits at sixty-two, those benefits will be permanently reduced by 30 percent. Remember, when you retire and when you start to collect Social Security benefits can be two separate decisions. Even if you are laid off from work early, you can still delay taking your Social Security benefits by using other assets first.

Consider delaying Social Security benefits for as long as possible to increase your retirement security. In some cases, you might need to use other assets like your 401(k) or personal savings in order to defer Social Security benefits. Delaying Social Security until age seventy will result in annual payments that are 76 percent higher than they would be had you started collecting at age sixty-two.

Early retirement might also cause you to tap into your 401(k) or pension early. If you have a defined benefit pension plan, you can usually start collecting benefits as early as age sixty-two without a reduction in benefits. If this is the case, it might make a lot of sense to take advantage of the early retirement and turn on the defined benefit plan. However, in some cases, you might have to wait until age sixty-five for benefits to begin.

When retiring from your employer, take a serious look at the distribution options that are being offered. Make sure you look at the differences between the annuity option and the lump-sum option. An annuity option might be the best choice for your specific situation, especially if you have a spouse who might need future income. A lump sum might seem preferable so you have control of your money, but the annuity option offered in your plan might be better than anything you can purchase on the open market for the same cost. Individuals with guaranteed sources of income like a pension also tend to be happier in retirement, as they have more peace of mind about their income.

If you do decide to take a lump-sum distribution, make sure you roll over the lump sum into an IRA or other qualified plan. Consider doing a direct rollover or transfer to an IRA so that your previous employer does not have to withhold a 30 percent mandatory tax from your 401(k). This will help you get the full 401(k) account balance into your IRA and allow it to continue to grow until you need to take a distribution. The IRA rollover decision is an important one for your retirement. Make sure to find a knowledgeable advisor or specialist who can help you with your rollover decisions and guide your subsequent investment strategies. Pay attention to the fees in the investments you roll over and understand how your advisor or IRA rollover specialist gets compensated.

When rolling your 401(k) or other qualified plan over to an IRA, make sure you know if you have any employer stock inside of your 401(k) that could be eligible for special tax treatment as net unrealized appreciation. If you did have employer stock in your 401(k), you will want to consider doing an in-kind distribution. This would mean taking the stock out of the 401(k) and not rolling it into an IRA but instead holding it as a taxable account. You will also need to distribute your entire remaining 401(k) balance within the year, or you will lose the special tax treatment. The employer stock will be taxed as ordinary income as a distribution in the current year up to the amount that you invested, essentially your cost basis in the stock. Any additional growth in the employer stock while it was in your 401(k) can then be taxed as long-term capital gains instead of ordinary income when you decide to sell the employer stock. Long-term capital gains rates, usually 15 percent, tend to be much lower for individuals than their ordinary income tax rates. As such, correctly managing your distribution and employer stock can save you hundreds of thousands of dollars if you invested heavily in your employer’s stock.

Early retirement can create a lot of unique challenges, but if you prepare properly, you can retire on your own terms. Furthermore, early retirement does not mean that you have to make bad financial decisions. You can still defer Social Security benefits, take the right distribution from your employer retirement plan, and roll over assets into an IRA. Lastly, don’t forget to continue to invest in yourself. This can keep you employable late into life, improve your lifetime earning potential, and allow you to minimize the risk of forced early retirement.

Rewirement Mindset Questions

What have you done to invest in yourself in the past year or two?

What community or professional organization would you like to get more involved with?

Do you know anyone who was forced to retire earlier than expected and what impact did this have on their life?

III. Retirement Risks

Unexpected Financial Responsibility

“The man who complains about the way the ball bounces is likely to be the one who dropped it.”

– Lou Holtz, Football Coach

Another roadblock to a secure retirement can be unexpected expenses. These can come in a variety of forms. You could get in a car accident, get sick, your house could burn down or flood, you could lose a spouse earlier than expected, or you could suddenly discover that you have to support a family member. When planning for retirement, it is important that you have the right insurance protection to avoid potential setbacks. This means having the right amount of property and casualty insurance (through good auto and home coverage) to protect you and your family. Consider getting more auto coverage than the state required minimums, as these often do not protect you properly against liability. Being underinsured could threaten your retirement savings.

A car accident or sickness could easily ruin your retirement savings and security if you are not properly prepared. This is why it is necessary to have the correct amount of disability and health insurance coverage. If your employer does offer them, consider signing up through work, as your company is likely paying part of the costs. However, if your employer does not offer health or disability insurance, you can still purchase the insurance on the open market.

The early loss of a spouse can have a huge impact on your retirement income security, overall plans, and happiness. Honestly, the last thing you want to be thinking about when you lose a life partner is whether you will be financially secure in retirement. Make sure you have the proper amount of life insurance to protect against this risk. Life insurance can be a valuable retirement income asset. It can help protect the family unit during working years and into retirement. Whole life policies with cash value can also provide a source of income, as the cash value can be accessed in retirement. Additionally, life insurance is one of the few ways to generate millions of dollars as a legacy in an estate.

Life insurance should be purchased for both working and nonworking spouses. One of the biggest underinsured areas in the country is the nonworking or part-time working spouse. This spouse adds a lot of value to the household, and this person’s loss would put a huge financial burden on the surviving spouse. Don’t get caught unprepared. Get adequate life insurance to help protect your family and your retirement income security. One way to think about life insurance is that it is sold in two different forms. Either temporary life insurance or permanent life insurance. A simple way to put it is that temporary life insurance (term) is more about protecting families and permanent life insurance is more about wealth accumulation and legacy planning. Term is typically the cheaper and more affordable policy.

Some people think that life insurance is only about your working years. However, it is also about protecting income streams. In retirement, you are still a source of income. For instance, when a spouse dies in retirement, Social Security will pay the surviving spouse the higher of the two spouses’ benefits. However, the lower benefit is gone. In some cases, this could cut your retirement income almost in half, while you still have nearly 80 percent of the expenses you had before. Life insurance can help protect against the lost Social Security income from the death of a spouse.

Rewirement Alert

Life insurance should not be underestimated as a retirement income planning tool. The right policy can protect the family unit, provide income streams to make up for lost Social Security benefits, and provide a legacy amount to your heirs.

You can also suffer a financial burden by gaining a family member instead of losing one. Perhaps a parent, sibling, or child moves back into your home. This can become a serious financial burden and can often be unexpected. If your child moves back in, make sure you are still fostering a home that supports financial independence. You need to take care of yourself and cannot sacrifice your retirement security to fund your children’s lifestyles. Make sure you set goals and clear parameters; don’t let them become reliant on your finances. Helping a child or family member can feel like an obligation and be the right thing to do for you, but make sure you do it the right way. Don’t allow yourself to be taken advantage of financially, and make sure you are encouraging sound financial behavior. This can help you minimize the financial impact on your own savings and still support your family.

Rewirement Mindset Questions

Have you experienced an unexpected financial change due to a family member or other loved one?

Is there anyone in your life whose lack of planning or life insurance could negatively impact you?

Have you discussed the what-if scenarios with your loved ones?

IV. Putting a Retirement Plan into Play

When to Begin Retirement Planning

“It does not do to leave a live dragon out of your calculations, if you live near him.”

– J.R.R. Tolkien, Author

Once you understand the risks you face in retirement, you can develop a comprehensive plan to deal with them. However, at some point you will need to prioritize your risks. This will require setting out goals, reviewing your personal finances, and examining your sources of retirement income. Depending on your unique situation and goals, certain risks might require more attention. For instance, if you are single, you will be less concerned about providing care to other family members. However, you might be more concerned about your own long-term care risk, as you won’t be able to rely upon a spouse to provide the care.

Remember, you really cannot properly prioritize your risks until you take a comprehensive look at your retirement income plan and situation. If you worked for a company that provides a large defined benefit pension plan with cost-of-living adjustments, you will be less worried about longevity and inflation risk. However, if you want to leave a large legacy, this might change your plan and compel you to invest your other assets in higher-risk investments to increase the likelihood of higher returns.

Also, when engaging in comprehensive retirement planning, you may solve one risk while exacerbating another one. For example, if you deal with longevity risk by purchasing a single premium immediate life annuity, you have likely increased your liquidity risk. Again, because you have limited assets to meet your retirement income needs, you will need to prioritize your goals and risks. An advisor who specializes in retirement income can help you build a plan to meet your unique situation. There are also software programs available to help you prioritize your retirement goals and risks, such as LIMRA’s Ready-2-Retire. Additionally, nonprofit mission-driven organizations like the American College of Financial Services and the Society of Actuaries both provide free information on retirement income planning and post-retirement risks.

While the risks and roadblocks to a successful retirement are around every corner, a well-defined retirement income plan can help you reduce these risks and improve your financial security. Remember, you don’t need to save more money to deal with all of these retirement risks. Instead, you can limit the impact of many of them by making well-informed and strategic decisions. Understand the risks you face, know what strategies are available, don’t be afraid to ask for help, and be proactive. The biggest impediment to a more secure retirement is inaction. But most importantly, everyone can improve their retirement income security without saving a single dollar more simply by making better and more informed decisions. So let’s start looking at how to plan.

An important question is When is it time to begin putting together a retirement income plan? Since there is almost always something you can do to improve your retirement security, planning should begin when you are ready. Unfortunately, most don’t begin to think about this stage of planning until they are about to retire and begin to confront retirement decisions—like when to retire or when to claim Social Security benefits. Others begin to plan even later, once they are in retirement and begin to question whether their resources will last a lifetime. If you start late, don’t worry; there are still strategies discussed in this book that will help you. Also, planning is required throughout retirement, so it’s never too late to build a plan.

If you are reading this book before retirement, the best time to build your first comprehensive plan is five to ten years prior to retirement. Before then, you may not have enough details about your retirement to formulate a comprehensive plan. Many who are five to ten years from retirement have an established lifestyle with a relatively clear cost, a sense of when retirement may begin, and at least some feeling for the changes that retirement will bring. They will also have accumulated resources that can be used to fund retirement and still have time to make some changes if the current goals are not easily obtainable. Using a simple ten-step process can help you to build a plan to meet your needs. However, the plan should be revisited at least annually throughout retirement.

If you are further from retirement than this—good for you for planning early. There are still plenty of steps that you can take to better prepare yourself for retirement. Also, starting to think about income planning early will change the way you think about your retirement planning. When you think in terms of generating income versus simply building wealth, you pay attention to the costs of generating income.

It also starts to switch the conversation to a life cycle investment approach where the goal is smoothing income from a time of work to a time that you are not working. Thinking in terms of income also expands the way we think about building retirement resources. Buying rental property can mean steady income in retirement, as can the equity built with home ownership.

Maybe the most critical issue when you still have many years to retirement is focusing on building retirement assets. For millennials and other young individuals, the focus should not yet be on retirement income planning but rather on wealth accumulation. Now the real issue becomes how you can accumulate the appropriate amount of wealth in order to set yourself up for a financially secure future and retirement.

There are many other opportunities to plan for a financially secure future prior to retirement. Here are some ideas.

Retirement security is affected by employment decisions, as some companies have better pensions, retiree healthcare, and executive benefits. Take employer-sponsored benefits into consideration when looking at the overall compensation package.

If you choose self-employment, your retirement could be adversely affected as the onus of planning will be placed solely on you.

Once you have begun to build wealth, it is important to protect it. Having sufficient homeowners insurance, liability coverage, life insurance, and disability insurance all go a long way to improve retirement security for you and your family. Remember to protect yourself. Your human capital, which is your ability to make a living, is the best way for you to build financial wealth over time. However, in retirement, when you stop working, your human capital is gone. At this point, you need to replace that with financial savings and other retirement income sources.

Purchase long-term care insurance when you are still healthy and able to afford it. Many consider age fifty the right time to look into this product, which provides protection if you become unable to care for yourself.

If your employer does not have a defined benefit pension plan, you may want to consider looking into some guaranteed income, which will begin at retirement age. There are several types of annuity contracts that can be used to lock into a specified amount of income when you retire, but you should begin the process well before retirement.

If you are still decades away from retirement, you still need to be saving. Even in your twenties and thirties, you should be setting aside money for the future. It can feel very daunting during your early work years to set aside money into the company 401(k) plan or to set up an IRA. However, it is so important that you save early and often. It is also important that you save in a smart way. This means taking advantage of the tax benefits and any employer-provided benefits. For instance, if your employer offers a 401(k) match for your salary deferral, you should consider saving at least enough into the 401(k) to get the employer match. However, if you have outstanding credit card bills that you are not paying, you might want to consider suspending any retirement savings until those credit cards are paid off and your budget is back in order.

Another thing to consider is whether or not a traditional 401(k) is the best place to be saving early in your work career. Traditional 401(k) salary deferrals allow you to contribute a portion of your income into the account and defer taxes into the future. The benefits of deferred taxes are quite substantial, even if tax rates rise in the future. However, if you are in a low tax bracket, a Roth IRA or Roth 401(k) salary deferral is likely much more beneficial in the long run. While the Roth contribution is taxed today, any gains in the investments will come out tax free later in your life if you meet certain Roth holding-period requirements for qualified distributions. So if your employer does not offer a 401(k) match, and you are early in your work career, you might want to consider forgoing any savings in the 401(k) and instead set up a Roth IRA. Additionally, the Roth IRA has more flexibility with regards to taking withdrawals than an IRA or 401(k). For many people just getting started with their savings, it is a great relief to have some access to their savings in a Roth IRA without having to worry about the additional 10 percent early-withdrawal penalty tax that accompanies most withdrawals from 401(k)s prior to age 59.5. In fact, this can actually encourage someone to save more money because they know they have access to their contributions without penalties.

One last tip relates to your investments at an early age. The simplest idea is that people in their twenties and thirties should be primarily invested in stocks or other high-earning investments. However, for your very first investment, it does make sense to be a little more conservative. Behavioral finance shows that if you pick a super risky investment as your first investment and the value of that investment drops dramatically, like the stock market did in 2008 and shortly in 2020, you could be driven away from making similar investments in the future. As such, it is best to ease your way into the stock market over the first few years of your savings. However, if you are comfortable with the ups and downs of the market, you can start off with more of your investments in equities.

If you just landed your first job, make sure you understand your employer-sponsored retirement plan. If it is a 401(k), find out if there is a company match, and consider deferring enough salary to get the match. However, after you get that company match you might want to consider saving any other money in a Roth IRA if you are in a low tax bracket instead of putting additional savings into the 401(k).

Rewirement Alert

You cannot beat the company match. It is basically free money. Too many people still do not defer enough to get the full employer match in a 401(k). If you have this option, take advantage of it.

Now, once you have accumulated a significant amount of savings and start to near your retirement, the emphasis on accumulation planning will start to switch to decumulation or income planning. It is time for us to take all of those assets you have saved and turn them into a reliable stream of income that can last throughout your retirement and meet your income needs.

Rewirement Mindset Questions

When do you think is the right time to start putting together a retirement income plan?

What is the biggest hole or missing part of your plan today?

What is the biggest fear you have about spending down assets in retirement?

IV. Putting a Retirement Plan into Play

Building a Retirement Income Plan in Ten Steps

“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.”

– Abraham Lincoln, President

Now that we have looked at many of the risks you face in retirement, we can start the process of putting together a plan.

A retirement income plan needs to be comprehensive in nature, taking into account both financial and nonfinancial aspects of your life. There is no way around the fact that retirement income planning is difficult. In order to generate a plan that will meet your retirement income needs, a broad range of factors must be considered. For instance, you will need to review your current situation, determine your retirement goals, estimate your retirement income needs, understand your Social Security options, manage expenses, look at tax issues, and develop a plan to turn your assets into income that will meet your retirement objectives. A well-positioned and developed retirement income plan can improve your financial security without you needing to save another dime toward retirement. There is real value in planning when it comes to retirement income.

While getting a plan set up is difficult because of the breadth and complexity of issues that must be addressed, maintaining that plan over time might be even more difficult. Change is constant and will impact your plan. You could spend thirty or more years in retirement. Pause for a minute and reflect on where you were thirty years ago. Are your desires the same? Would a plan that you set up decades ago work for you today? The answer is probably no.

Take another look at how much the legal, tax, and financial landscapes have changed over the past thirty years. You cannot rely on today’s market and legal forces to remain constant for decades. Today’s interest rates are low, people haven’t saved enough for retirement, employer-sponsored pension plans are a rarity, and people are living longer than ever. However, it’s unrealistic to expect these trends to be the same forever. Interest rates will rise, and the market and world will continue to evolve. You need to be ready for changes and for your own future. Having a process in place to develop a retirement plan is crucial. In this section, a ten-step retirement income plan is provided to help you review your own situation and get on the right path to a successful retirement.

Rewirement Mindset Questions

What led you to start thinking about retirement planning for yourself?

What does a successful retirement look like to you?

What are two things you could do to improve your retirement planning this next year?

IV. Putting a Retirement Plan into Play

Step 1: Evaluate Your Current Situation

“If you don’t know where you are going, you’ll end up someplace else.”

– Yogi Berra, Hall of Fame Baseball Player

In order to figure out where you are going, you first need to know where you are coming from. You need to take a full accounting of your financial, emotional, and personal situation. This information will be crucial in developing an effective retirement income plan. Without good information up front, the plan will not be successful. Putting garbage into the plan creates garbage out of the plan.

First, you will need to take a look at your family situation. Retirement planning is really goals-based planning. Most people structure their goals around their family obligations. You might have a large family where many people depend on you as the bread winner and earner of the family unit. Sometimes you might be needed to provide emotional and constructive support that is nonfinancial in nature. However, in other cases, you might be relied on financially to support a dependent adult child, a sibling, a parent, or other family member. This type of situation can create a real financial hurdle when planning for retirement.

Even if you do not have large familial support obligations, you might find that your retirement happiness will, in part, be driven by spending time with your family. This could determine your living location in retirement and the manner in which you want to spend your time. Relocating to be closer to grandchildren or planning regular long-distance visits to family members might be part of your future. Additionally, strong family relationships often create a desire to leave a legacy, which can include money left to heirs after you pass away.

Besides caring for your children or parents, you also need to take a look at any support you might have to provide to a spouse, partner, or divorced spouse. This can also create financial and emotional hurdles for an individual. Do you still owe support to a former spouse? Will you have to support your current spouse or partner? Do they have any family members that you might have to support, individually or as a couple? While putting together a good overview of one’s demographic data might not seem like the most important step, it is fundamental to envisioning your retirement and generating a comprehensive plan.

Next, you will have to spend some time thinking about yourself. Make a list of the activities you enjoy, the activities you would rather eliminate, the things that you consider important in your life, and the issues that keep you up at night. This personal inventory list will serve as a collection of qualitative information that can help you better understand what you need and want from a retirement income plan.

Finally, you need to put together a complete list of your financial assets and liabilities. Collecting this quantitative data is crucial to understanding your current financial situation. You cannot develop a path to a successful retirement income plan without knowing where your current resources stand. You will likely want to develop a balance sheet that represents all of your assets and liabilities. There are a variety of free online balance-sheet tools that can help you, and you can even do this in a simple Excel file and keep it safely on your home computer. If you do not feel comfortable putting together all of this information, you can go to a financial planner or your accountant to get help.

When setting up a balance sheet, categorize your assets by how available they are for use in retirement. For instance, figure out how much cash, or cash equivalents, you have. Cash equivalents mean anything that can be readily turned into cash in just a few days. Next you should look at your financial assets, which include amounts invested in stocks, bonds, mutual funds, and other investment vehicles. This would include amounts you have saved in your 401(k), IRA, health savings account (HSA), a trust, or other investment-management vehicles. These financial assets are not as readily available, as they are more subject to timing restrictions and sensitive to market considerations. Another important asset category includes insurance products like life insurance, health insurance, disability insurance, long-term care insurance, or longevity annuities.

Next, consider any business interests you own. For example, you might own your own business or own part of a family business. This asset could have tremendous value but might require special planning in order to successfully monetize your business interest wealth. For many small business owners and family-owned businesses, it can be tremendously challenging to liquidate the business and realize the full value of the company.

After accounting for business interests, you need to account for any real property, such as your residence, land, vacation home, or investment property. These assets are not always listed as financial in nature because you often need a place to live so you might not be in a position to monetize your home. For most people their homes tend to be one of their largest assets, even though they do not always have easy access to that value, as homes are a bit illiquid and cannot always be sold immediately for their full market value.

Lastly, you need to consider any tangible or intangible personal property you might own. Tangible property tends to include all of those things you can pick up and move around, such as cars, jewelry, paintings, furniture, and so on. Intangible personal property items can be equally important and represent considerable value. A new type of intangible personal property is causing havoc for retirement and estate planning: digital assets. Do not overlook these special assets as they can cost you a great deal of money if not properly managed. Digital assets are not computers or cell phones but instead all of those accounts that you have stored on your phone, computer, or online. This could be your bank account, PayPal, Bitcoin, Amazon, email, or social media accounts. Some of these accounts feel sentimental only in nature but can have tremendous value. Again, if you are operating a small business or blog, your online accounts could have a lot of financial value.

Even if you do not generate money from your digital assets, failure to account for them and manage them over time could put you at risk of financial loss. For example, if one of the online accounts is hacked, your personal and financial information would be vulnerable. If you own a business, who would have access to the login information and manage those online accounts if you were suddenly unable to do this yourself? Digital assets have real value and need to be considered and properly managed over time.

After you have all of your assets accounted for in the balance sheet, you need to start determining your liabilities, a task that might be even more painful than adding up your assets. No one likes to look at the debts they owe each and every day. The three most common types of liabilities are housing debt, student loan debt, and credit card debt. However, you could have other types of debt obligations such as a business debt, an installment-sale debt obligation, and unpaid utilities or medical bills.

Behavioral Bias Alert

Positivity effect: Research has shown that older individuals tend to remember positive emotions more easily than negative emotions. This can lead to avoiding or ignoring situations that cause negative emotions.

Avoiding the bias: It’s natural to want to avoid situations like debt management or studying your liabilities. But it’s vital to your retirement income planning process. By attacking the situation head-on, you’re likely setting yourself for way more positive emotions in the long run.

In addition to listing your debt obligation, you should also review the reason for the debt obligation. Was it to help grow a business, was it to help go to college, was it an unexpected or uninsured medical event, or was it poor money management? Also of importance is the payment schedule for each debt. Do you have monthly payments, yearly payments, or late charges to consider? The interest rates that accompany these debt obligations are worth noting, too. For instance, the interest rates on credit card debt are usually substantially higher than those on student loans. Credit card rates are going to be higher than what you can reasonably expect as an investment return from the stock market, so you might be better served paying off high-rate debt as opposed to saving more money. However, until you take a look at all of your debt, the reasons for the debt, their payment schedules, and the applicable interest rates, you will not know how to prioritize payments.

Once you have set up a balance sheet of your assets and liabilities, you will be ready to create a cash-flow statement that tracks your income and expenses for at least a month. Ideally you should track every dollar of income and every dollar of expense for a full year. Establishing your income is relatively easy as you have documentation for income sources such as your employer-provided W-2s.

Tracking your expenses, on the other hand, can be more difficult. Your bank account and credit card statements can help you track this information. Some credit card companies and banks even offer a breakdown of your expenditures online as a free service. Take advantage of these services if they are available.

Just seeing how much you spend on a given item in a year can help you reprioritize your goals and spending habits. I had a friend who, at the end of the year, checked her credit card statement, which was broken down into spending areas. She realized that she spent over $3,000 that year on coffee alone! This was shocking to her. The five-dollar coffees didn’t seem like a lot to her at the time of each purchase, but over the course of the year it was a tremendous amount of money. This information motivated her to reevaluate her spending habits and contribute more to her savings by brewing her own coffee. For many people, there are limited options available to increase your income each year aside from the raises you get from your employer. However, you do have much more control on the expense side of your life. A good cash-flow statement can help you identify key spending areas and prioritize your spending accordingly.

Rewirement Alert

Don’t forget to include the value of your home in your plan. Accounting for all of your current assets and expenditures can help you prioritize spending cuts and areas for increased savings.

Action Steps: Gather Data

- Start with how you feel about your finances. How much do you value security of principal? How much do you value avoidance of fees? How much do you want to automate? How much do you want in liquid assets? Do you want inflation protection? Do you want high returns?

- Collect all your financial information. Having everything in one place will help you get started, it’s useful if you are going to seek help from a professional, and it is helpful to your family if something happens to you.

- Keep track of your spending. Pick a software tool that helps make this process simple.

- Create a personal balance sheet and a cash-flow statement with the personal finance tool that you have chosen.

Rewirement Mindset Questions

Do you enjoy budgeting?

Did your parents follow a strict budget when you grew up? How has that impacted you?

If you had to improve your cash flow next year, what would you do?

IV. Putting a Retirement Plan into Play

Step 2: Determine Your Retirement Goals

“Setting goals is the first step in turning the invisible into the visible.”

– Tony Robbins, Life Coach

The second step of the retirement income planning process requires envisioning your retirement. What do you want to be doing? Where do you want to be living? Do you want to have to worry about long-term care, your children, or a legacy goal? Envisioning your retirement is extremely important when setting out a retirement income plan. So many people never really take the time to think about what they want their retirement to be like. Instead, they just find themselves retired, struggling to meet their needs, and searching for meaning. Furthermore, while you might envision one thing for your retirement, your spouse might envision something entirely different. You also might find out that you do not have the retirement assets to fund your desired retirement goals, forcing you to either revise your goals or somehow enhance your retirement savings.

It is often easier to envision the beginning of retirement than the later stages. First of all, the earlier retirement years, or the “go-go” years of retirement, are the closest in time and often represent an active lifestyle. It is during this retirement time period that most people expect to travel, play golf, and experience the joys of retirement. As such, increased travel, activities, and spending must be accounted for in the plan.

Following the “go-go” years of retirement comes a time marked by declining activity and health and other life limitations—the “slow-go” years. This period can still be incredibly rewarding and enjoyable. However, your expectations, planning, and financing need to adjust to a changing lifestyle.

It is the years following the “go-go” and “slow-go” years that people do not enjoy envisioning because it often puts people face-to-face with their own mortality, fears, and suffering. These are the “no-go” years, a time period that requires comprehensive and thoughtful planning because we may no longer be able to take care of ourselves independently, and we may no longer be able to make informed decisions. Instead, we will have to rely upon others while trusting that we have managed our financial assets appropriately and will have sufficient income for the entirety of our lives. This time period is often marked by decreased health to the point where travel and daily activities become challenging. Many people end up needing long-term care services, as they are no longer able to care for themselves. This can be an incredibly expensive time period, especially if long-term care services are needed or a catastrophic healthcare event occurs.

It is important to sit down and discuss your retirement goals. This is your life; make sure you live it the way you want. Be honest and open with your spouse and family members about what you want to do, where you want to live, the people you want to spend time with, and how you want your care delivered if you cannot take care of yourself in the future. If you don’t tell people what you want and you don’t plan for it, no one else will. You will not be able to generate a well-defined retirement income plan without first defining the kind of retirement you expect to live. Take the time to envision your retirement honestly and realistically. A great place to start is by asking yourself the following questions. If you are married, you may want to do this exercise separately and then discuss the answers.

Action Steps: Questions to Ask Yourself

1. When do think you want to retire?

2. Where do you think you would like to live when you first retire?

3. Does work factor into your idea of retirement?

4. If you are going to work, will you continue with the same type of work or choose something different?

5. Is continued work tied more to life meaning, filling your time, or needing the income?

6. If you are not planning on working, what types of activities do you expect will provide meaning?

7. Will you travel extensively in retirement to see new sites or to visit friends or relatives?

8. What recreational activities do you want to do?

9. Do you have family members who rely on you, and how does that impact your retirement?

10. Do you want to go back to school?

11. Do you want to volunteer?

12. Who do you want to spend time with in retirement?

13. Do you have any health issues that might impact your retirement lifestyle?

14. How are you going to stay healthy?

15. If you needed more help later in retirement, would you be likely to move again, possibly to be closer to family?

16. If you needed more help later in retirement, how do plan on getting that help? Would you seek help from family and friends? Where would you get long-term care should the need arise?

Rewirement Mindset Questions

What is a financial goal you achieved in life that you are proud of?

What positive behaviors did you exhibit in achieving this goal?

What is a financial goal you didn’t reach that you could have achieved if you made a behavioral change?

IV. Putting a Retirement Plan into Play

Step 3: Estimate Your Retirement Income Needs

“By failing to prepare, you are preparing to fail.”

– Benjamin Franklin, Inventor

Now that you have looked at how much your life is costing in step one and have identified how retirement may be different, you will be able to estimate your retirement income needs. Essentially, this step is figuring out how large of a paycheck you need each and every month to live your life according to your goals.

There are a variety of ways to calculate your retirement income needs. If you are more than five years from retirement, the ratio-of-income replacement method is the best method to use. This method takes your average gross salary for the past three years and multiplies that by somewhere between 60 percent and 80 percent to give you an expected yearly income amount that you need to meet your goals. This method assumes that you do not need 100 percent of your current income because you are no longer saving for retirement, will maintain the same standard of living, and will see some general lifestyle reductions in retirement. Most people experience lower tax rates in retirement because of decreased taxable income, as a portion of Social Security benefits are not subject to taxation and there is a higher standard deduction starting at age sixty-five. Other expenses related to employment, such as clothing and commuting costs, also tend to decrease. However, you could experience higher costs associated with increased travel and rising health-care expenses. The largest reduction is usually attributed to a cessation in saving for retirement, which should free up about 10 percent of your income per year.

The ratio-of-income replacement method can be a useful yardstick for predicting retirement needs during the years preceding retirement. However, this method will fall short in predicting an extremely accurate account of your retirement expenses. Luckily, there is a far better method once you near retirement: the adjusted-expense method. In the adjusted-expense method, you take all of your annual expenses just before you retire and use that as an estimate of your aggregate expenses for retirement. You need to account for all of your expenses: housing, transportation, food, health, personal items, insurance, recreation, interest payments, entertainment, dining, travel, gifts, and charitable donations.

The adjusted-expense method does need modifications based on your lifestyle, your finances, your own retirement goals, and your current economic conditions. Remember too that your expenses should go down a bit in retirement. However, this does not occur for everyone. Other adjustments could occur if you are expecting to pay off your house in a few years, enter into a reverse mortgage, or downsize. By relocating, you could also significantly change your expenses in retirement. Remember, you cannot predict your retirement expenses with 100 percent certainty, but you can get pretty close by following a process, setting retirement goals, tracking your income and expenses, and reviewing the current economic conditions present when you near retirement.

As discussed earlier, inflation is a huge factor that you need to consider as it removes your purchasing power over time. If you are estimating expenses for your first year of retirement and are a number of years from retirement, it is appropriate to add an inflation factor to this estimate as well. This topic will be discussed further in Step 5.

Additionally, by categorizing your expenses, you can now see where you are spending your money and determine if any of those items are experiencing higher or lower rates of inflation. For example, health-care costs are currently experiencing higher-than-average inflation, while electronics are experiencing deflation.

As you inventory expenses, some will clearly be essential to your lifestyle, such as mortgage payments, taxes, groceries, and medical insurance premiums. Others may be more discretionary, such as how much you dine out or entertain. Others may even feel like luxuries, like a trip to Europe that can be replaced by a less expensive trip to the beach. Making these distinctions may help you begin to identify where you could cut back when necessary. You’ll see in Step 9 that you may also want to choose to fund essential expenses with fewer risky approaches than discretionary and luxury expenses.

Rewirement Alert

Many people mistakenly believe that if one spouse dies that expenses will go down. In some cases, expenses actually go up after the death of one spouse. So, when planning for this contingency, make sure you do not undershoot your expenses.

Action Steps: Estimating Retirement Expenses

Monthly Budget Worksheet

Housing

Mortgage or rent

Real estate taxes

Insurance

Utilities

Other fees and regular maintenance

Telephone and cellphone

Internet and cable

Other

Food

Groceries

Dining out

Coffee

Takeout

Other

Other living expenses

Clothing

Hair and beauty

Other personal care

Health care

All medical insurance premiums

Out-of-pocket costs for health care

Out-of-pocket costs for medication and other supplies

Transportation

Car payments

Insurance

Gas

Public transportation

Estimate other periodic expenses on an annual basis, and divide by twelve for a monthly estimate.

Education

Courses

Books and other publications

Professional dues

Taxes

Federal

State

Local

Entertainment

Tickets

Transportation

Other

Travel

Transportation

Hotel

Meals

Entertainment

Gifts

Other

Gifts

Christmas or other holiday gifts

Birthday gifts

Weddings and other occasions

Home maintenance and improvements

Major home maintenance and repair

Home improvements

Furniture and other home goods

Charity

Gifts to charity

Other expenses

List any additional expenses

Rewirement Mindset Questions

Do you think about your spending as essential vs. discretionary?

What is an expense you could reduce or eliminate today without any loss of quality of life?

What steps can you take today to improve your budgeting process?

IV. Putting a Retirement Plan into Play

Step 4: Identify Your Sources of Retirement Income

“Risk comes from not knowing what you’re doing.”

– Warren Buffet, Investor

One of the most important questions about retirement income planning is Where will your income come from once you reach retirement? Unfortunately, most Americans cannot answer this question. However, the answer is not as difficult as it might first appear. For instance, most Americans have access to several main assets as they head into retirement. First, there is Social Security, which provides the retirement income for the majority of America’s retirees. Second, there is home equity, which is often underutilized as a retirement income source. Third, there are the qualified retirement savings from an IRA or an employer-sponsored retirement plan. And lastly, personal savings can play a significant role. These four assets make up the majority of assets available for retirement income. However, they are by no means the only possible sources as some people have business interests, family wealth, and other sources of retirement income to rely upon.

When you inventory your retirement income assets, you will need to determine the source of income, how much income it can generate per year, the impact of inflation, how long it will generate income, and its reliability. For instance, Social Security is a federal benefit program run through the Social Security Administration and is funded through payroll taxes. Your benefits are calculated based on the number of years you worked, your income in those years, the age at which you collect benefits, and your full retirement age. As such, you can get a very accurate estimation of your Social Security retirement benefits based on different claiming ages. Additionally, Social Security is protected against inflation as it has cost-of-living adjustments. Social Security benefits are also payable for life, with a potential survivor benefit for your surviving spouse.

However, when you discuss reliability, the answer is not so clear today. Sometime around the years 2033-2034, Social Security is only expected to be able to pay 77 percent of promised benefits. So for some people, you might consider calculating a reduction of benefits into your income source when discussing Social Security. Additionally, Social Security is going to continue to change over the next few years. In 2015, a substantial bit of federal legislation was passed that removed so-called aggressive claiming strategies. Most specifically, the traditional file-and-suspend strategies have all but been eliminated.

If you are asking yourself, “How do I know what my Social Security benefits will be?” Social Security does mail out benefit statements every five years. In addition, you can check your projected Social Security benefits by setting up an account online. It is important to check your benefits each year to make sure that your earnings are correctly tied to your benefits. If you wait too long, you could lose the right to verify and fix your benefits based on your actual earnings. So make sure you keep up with your benefit statements. If you are married, consider maximizing the survivor benefit. The survivor is entitled to the higher of his or her own benefit or the survivor benefit. This means you usually want to defer the largest benefit between two spouses until age seventy, to maximize the survivor benefit in the event of the first spouse passing away.

In contrast to Social Security retirement benefits, employer-provided retirement income sources are very different. For example, while a defined benefit plan from your employer will also offer a lifetime benefit that is easily calculated, the benefit will not likely have any cost-of-living adjustments, leaving the benefit subject to a decline in purchasing power over time. However, these benefits are still very secure. In fact, they are prefunded according to federal law and are secured by an insurance program from the Pension Benefit Guaranty Corporation (PBGC).

If you have a 401(k) or other type of defined contribution plan, your benefits will be significantly different than those of a defined benefit plan. While they are both employer-sponsored retirement plans, most defined benefit plans were designed to help you replace a portion of your income in retirement and most almost always offer payment in the form of a lifetime annuity. If you are married, the required benefit must be offered as a 50 to 100 percent qualified joint and survivor annuity.

A defined benefit plan may also give you the option to elect a lump sum payment. Choosing the annuity can mean having an excellent base of income that, along with Social Security, can meet your basic income needs for your entire lifetime. It also allows you to be comfortable taking more risk with your other investments. Retirees are often tempted to take the lump sum, and a large percentage do when they are given the option. Be cautious before taking the lump sum—the pension annuity payment is generally larger than what can be purchased outside the plan, and if you decide to invest the lump sum, it means taking the responsibility and risk of choosing investments and determining how much you can withdraw each year.

Rewirement Alert

Too many people take the lump sum option from their employer plan so they can have access to the money. Instead, think about how it will impact your retirement security. The annuity option could be a much better financial deal for your retirement income plan.

Defined contribution plans, like your 401(k), are more difficult to manage for retirement income. You essentially have to make your own defined benefit plan. At retirement, your 401(k) plan will likely be distributed to you in the form of a lump sum. While some 401(k) plans offer other forms of payout, they are rarely exercised by the plan participants. This does not mean taking the lump sum is the correct decision. You should review all of the distribution options to see how they fit into your overall retirement income plan. In some cases, the annuities offered in a 401(k) are better than anything you can buy on the open market. Also, if you are in need of more guaranteed retirement income, an annuity distribution option from your 401(k) might be beneficial. For others, the annuity is safer and simpler because you will not need to continue to manage your investment portfolio, and you will not have to take distributions each year to meet your needs. For someone early in retirement, managing investments might seem doable, but will you still want to do that or even have the mental acuity to do that when you are ninety?

In addition to your qualified plan assets, your largest personal financial asset will likely be your home. However, you cannot always list this as a financial asset or a retirement income source. This might bother you at first because you have probably put a lot of money and savings into your home. However, you will always need a place to live in retirement, and this will likely be funded in part by your home equity. Homes are often not good investments, but they are usually a better investment than renting or paying for housing services. Home values in the United States tend to adjust for inflation but do not otherwise show any other returns. However, this does not mean that buying a home is a bad idea. Owning a home can provide much needed peace of mind and a sense of pride, while at the same time reducing housing expenses. Additionally, if used properly, home equity can be an incredibly valuable source of retirement income.

Just remember to start thinking about how you might use your home equity strategically to support your retirement income needs. Are you planning on leaving all the value in your home and passing it as a legacy asset to your children? If so, you might want to ask yourself and your children if they want the home. Or are you going to downsize and sell your home early in retirement, freeing up some of the home equity to spend on other goals? As discussed earlier, reverse mortgages can be an incredibly valuable tool for generating retirement income. Most importantly, think about your house as an asset. Make your house work for you in retirement. Far too many people leave their home equity untouched throughout retirement and never realize the potential that it holds to generate income and still provide a place to live.

A reverse mortgage, simply put, is a mortgage that does not have to be repaid until you and your spouse permanently leave the home. It can be used a number of ways. Those with conventional mortgages in retirement can reduce monthly expenses by paying off the existing mortgage with a reverse mortgage. You can also take a line of credit, which can be saved until there is an emergency or to generate income instead of selling other assets when the market is down. Another option is to receive a stated monthly payment for as long as you remain in the home. A reverse mortgage can also be used in part to purchase a new home in retirement.

Rewirement Alert

Don’t just think of your house as a place to live. Consider it an income source, long-term care funding tool, or legacy asset.

Lastly, make sure you add up all of your other individually sourced assets. Make sure you are paying attention to your IRAs, bank account savings, bonds, business interests, collectables, and insurance products. Make sure you are protecting and properly managing all of your assets.

As our lives become increasingly digitalized, new risks are developing that challenge traditional asset management and retirement planning techniques. For instance, someone can now steal your money from a bank without ever stepping into a vault. Online fraud and theft are at an all-time high and are expected to continue to grow at a rapid pace. Additionally, as people spend more of their personal time online and more businesses offer digital services, the management and disposition of digital assets is becoming increasingly complex and important. A decade ago, few business executives were concerned about their digital assets or a digital estate. However, this has changed. Digital assets, if not properly managed, can endanger the strategic plans of their employers, the coworkers who depend on the success of the employer for their own wellbeing, and their personal beneficiaries. As such, forgetting about valuable online assets can lead to financial loss, lawsuits, complications due to theft or fraud, or a lost source of retirement income.

Digital assets are not your computer and cell phone; they are all of the information recorded and stored on those devices. For some people, digital assets are primarily sentimental in value. For example, personal photos, social networks, video games, and email correspondences are worth little monetary value on the open market. However, if you are an executive in a large corporation, running a small business, or blogging online, your digital assets could be worth a tremendous amount of money. This can be a challenging area of the law and business-succession planning, so you might want to consider consulting an attorney who can help you maximize your online wealth. This might be selling a website or transferring ownership of a digital asset. However, all digital assets cannot be transferred, so it’s important to take a look at what you are allowed to do. Certain digital assets like Bitcoin and PayPal accounts have clear financial values and should be protected accordingly. You will also need a strategy to convert financial assets like cryptocurrency into retirement income.

Cryptocurrencies, like Bitcoin, will continue to grow in popularity and usage. However, as an investment they are very risky. Instead, putting money into a cryptocurrency is more like speculating on increased adoption of that specific crypto. This is hard, if not impossible to predict with any certainty. So, while I am favorable of having some assets used as a speculative fund, it should be small, between 1 and 5 percent of your investment portfolio. The idea is, what can you stomach going away completely? If you can’t handle losing 5 percent of your wealth, then don’t speculate.

Over the last few years Bitcoin and other cryptocurrencies have risen in popularity and value. There has been research showing some investment in these can provide beneficial risk adjusted returns. However, these still remain very volatile assets. I personally believe in digital currencies and their use case. However, there is vast disagreement as to what role they play in storing wealth, investing, and diversification. Before you start investing in cryptocurrencies make sure you learn about the assets, their taxation, and have clear goals for these assets in your plan. Additionally, make sure if you own digital assets like Bitcoin you are properly storing and protecting them. The storage of the Bitcoin keys are crucial to protecting these assets from loss. Additionally, estate plans should be updated for any digital currencies or cryptocurrencies you have to ensure proper transfer upon incapacity or death.

You need to have a good understanding of the income sources available to provide you with your retirement income. Once you have accounted for the assets you own, make sure you are protecting them and maximizing the income from each source to meet your needs. As technology, businesses, and economic trends change, your income sources could change also, so pay close attention to your assets—they are the source of your future retirement paychecks!

Action Steps: Identify Potential Retirement Income Sources

1. Estimate Social Security benefits based on what age you expect to claim.

2. Estimate your home’s market value, reduced by the outstanding mortgage, to determine available home equity.

3. Inventory all employer-provided projected monthly retirement benefits from current or prior employer-provided defined benefit plans.

4. Calculate the current account balances in any defined contribution plans, as well as current contributions that you and your employer are making, to project your benefits at retirement.

5. Add up values of all IRA and Roth IRA accounts, and estimate future contributions in order to project your benefits at retirement.

6. Inventory the current value of any deferred nonqualified annuities (outside of your IRA or other tax-advantaged retirement plans), and identify estimates of future premium payments.

7. Inventory any projected income payments from any deferred income annuities that you own.

8. Add up all other personal savings that you are likely to use to fund retirement needs. This can include investment accounts, savings and checking accounts, and values of any emergency funds. Again, estimate any additional savings that you expect in order to project the value of these accounts at retirement.

9. Identify and estimate the value of any direct business interests (including real estate investments) that you have—you may be anticipating ongoing income from these interests or proceeds from the sale of these business interests.

10. Executives may have additional benefits that they are entitled to from deferred compensation plans or equity-based programs.

11. Identify the value of any collections or other personal property that you are expecting to sell to support your retirement needs.

12. Look at any cash value life insurance policies that you have and determine the value of any death benefits as well as the cash value of the products.

13. Low-income individuals may be eligible for Supplemental Security Income (SSI) in addition to Social Security benefits.

14. Review any long-term care insurance policies to identify the available pool of supplemental income that will be available when long-term care is needed.

15. Counting on future inheritances as a retirement resource is generally not a good practice, unless there is a high degree of certainty that the inheritance will be received.

16. Identify whether there are digital assets that will be sold to support retirement needs.

17. Values in any health savings accounts (HSAs) can be withdrawn tax free to pay medical expenses currently or in retirement.

18. Part-time work can be an important source of income in retirement. Be realistic about the possibility of working and about how much you will earn—statistically the percentage of pre-retirees that report that they will work in retirement is much higher than the actual percentage of retirees that work.

19. Individuals in sales positions may be entitled to residual sales commissions for a period of time after they stop working.

Rewirement Mindset Questions

If you passed away tomorrow, would your loved ones be able to find all of your assets?

Are there any financial investments that you have today that you do not know how they will fit into your retirement plan?

What is the biggest risk you can identify as it relates to your current retirement income sources?

IV. Putting a Retirement Plan into Play

Step 5: Calculate Financial Preparedness

“Cessation of work is not accompanied by cessation of expenses.”

– Cato, Philosopher

People often ask me about the amount of savings needed to be ready for retirement. Unfortunately, as discussed earlier in this book, there is no magic retirement savings number. So while having $1 million or $2 million, or ten times your salary saved is nice, it’s not something that guarantees a secure retirement. While these rules of thumb can be helpful as a general guideline, they fall short in determining if someone is really financially prepared for retirement. Your retirement income security depends in part on how much you save, but it also depends on many other factors, some of which you can control and some of which you cannot control. For instance, you will have some control over when you retire, but you will have no control over the inflation rates you experience during retirement. In order to figure out if you are financially prepared, you will need to calculate the amount of income you will be able to generate in retirement.

In order to calculate this number, you will need to make several assumptions. Furthermore, to get a more accurate calculation, you will likely need to utilize a retirement income software program or calculator. The good news is that there are a lot of user-friendly and free online calculators. Most financial institutions, banks, and investment companies now offer some type of online retirement income calculator. For instance, Vanguard, BlackRock, New York Life, and MarketWatch all offer free retirement income tools. Now these free tools vary in their level of sophistication and will often use different assumptions in their calculations. This means your projected retirement income might vary from one calculator to another. If you are looking for a more sophisticated retirement income program, there are a variety of programs out there like Income Discovery, MoneyGuidePro, or Moneytree. Just remember, when using any software program, the output is just a projection and is only as good as the assumptions and numbers you enter. Garbage in, garbage out!

So what are the assumptions and the factors you need to consider? Many software applications will have built-in assumptions for a number of variables. However, it is likely you will have to modify some of them in order to tailor the calculation to your situation. First, you need to put in an accurate account of all the resources that could provide you retirement income. This makes the work you did earlier in your planning even more important! Without an accurate list of potential income sources, there will be no way to calculate your projected retirement income. So remember to put in Social Security, your 401(k), IRA, annuities, home equity, personal savings, business interests, and any other potential sources of retirement income.

Next you will need to decide on a projected retirement date. This is a very important decision, and while you will not have full control over the exact day you retire, you will likely have some control over when you retire. Some people are forced into early retirement due to declining health, corporate downsizing, or family responsibilities. However, most people are able to retire on their own terms. When you retire is an important decision with regard to your retirement income security. Just working a year or two longer can make all the difference in the world. In fact, working a year or two longer will have a much bigger impact on your retirement income security than saving an additional 5 percent of your salary for the last five years of your employment. When it really comes down to it, the question of when you should retire is the single most important retirement decision you will make.

About 45 percent of people retire earlier than they expected to, about 45 percent of people retire when they expected to, and about 10 percent of people retire later than they expected. This means it is just as likely you will retire earlier than you expected to as it is that you will retire when you expect to. With that in mind, you need a contingency plan for an earlier-than-expected retirement date. Run the software calculations based on when you plan on retiring, and then run it a few more times and see what happens to your retirement income security if you have to retire two or three years earlier than planned.

Rewirement Alert

Far too many people get forced into an unexpected early retirement. You must plan for this possibility.

Figuring out when you are going to retire is the starting point. You will also need to figure out how long your retirement is going to last. This is really the longevity or life expectancy assumption that we discussed earlier. In a lot of ways, this is a much more challenging questions than when you will retire because you have far less control over your longevity. An uncertain retirement period creates unique challenges for retirement income planning. At some point, you will typically need to liquidate some of your assets to help meet your expenses. However, the rate at which you can liquidate those assets depends heavily on how long they need to last. By vastly underestimating or overestimating your life expectancy, you might not be able to meet your retirement goals. For instance, if you underestimate your life expectancy you will likely deplete all your savings well before you pass away. On the flip side, if you overestimate your life expectancy, you might end up holding on to too many assets and not enjoying increased spending while you are alive.

Determining your life expectancy might not be the most enjoyable activity you undertake when planning for retirement, as it brings you face to face with your own mortality and presents potentially difficult family situations. Life expectancy tables can be used to help you in your calculations. For retirement planning, it is more appropriate to measure life expectancy from the current age of an individual than the life expectancy of the person based on birth date. For instance, a person who is sixty-five years old has a much longer life expectancy at age sixty-five than they would have had when their life expectancy was estimated at the time of their birth. Today, someone at age sixty-five has roughly a 25 percent chance of living to age ninety and a 10 percent chance of living to age ninety-five. Unfortunately, most people tend to underestimate their own life expectancy.

If you are planning for yourself and your spouse, remember that the joint life expectancy of a couple is longer than the individual life expectancy of one person alone. You should look at a joint life expectancy table to get a more accurate projection. Social Security does provide free life expectancy tables online. In addition, Social Security provides a free online longevity calculator to help you project your life expectancy. Additionally, the Society of Actuaries also publishes a life expectancy table that is a bit more accurate. So, you might want to check out how long these tables say you have left! I know—such a fun endeavor. But remember, the tables only provide the average.

Other factors should be considered when determining your projected life expectancy besides just your age and available mortality tables. For instance, you should review the actual life spans of your parents and grandparents. This can help give you a general understanding of longevity in your family. Additionally, you should look at your health. If you have a history of major health issues, you might be inclined to lower your life expectancy and increase your expected retirement health-care expenses. Those in good health who are living a healthy lifestyle may want to raise that life expectancy number. Also, take into consideration your socioeconomic standing. People in higher socioeconomic groups tend to have longer life expectancies, in part due to better health-care systems and better access to preventative care. Use the available statistical life expectancy information to help get a starting point, then adjust your life expectancy up or down based on personal factors like family history, health, lifestyle, and socioeconomic status.

The next factor is determining how much income you will need in retirement. We tackled the issue of estimating the first year’s income need in retirement in Step 3, but in a retirement calculation, expenses must be projected throughout retirement. Part of this exercise requires an expectation about inflation. Inflation is really a measure of how the increase in the cost of living will erode your purchasing power over time. The concept is simple: a dollar today is worth more than a dollar tomorrow.

Since the year 2000, inflation has remained very low in the United States. However, when choosing an inflation assumption for your calculation, you should pick a long-term inflation number as opposed to the current year’s inflation rate or even the average inflation rate of the past ten years. Historically, inflation in the United States has averaged around 3.25 percent. However, we have seen thirty-year periods in the United States when inflation was 5 percent on average. During other periods, the inflation rate averaged just 2 percent. A risk-averse individual might want to assume a higher rate of inflation, somewhere in the 3.5- to 5-percent range when calculating their retirement expenses. However, others might feel more comfortable with a lower rate.

In addition, there are other factors to consider. For instance, inflation is not consistent across the country. Regional inflation rates might differ drastically from the national rate. Furthermore, you need to consider your own specific spending habits and the spending habits you expect to have in retirement. For a number of years, retirees have experienced higher-than-average inflation on their goods and services. The main reason has been that health-care and long-term care costs have risen faster than the average inflation rates. Because retirees spend more of their money on health and long-term care services, they are experiencing higher than average inflation rates. A more sophisticated software tool will allow for modeling different inflation rates for different expenses.

One countervailing consideration here is that some data shows that retirees do not tend to increase their spending to keep up with inflation during retirement. The spending pattern can change later in retirement, however, as costs may increase as additional care is needed. Having at least some changes in spending over retirement makes perfect sense, as life can change significantly as retirees age. Again, software programs often allow adjustments in spending over time. These predictions are difficult, but there are a couple of adjustments that may be appropriate when planning to address this issue.

- Choose a slightly lower inflation rate to reflect a reduction in spending in retirement.

- Choose a 20 percent reduction in spending after a certain age or after the death of a spouse, with the expectation of life being more sedentary.

- Choose an increase in spending later in retirement to reflect the need to pay for additional care—another option is to disregard the additional spending if long-term care insurance is likely to cover the additional expenses.

Even when calculating our retirement income needs, we cannot escape Benjamin Franklin’s infamous words, the only thing certain in this world is death and taxes. As we have already addressed death in the form of life expectancy, we must now address taxes. When generating retirement income, it is likely that at least a portion will be taxable. For example, distributions from IRAs, 401(k)s, and defined benefit plans are normally tax-deferred savings and will be taxable upon distribution. Other income sources like annuity payments will likely be partially taxable and partially a return of your cost basis (what you paid into the annuity). As much as 85 percent of your Social Security benefits are potentially taxable. So to more accurately determine how much income you will have after taxes, you need to make another assumption: your projected retirement tax rate.

It is also prudent for me to mention that tax laws change. In fact, at the end of 2017, we saw one of the largest tax code changes and corporate tax cuts in U.S. history passed into law. However, many of the changes go away in 2025. So for a few years there will be a lot of tax law uncertainty. But, you play the game by the rules you have in place. So, today, you have to deal with the tax laws that are here now. I guess the good news is that at least the CPAs and tax attorneys are happy?

This tax-rate assumption is a very difficult number to pin down because tax rates evolve and change drastically over time. As I have said before, retirement income planning is like shooting a moving target in the wind. Tax laws, like the wind, can change at a moment’s notice. When determining your potential tax rate, you need to consider both federal taxes and state taxes. For instance, certain states do not tax military retirement benefits nor do they tax qualified retirement plan distributions like your 401(k). However, other states tax both distributions. Property taxes and state deductions can also vary dramatically. So if you are planning on relocating in retirement, you will need to examine the local tax rules to see how they will impact your retirement income. Unfortunately, even the most complex software will only be able to provide a rough estimate of your future taxes. Taxes change every year and will continue to change. You will need to stay on top of new tax laws so that you can understand the impact that they will have on your plan.

There are strategies to reduce your potential tax liabilities. For instance, using life insurance as a retirement income source and taking withdrawals from the cash value will not result in taxable income in most instances. Additionally, proper use of a Roth IRA can help lock in taxes today, hopefully at a lower rate, and reduce your taxable income in retirement. Other planning tools like health savings accounts (HSAs) and long-term care insurance can help provide funding for your medical and long-term care costs without resulting in taxable income, as qualified distributions from both the HSA and long-term care insurance are income tax free. Lastly, a reverse mortgage is a loan and is not considered taxable income. As such, if you are concerned about future tax rates coupled with the belief that the United States is in a rising tax rate environment for the foreseeable future, you can take advantage of a variety of planning tools to reduce this risk.

Diversify your investments among accounts with different tax attributes. For example, use a mix of Roth accounts, tax-deferred accounts like an IRA or 401(k), and some investments in after-tax accounts like an investment brokerage account. Also, to the extent possible, hold bonds and income sources taxed as ordinary income in tax-deferred or Roth accounts.

Rewirement Alert

Don’t think all investments and advisors are created equal as fees range dramatically. Remember, you don’t get what you pay for in fees! Fees bring down your returns over time. That is not to say the advisor doesn’t add value above their fees (they better), but still shop around even if it’s not fun.

In addition to taxes, high investment fees can also reduce your available retirement income. Now, don’t mistakenly believe that you need to avoid all investment fees. Fees can provide value, so focus on the value you get for your fees as opposed to focusing solely on the amount of the fees. As such, if you are working with a financial advisor, retirement income professional, or investment manager, make sure you understand how they are compensated and how the fees impact your future retirement income.

The last assumption you need to consider is your rate of investment returns. The returns you experience on your retirement assets will be crucial to determining how long you can make your retirement income last. Historical investment returns are often used to help predict future investment returns. However, remember that past performance does not guarantee future performance. So while a similar portfolio of investments might have averaged 8 percent historically, it is not guaranteed the investments will return 8 percent for you moving forward.

In the past there was a tendency to invest more and more conservatively as you age. However, this approach should be tempered somewhat in light of new research. The best investment practices have moved away from super bond-heavy and conservative investment strategies for retirees. What we see now is that super conservative investment strategies give up too much return over time and put the retiree at a higher risk of running out of money. Considering this, your investment allocation should remain somewhat steady throughout retirement. Common asset allocations consist of 70 percent in stocks and 30 percent in bonds. Even a conservative investment portfolio might be near 50-50 stock to bond allocation. However, there are people who like the security and reliability of guaranteed income sources and stay away from the market completely.

Retirement Income Calculation Assumptions To Consider:

1. Sources of retirement income (financial assets)

2. Retirement date

3. Life expectancy

4. Income need

5. Inflation

6. Tax rates

7. Investment fees

8. Investment returns

Remember that your investment allocation should be specifically crafted to satisfy your own level of risk tolerance and your own retirement income objectives. One effective strategy to improve the longevity of your investment portfolio is to reduce your equity allocation investments during the last two years of your employment and during the first two years of retirement. By being a little more conservative during these years, you can help avoid the risk of a large market drop close to your retirement date. Remember that bond funds are not the same thing as bonds! Even in a low interest rate environment, bonds can play an important role as they provide a guaranteed investment return. A 2 percent return might not sound good when compared to the stock market in the long run, but a 2 percent return seems fantastic when a situation like 2008 occurs and the market drops 30 percent in a year. Ultimately, your investment-return assumption will be driven by your specific combination of investments.

Action Steps: Calculate Whether Your Plan Is on Track

- Review the software programs mentioned in this step, as well as other programs available to you through work or other means.

- Choose a program and calculate whether your plan is on track.

- Run the numbers with a range of assumptions about when you will retire, inflation rates in retirement, and the return on your investments.

- Consider using at least two different calculators as programs differ in how they calculate the results.

- Recalculate whether your plan is on track at least once a year.

Rewirement Mindset Questions

What would you rate your retirement plan on a scale of 0 to 10?

What does it mean to you to have a plan that is on track?

Do you get enjoyment out of doing retirement planning or reviewing your plan?

IV. Putting a Retirement Plan into Play

Step 6: Develop a Strategy to Address Any Shortfalls

“The root of all evil isn’t money, Rather, it’s not having enough money.”

– Gene Simmons, Musician

Once you run the software and compare your potential income to your expected retirement expenses, you will better know if you are financially prepared for retirement. Many software programs give you a percentage for success, meaning you have enough money to meet your needs based on your assumptions and historical data. You might find that you have a retirement income shortfall 100 percent of the time or only 5 percent of the time. In either case, it is possible that you do not have enough income sources to meet all of your retirement goals and expenses. Now the real question is, if you have a retirement income shortfall, are there any options available for you to address the shortfall and still meet your retirement goals?

If you have enough time before you are planning on retiring, you could save more money. However, as you near retirement, this strategy will be less and less effective. Saving money for retirement at an early age will have a much bigger impact than saving money in the few years just prior to retirement. You can also be more efficient with your savings. This means taking advantage of the tax benefits offered by the federal government. When saving for retirement, utilize the tax deductibility of salary deferrals in your employer-sponsored plan and in a traditional IRA to get a better bang for your buck. Saving on a tax-deferred basis will generally result in much higher savings in the long run than saving on an after-tax basis. Be smart and use the tax-advantaged savings options available to you.

Sometimes all your plan needs is a careful rebalancing of your investments. Perhaps you have too many safe investments like bonds in your portfolio. By moving to a more heavily stock-weighted asset allocation investment strategy, you can increase your retirement income and your retirement security without having to save any more money, though you would likely be adding risk. Additionally, you might have the right bond-to-stock ratio, but you could be too heavily invested in one company. Again, a rebalancing of your investment portfolio to a more diversified allocation could do wonders for your retirement income.

Take a look at why you have a retirement income shortfall. It could be because you don’t have enough money saved, you are retiring too early, or you are spending too much. Make sure you have not left yourself exposed to a risk that could potentially undermine all of your hard work and planning. For instance, your plan might fail because you project a three-year long-term care event near the end of your life. This long-term care event could cost hundreds of thousands of dollars. As such, maybe you will be better off with insurance to help cover the risk that is undermining your plan. This means you might have enough assets to have a secure retirement but that you need to reorganize them a bit and shift some of the risk to an insurance company.

If you have a shortfall, there might be very little you can do to improve your retirement income. In that case, you will need to focus on the expense side of the equation. This might mean rethinking your retirement goals. Perhaps you can’t join the country club you want or take as many international cruises. Perhaps you need to downsize sooner than you anticipated. There is a lot you can do on the expense side without giving up those things that provide you happiness and enjoyment in retirement. Reducing expenses can help make your money last longer and can improve your retirement income security.

Action Steps: Consider How You Can Improve Your Retirement Security

In this and previous steps, we have talked about ways you can improve your retirement security prior to retirement. It’s a good time to stop and ask yourself these questions to see what else you can do.

Saving More

- Do you have a savings plan at work? If so, do you contribute enough to receive the full employer-matching contribution? If you contribute enough to receive the match, do you take advantage of the opportunity to either contribute more or contribute to a Roth IRA?

- Are you self-employed? If so, have you established your own retirement plan, which can be a Simplified Employee Pension Plan (SEPP) or a solo 401(k) plan?

- If you don’t have a savings plan at work, do you contribute to a traditional IRA or Roth IRA?

- If you have a high-deductible health insurance plan at work, do you contribute to an HSA account?

Spending Less

- Have you looked into relocating to a place that could reduce retirement costs?

- Have you evaluated if you are spending on items that don’t really mean much to you?

- Are you making the most of your money, looking for bargains and good deals?

Working Longer

- Are you maintaining your employment skills and professional network if you choose to continue to work?

- Are you managing stress through sufficient vacations to avoid burnout at work?

- Are you paying attention to maintaining your health so that you can continue to work if you choose to?

- If you are planning to work part-time in retirement, have you given thought to what you may do?

Deferring Social Security

- Have you looked into the impact of deferring Social Security benefits? Have you tried using the Consumer Financial Protection Bureau Social Security claiming tool?

- Have you considered how you would meet your income needs if you retired and decided to defer receiving Social Security benefits?

Improving Investment Performance

- Have you evaluated your investment mix and investment performance recently?

- Have you read about or talked to a professional about whether your investments are appropriate given your age and retirement objectives?

Rewirement Mindset Questions

What have you done in the past year to improve your retirement situation?

What can you do in the next year to improve your long-term financial situation?

How concerned are you about changes to Social Security?

IV. Putting a Retirement Plan into Play

Step 7: Develop a Tax-Efficient Withdrawal Strategy

“No government can exist without taxation. This money must necessarily be levied on the people; and the grand art consists of levying so as not to oppress.”

– Frederick The Great, General and King

Let’s be honest. No one likes paying taxes. But governments need the money to function. However, you do not need to pay more taxes than legally required. In this step of the retirement income planning process, you need to focus on developing a tax-efficient withdrawal strategy, which can save you thousands of dollars. It does, however, require understanding a myriad of federal tax laws and the way each one interrelates to your retirement plan. In order to develop an effective tax-efficient withdrawal strategy, you will need to be aware of the applicable federal and state taxes, understand the impact of required minimum distributions, consider the tax benefits of a Roth IRA conversion, and review the impact of your distributions on the taxation of your Social Security benefits.

Developing a tax-efficient withdrawal strategy can be challenging and often will require the help of a CPA and a financial advisor. If you have multiple types of retirement savings vehicles, a 401(k), IRAs, Roth IRAs, and a brokerage account, you will need to develop a strategy for turning these assets into income in a tax-efficient manner. Certain accounts like deductible IRAs and 401(k)s are often tax-deferred accounts that allow you to take a deduction for contributions when you fund the account and avoid income taxes on investment growth until you take a distribution in the future.

Other accounts, like an investment brokerage account, are taxable accounts funded with after-tax dollars. This means you already paid taxes in part but still owe taxes on investment gains. In some cases, you will owe taxes each and every year, and in other cases you will owe taxes just when you sell the investment. There are some tax-exempt accounts, like an HSA, which means you will never pay taxes on that money as long as you use it for a qualified health-care expenditure. Additionally, you might have a Roth account of some type, either in a 401(k), 403(b), or Roth IRA. Roth tax treatment is a little bit different. These accounts are funded with after-tax dollars, but the growth, as long as it is a qualified distribution, comes out tax free. If you have a mix of these accounts, you will likely need to do some tax planning to minimize your taxes and maximize your income.

The primary purpose of a tax-efficient withdrawal strategy is to improve your retirement income by extending the longevity of your retirement assets, both through decreased taxes and increased investment gains. A good tax-efficient withdrawal strategy will be uniquely developed for each person or couple to meet their needs and will reflect the complexities of their specific retirement accounts. Additionally, a tax-efficient withdrawal strategy needs to be nimble enough to react to changes in current tax law and an individual’s tax situation in a given year.

In order to develop a tax-efficient withdrawal strategy, you need to look at your list of potential income sources that you laid out earlier in your plan. Next, you need to look at the amount of income you need each year. After you know how much income you need, take a quick look at your future guesses for tax rates. Now you can make some decisions on a tax-efficient withdrawal strategy and determine which accounts you will withdrawal from first. As a general principle, it is best to take withdrawals from taxable accounts first—your brokerage accounts. Withdrawals from tax-deferred accounts should come next, and lastly, use up your tax-free or Roth accounts. However, in any given year you might decide to take withdrawals from all three types of accounts.

Not surprisingly, the decision of where to take withdrawals and when to take withdrawals is often driven by your federal income tax rates. Distributions from your taxable accounts, Social Security, pensions, 401(k)s, and IRAs are taxed as ordinary income. Other investment income, such as interest, dividends, and capital gains, will also be subject to federal income taxes, some at capital gains rates and others at ordinary income rates. Because of that, you will need to be aware of your current income tax rate and know how large of a distribution you can take as income each year before you are backed into a higher tax bracket. For example, let’s say you are married, filing jointly, in 2021 and have $80,250 of taxable income. Any dollar you earn over that amount will now be taxed at 22 percent for federal income taxes as opposed to the 12 percent rate you had enjoyed before. This additional 10 percent in taxes could be a big deal, especially if you didn’t need the money in that particular year.

There is another federal tax you want to be aware of when planning for retirement income: the Net Investment Income Tax. This relatively new tax took effect in 2013 and applies an additional 3.8 percent on the lesser of your net investment income, or the amount of modified adjusted gross income (MAGI) you have over a federally established threshold amount. In general, investment income includes things like interest, dividends, capital gains, nonqualified annuity payments, and rental income. The thresholds are $250,000 for married filing jointly, $145,000 for married filing separately, $200,000 for single and head of households, and $250,000 for a qualifying widow(er) with a dependent child. These thresholds are not indexed, so they will remain the same for future years unless Congress enacts new legislation, which has been debated in recent years. While 401(k) and IRA distributions are not investment income for purposes of the tax, they could increase your MAGI, and therefore subject some portion of your retirement income to this additional tax.

Another big tax issue is the section 72(t) early-withdrawal penalty taxes that apply to the taxable portion of distributions from qualified retirement plans. Generally, if you take a withdrawal from an IRA, 401(k), or other retirement plan prior to age 59.5, you will be subject to an early-withdrawal penalty tax of 10 percent. Now, there are a variety of exceptions to this 10 percent penalty tax. For instance, the 10 percent penalty usually just applies to the taxable portion of the account. So if you have a Roth IRA, you can withdraw your own contributions tax free without having to worry about the 10 percent penalty tax. However, if you also withdraw gains, you might have to pay the tax.

For IRAs there are a variety of exclusions from the tax: (1) age 59.5, (2) death of the owner, (3) total disability of the owner, (4) qualified education expenses, (5) substantially equal periodic payments, (6) $10,000 first-time home-buying expenses, (7) to pay off an IRS levy of the plan, (8) qualifying medical expenses, and (9) Roth conversions. The rules are slightly different for a 401(k) or other qualified employer-sponsored retirement plan, as you cannot use the money for home-buying expenses or for qualified higher education costs. Additionally, there is an exception for withdrawals from a qualified employer-sponsored retirement plan that lowers the 59.5 age requirement to age fifty-five if you leave service with the company in the year in which you reach age fifty-five or later. However, if you roll your employer-provided plan into an IRA, you are back to the age 59.5 rule as opposed to the age fifty-five rule. Remember, this 10 percent penalty tax applies to the entire taxable portion of the distribution and is added right on top of your normal tax rate. If you are going to take a distribution from a retirement account before the age of 59.5, you need to be aware of the 10 percent penalty tax and plan accordingly.

If you need money from your retirement accounts before age 59.5, consider using a strategy called substantially equal periodic payments (SEPPS), which requires you to take close to equal distributions from the account for longer than five years or age 59.5 to avoid the 10 percent early-withdrawal penalty tax.

Rewirement Alert

Relocating can be a powerful tax saving strategy in retirement. Don’t forget that some states do not tax IRA, Social Security, or pension income. You could be saving thousands of dollars a year by moving to a new state.

There are two big issues in addition to your federal income tax rates that must be examined. First, you should understand the impact of required minimum distributions, and secondly, you need to be aware of the Social Security tax torpedo. Both of these topics highlight the importance of having a tax-efficient withdrawal strategy in place for your retirement income plan.

In the year in which you reach age 72 and in each year afterward, you are subject to required minimum distributions (RMDs) from your qualified retirement accounts such as your 401(k) and IRAs. However, you do have the ability to defer the first year’s RMD until April 1 of the following year. While there are a few exceptions to the RMD rules, if you are still working and active in your retirement plan, the general idea is that the government wants you to take withdrawals from your tax-deferred accounts and spend down the assets over your life. A failure to meet your RMD results in a 50 percent excise tax on the amount that is not distributed. In order to calculate your RMD for a given year, you take the previous year’s account balance that is subject to RMDs and divide that balance by the remaining number of years in your life expectancy. At that point, you will need to withdraw that amount from the account by the end of the year. The distribution will likely be treated as ordinary income and be subject to income taxes. Additionally, a large distribution could force you into a higher tax bracket rate.

An RMD could also increase the amount of your Social Security benefits that are subject to taxation, thereby costing you thousands of dollars a year in additional taxes. This concept is often referred to as the Social Security tax torpedo. Social Security benefits can be up to 85 percent taxable depending on your annual provisional income. Provisional income is determined by taking your adjusted gross income, adding your tax-exempt interest for the year, and adding half of your Social Security benefits for the year. Even a modest RMD from an IRA or 401(k) could increase your provisional income to a level high enough so that 85 percent of your Social Security benefits are now subject to taxation.

Let’s look at an example to illustrate the Social Security tax torpedo. Say you are seventy-six, have a $1 million IRA, and your remaining life expectancy is twenty-two years. This means you take the $1 million and divide it by twenty-two, which is $45,454.54. As a single individual or as a married couple filing jointly, your Social Security benefits are now 85 percent taxable. Now the real question: Was there anything you could have done to avoid the higher taxes? The answer is yes.

That planning opportunity takes place during the development of a tax-efficient withdrawal strategy. If you had at one time, or over the course of a number of years, converted your IRA into a Roth IRA, you could have avoided the RMD. A Roth IRA conversion would have brought the $1 million IRA into your income at the time of the conversion. You would now have had an account that is not subject to RMDs while you are alive. The Roth IRA and all qualified distributions would come out income-tax-free, not impacting your provisional income or adjusted gross income. As such, you could have the same amount of income, avoid the RMD, and reduce the amount of taxes you owe on your Social Security benefits.

A tax-efficient withdrawal strategy can save you thousands of dollars a year in taxes. Look for years in which you have an abnormally low tax rate, perhaps when you retire, and consider converting some money into a Roth IRA. Try to minimize the negative impacts of RMDs by planning ahead and seeing how they will impact other taxes and benefits. Lastly, try to keep your tax-advantaged accounts for as long as possible, as they will generate more income over time than your taxable accounts. By paying attention to these key tax issues, you can plan around higher taxes and improve your retirement security.

As discussed earlier, taxes changed dramatically after the 2017 Tax Cuts and Jobs Act was passed. In 2018, a number of deductions were removed and tax rates were changed. The tax bill changes highlighted the need to do annual tax planning and also served as a great reminder of public policy risk. However, the 2017 tax bill left most of retirement planning and retirement laws untouched. But, the tax brackets did change and are listed here (from TCJA). However, there have been numerous tax changes since 2017 and expect more tax changes in the future. As new administrations come into power, tax laws will continue to evolve and change. I do not expect this book to be a guide to all current tax planning but to give an idea of what you can expect. Additionally, I have listed out the provisional income that is needed to subject Social Security benefits to taxation.

Unmarried Individuals Other Than Surviving Spouses and Heads of Households

If taxable income is:

The tax is:

Not over $9,525

10 percent of taxable income.

Over $9,525 but not over $38,700

$952.50, plus 12 percent of the excess over $9,525.

Over $38,700 but not over $82,500

$4,453.50, plus 22 percent of the excess over $38,700.

Over $82,500 but not over $157,500

$14,089.50, plus 24 percent of the excess over $82,500.

Over $157,500 but not over $200,000

$32,089.50, plus 32 percent of the excess over $157,500.

Over $200,000 but not over $500,000

$45,689.50, plus 35 percent of the excess over $200,000.

Over $500,000

$150,689.50, plus 37 percent of the excess over $500,000.

Married Individuals Filing Separate Returns

If taxable income is:

The tax is:

Not over $9,525

10 percent of taxable income.

Over $9,525 but not over $38,700

$952.50, plus 12 percent of the excess over $9,525.

Over $38,700 but not over $82,500

$4,453.50, plus 22 percent of the excess over $38,700.

Over $82,500 but not over $157,500

$14,089.50, plus 24 percent of the excess over $82,500.

Over $157,500 but not over $200,000

$32,089.50, plus 32 percent of the excess over $157,500.

Over $200,000 but not over $300,000

$45,689.50, plus 35 percent of the excess over $200,000.

Portion of Social Security Benefits Subject to Federal Income Taxation

Filing Status

Provisional Income Threshold

Amount Subject to Federal Income Tax

Single

Under $25,000

0%

Single

$25,000 to $33,999

Up to 50%

Single

$34,000 or more

Up to 85%

Married Filing Jointly

Under $32,000

0%

Married Filing Jointly

$32,000 to $43,999

Up to 50%

Married Filing Jointly

$44,000 or more

Up to 85%

Married Filing Separately

$0

Up to 85%

Action Steps: Evaluate Your Personal Tax Considerations

- Are you having a year where your tax burden is lower than normal? This can be due to a large charitable deduction, a year of lower-than-normal income, or you might be early in retirement and living on resources that are not heavily taxed. If any of the above applies to your situation, it is a good year to consider converting a portion of your IRA to a Roth IRA.

- Are you close to retirement and at your maximum earnings capacity? In that case you may want to maximize deductible contributions to reduce your current income. Once in retirement, you may have the opportunity to take withdrawals or convert to a Roth IRA at a lower-than-normal tax rate.

- Do you have almost all your retirement assets in tax-deferred retirement plans? If you only have tax-advantaged savings, all of your income will be taxable in retirement. If tax rates go up, or you need a large withdrawal for a purpose, you will be stuck paying higher taxes. By developing sources of income with either no tax burden (Roth IRAs) or a lower tax burden (taxable accounts and nonqualified annuities), you will have more flexibility in retirement.

- Can you take some withdrawals from your tax-deferred plan at a lower-than-normal tax rate? If you are in early retirement, you may want to first take withdrawals from taxable investments, but you also want to take some withdrawals from a tax-deferred plan to take advantage of a lower tax rate.

- Are you in retirement and have a big expense this year? If you take the extra amount out of your IRA, you may end up paying a higher tax rate. You may choose instead to take withdrawals from an account that does not have tax consequences. This could be a Roth IRA, distributions from a life insurance policy, or even borrowing with a reverse mortgage line of credit.

Rewirement Mindset Questions

Do you plan to manage your retirement plan throughout retirement?

What unexpected expenses might you want to plan for in retirement?

Are you relying on a single strategy or asset to provide the majority of your retirement income?

IV. Putting a Retirement Plan into Play

Step 8: Understand the Risks Facing Your Plan

“The four most dangerous words in investing: ‘this time it’s different.’”

– Sir John Templeton, Investor

You need to understand the risks that could derail your retirement income plan. There are many risks you could face and a variety of options available to manage these risks. Risks are those uncertain events that could adversely impact your plan. Some of these might be personal in nature, such as chronic health problems or the need for long-term care, while others might be market-wide disruptions, such as hyperinflation.

Two different concepts are important to consider when discussing risks: risk tolerance and risk capacity. First, consider your risk tolerance level, which is really finding out how comfortable you are with risk. In other words, what keeps you up at night? The second issue to consider is your risk capacity. This is the ability of you and your plan to handle risk. For example, you might be a very risk tolerant person when it comes to inflation, but your plan might not have any risk capacity, leaving it subject to a lot of inflation risk because your major sources of income do not have any cost-of-living protections against a decline in purchasing power over time. As such, risk tolerance and risk capacity often do not relate to each other. However, we want to look at the risks you could encounter and determine what type of impact they would have on the plan.

Risk management techniques are important to understand. First, you need to understand the risks you face and analyze how they would impact your retirement security. For a lot of risks, you might look at the worst-case scenario and stress test your plan for that black swan event. For example, could you handle a substantial long-term care event or 5 percent average inflation? If your answer is no, then you need to decide on how you want to tackle that specific risk factor. There are a variety of options available.

First, you might decide to reduce the risk you face. Not all risks can be managed this way, but some can. For example, you can reduce health-care risk by living a healthier lifestyle and engaging in preventative care.

In some cases, you can also avoid risks. If you are worried about the uncertainties of investment performance (market risk), you could choose to only invest in low-risk investments, although that is not advised here! You can also transfer risk to someone else. For example, if you are concerned about outliving your money, you could transfer longevity risk to an insurance company by buying an inflation-protected longevity annuity that would make annual payments for the rest of your life.

Lastly, in some cases you might just want to avoid escalating your risk. For example, the risk of financial elder abuse is more likely for those individuals who have large liquid savings on hand. As such, you might engage in behavior that would not escalate the risk during retirement. The exact strategy you employ will depend on your risk tolerance, risk capacity, and the specific risk.

Properly utilizing these risk management strategies can help you protect your retirement income security and bring peace of mind to even the most worried retiree.

Action Steps: Prepare for the Risks You Face in Retirement

Let’s briefly discuss the most critical retirement risks that need to be addressed and some of the key risk management techniques. This is a complex subject, which we covered in much more detail earlier on in the book.

Longevity Risk

Issue: The uncertainty of how long retirement will last is one of the most challenging aspects of retirement income planning. Living longer means a more expensive retirement as resources need to last longer, and other risks such are exacerbated by a long life, such as health-care costs, the costs of long-term care, and the risk of inflation.

Solutions: This risk can be transferred by creating sources of income that pay during your whole life. Options include deferring Social Security (to get a larger annuity payment), electing an annuity form of distribution from your company-sponsored retirement plan, or buying a commercial annuity that promises lifetime income. Another option is adding sources of income that pay for an indefinite period of time, like rental income from investment property. If you are relying on withdrawals from your portfolio to support your income needs, you need to carefully consider the investment mix and how much you withdraw each year.

Investment Risks

Issue: Individual investments carry a number of risks, and even investing in a diversified portfolio is risky as the market as a whole is quite volatile. Volatility is especially troublesome as you approach retirement, as hitting a savings target on a specific date is quite hard. In addition, when you begin to take withdrawals from a portfolio, whether you have positive or negative returns in the first few years of retirement has an impact on how long a portfolio will last.

Solutions: Even though investment risk creates some uncertainty, research shows that retirees cannot afford not to take some market risk—many studies have shown that a 40 percent to 50 percent equity exposure in retirement is needed to address the risk of inflation and increases the probability that the portfolio will last a lifetime. One approach to address this challenge is to choose a bifurcated investment strategy, which includes investments and products with little or no market risk chosen to meet basic needs, then investments with more market risk to address discretionary and unexpected expenses and legacy goals. Other ways to reduce market risk include:

- Having the lowest exposure to equities in the years nearest retirement age, where a bad order of negative returns can have the most negative impact.

- Considering market conditions when choosing how much to withdraw—lowering withdrawals in years of negative performance reduces the risk of failure.

- Reducing the volatility in the portfolio by increasing diversification. That means adding more asset classes—for example, adding small company and international stocks and adding alternative asset classes like real estate and commodities.

Inflation Risk

Issue: During working years, the impact of inflation is often offset by an increase in salary. In retirement, inflation reduces the purchasing power of income as goods and services increase in price. This can mean a reduction in standard of living unless you have the resources to increase your income to keep up with inflation. To see the erosive impact of inflation, try the Department of Labor’s inflation calculator online.

Solutions: A way to address inflation is to build income streams that increase with inflation. The easiest way to do this is deferring Social Security benefits, as this will mean a higher percentage of retirement income that is subject to annual cost-of-living increases. Other options include building income streams with Treasury Inflation Protected Securities (TIPS) or buying certain types of annuities. The other primary option is to invest in asset classes that are likely to do well in inflationary times. Investments in real estate are one such category, as unanticipated inflation often correlates with increasing real estate returns. Investing in equities can also provide a limited hedge on inflation. International equities may provide an even better hedge as inflation is often associated with depreciation of home currency.

Medical Expense Risk

Issue: Costs for health care generally become more expensive and unpredictable as we age. Costs increase in retirement in part because the employer is no longer paying for part of the insurance premium. If you retire before age sixty-five, that can mean buying an individual policy or going into the healthcare exchange. After age sixty-five, it generally means paying premiums for Medicare Parts B and D and Medicare Supplement policies. Even with insurance, some expenses are not included. For example, Medicare does not cover dental care or hearing aids. Also, chronic or acute illnesses may mean more significant and unexpected out-of-pocket expenses.

Solutions: Planning for unexpected health-care costs begins by choosing appropriate insurance. For those aged sixty-five and older who are eligible for Medicare, there are many critical decisions. You can choose traditional Medicare Parts A and B, purchase drug coverage under Medicare Part D, and cover the gaps in coverage through a private Medicare Supplement policy. As an alternative, you can choose Medicare Advantage instead, which is a managed care approach that may provide more services at a lower cost in exchange for a limited network of providers. Proper planning also means planning to have sufficient funds to pay for noncovered services. Those who retire before age sixty-five are often surprised at just how much it costs to purchase individual coverage.

Other Risks Associated with Aging

Issues: As retirees age and begin to have more physical limitations, they may have to hire others to perform duties around the house that they once did themselves. In addition, cognitive limitations can require choosing family members or professionals to help make financial decisions. Frailty can also increase the possibility of elder financial abuse. At some point, chronic diseases, orthopedic problems, and Alzheimer’s can restrict a person from living alone, which will require financial resources for custodial and medical care.

Solutions: The aging process brings on many challenges that require planning. Planning begins by recognizing these contingencies and talking to family members about how you want to be cared for. Planning also includes drafting powers of attorney and trusts that allow for the transfer of control over decision making to those that you most trust. Planning also requires that you consider how to pay for long-term care if the need arises. This means looking at whether there are family members willing to provide care, the feasibility of purchasing long-term care insurance, the option of using a reverse mortgage to fund long-term care costs, and whether government programs are available to pay for services.

Public Policy Risk

Issue: As I have said many times, planning for retirement is like shooting a moving target in the wind. Your target moves because your life expectancy and goals will continue to change throughout retirement. The wind is similar to public policy risk. Taxes, laws, public policy, and government programs will change as you are planning for retirement and while you are retired. You might have been expecting and planning on having certain benefits from Medicare, Medicaid, or Social Security, but the government often improves, reduces, and tinkers with the programs, removing key benefits over time and adding others. These changes to Social Security, tax law, Medicare, and Medicaid can have significant impacts on your retirement income plan.

For example, significant changes occurred to Social Security late in 2015 with the passage of the Bipartisan Budget Act of 2015. The changes were the most significant changes to Social Security that have been seen in the past decade. The goal of these changes was to remove certain “aggressive” claiming strategies and to improve the overall funding status of Social Security. However, in the process, certain Americans, some nearing retirement, lost a great deal of potential future Social Security income, with some couples losing over $50,000 due to the changes. The lost benefits upset many people who felt that the rug was pulled out from under them just a few years before retirement.

This is important for everyone moving forward because Social Security is facing funding issues and could run out of money somewhere around 2033-2034 if nothing changes. However, government accounting is not like accounting for an average person. As such, Social Security does not really run out of money, nor does it have giant trust funds today. Instead, it is all a bit fictional. However, at some point the system will be changed, either in the way of reduced benefits, increased taxes, or a mix of both. But expect Social Security to remain in some shape or form, as far too many people rely on the system in the United States to just cut it out completely. The country would collapse, and I don’t think anyone in Washington, D.C., Republican or Democrat, is looking for that to happen.

So what happened with Social Security? Two major changes occurred: (1) extension of the deemed filing rule from full retirement age to seventy, and (2) removal of most file-and-suspend strategies. The extension of the deemed filing rule applies to everyone who was not age sixty-two by the end of 2015. Sorry millennials, this strategy is not around for you. In fact, it’s not around for many people at all anymore. Before the rule change, if you were eligible for a worker’s benefit and a spousal benefit at the same time, and you claimed benefits prior to full retirement age, the deemed filing rule applied, and you would simply receive the larger of the two benefits. However, if you waited until full retirement age to claim, you could choose the spousal benefit at full retirement age and defer your worker’s benefit, allowing it to continue to grow until you reached age seventy. In this way, you could receive some income now and still take advantage of receiving the deferred worker’s benefit at age seventy. This has been changed; now anyone filing for benefits will receive the larger of either the worker’s benefit or the spousal benefit.

In conjunction with the extension of the deemed filing rule, the new laws removed the ability to voluntarily file and suspend your Social Security benefits for the purposes of either: (1) triggering a spousal benefit for a spouse, or (2) protecting the right to file for retroactive benefits. The ability to take advantage of this file-and-suspend strategy ended in 2016. However, something like this could come around again. So pay careful attention to the changes that will occur to Social Security. The reality is that the system will continue to change, which could bring forth new claiming or planning opportunities.

The Social Security changes are worth talking about in their own right, but let’s highlight the impact of public policy risk with a current and relevant example.

Another major change that impacted retirement planning, especially legacy and estate planning, was the SECURE Act’s passing in 2019, which increased the age at which you have to take required minimum distributions from age 70.5 to age 72. But the SECURE Act also required most IRAs or 401(k) inherited from a non-spouse now be fully withdrawn over ten years, rather than extended over the beneficiary’s life, which was previously allowed. This creates a significant tax burden for many beneficiaries, and the original account owner may not have had the same opportunities to adjust accordingly, like by converting accounts to Roth IRAs, which would not be taxed on withdrawal.

Social Security changes and the passing of new legislation like the SECURE Act are worth talking about in their own right, but understanding certain fundamental retirement planning stratgies can help reduce public policy risk.

Solutions: Public policy risk is one of the most difficult risks to plan for because we cannot control when or how the government decides to change the laws. However, one way to minimize the risk and impact of public policy changes is to diversify your retirement income and diversify your savings accounts among a variety of asset classes and accounts. For instance, if your only retirement income is Social Security, any reductions to Social Security will hit you hard. However, if you can add in other sources of income, you can minimize the impact of legal changes to the current system. The same is true for any government program. The more dependent you are on one or two government laws or programs, the more public policy risk you face. Potential future public policy changes are not as impactful if you have a variety of asset classes, diversify the taxation of your savings (Roth, tax-deferred, after-tax), and build in some financial flexibility to account for reduction in Medicare or Social Security in the future.

Timing Risk

Issue: Timing risk refers to the variations in sequences of actual events that can have a significant impact on retirement security. Depending on when you retire, you have to face certain conditions. For example, today’s retirees face historically low returns on bonds, CDs, and other fixed-income investments.

Solutions: Planning for these circumstances that are outside of your control is more about staying knowledgeable and nimble and taking appropriate steps to address current market, inflation, tax, and other considerations that affect retirement security. For example, when fixed-income investment returns dropped a number of years ago, some retirees continued investing in CDs and just accepted lower returns—instead of considering a different, more appropriate investment strategy. One of the many reasons to work with a skilled financial advisor who is knowledgeable about retirement income planning is that they can help you address whatever the challenges of the day may be.

Rewirement Mindset Questions

What non-financial risks keep you up at night?

Which retirement risk are you most worried about as it pertains to your plan?

What can you do about these risks?

IV. Putting a Retirement Plan into Play

Step 9: Convert Assets Into Income

“I advise you to go on living solely to enrage those who are paying your annuities. It is the only pleasure I have left.”

– Voltaire, Philosopher

In the past, retirement income planning was relatively simple for many, as it was common for retirees to have enough monthly income from Social Security and company pensions to meet most retirement expenses. When that is the case, personal savings could be used primarily to meet extra and extraordinary expenses.

Today, the more common scenario is that retirees have two main retirement resources: Social Security benefits and a savings account—often accumulated in the company’s 401(k) plan. In this case, generating retirement income means converting the 401(k) or other assets into an income stream. Another complication is that in today’s investment environment, earnings from fixed-income investments (such as bonds and CDs) are quite low, making it difficult to generate sufficient income from investments. While most people would like to be able to live off the income that is generated from their savings, strategies today generally require the individual to invest for total returns with the expectation that they will have to sell some investments over the course of retirement to fund income needs.

So retirement income planning requires almost everyone—except for those lucky few who still have defined benefit pension plans—to make hard decisions about how they will generate income from their assets. There are a number of approaches. One option is to simply take regular withdrawals from a diversified portfolio. Withdrawals can consist of income, dividends, and proceeds from the sale of assets. Another option is to buy an annuity that pays a promised benefit for life. A third option is to buy a portfolio of individual bonds that will be liquidated over a specific period of time—with this approach income is created from a combination of principal and interest payments. An alternative to this third approach is to buy a term-certain annuity that promises a specific income payment for a set number of years.

When deciding which approach to use, it is helpful to look at how academics and practitioners look at this issue. Many academics use a framework called life cycle investment theory. Under this theory, retirement goals are prioritized. For most retirees, meeting basic or essential expenses in retirement is the highest priority, followed by meeting discretionary income goals and leaving a legacy to heirs. With this framework, it makes sense to choose assets with little risk when funding the most important goals. This means using bonds, CDs, TIPS (Treasury Inflation Protected Securities), or annuities to build an income floor that at least meets basic expenses. Other goals can be funded with riskier assets, and income needs can be taken from portfolio withdrawals.

In contrast, there are practitioners who don’t see much benefit in using annuities and other low-risk investments to build an income floor. They argue that as long as the retiree limits withdrawals to a safe withdrawal rate, staying fully invested provides more potential for the possibility of growing assets, which can be used to increase spending or to build a legacy. The primary limitation of this approach is the lack of guarantee.

Even those who choose the life cycle flooring approach to planning will want to maintain some of their assets in a portfolio. There are two primary approaches to managing the portfolio part of the plan. The first is managing a single portfolio invested for total returns and taking systematic withdrawals. Annual distributions can be taken from interest, dividends, or the sale of assets. The plan should identify a specified withdrawal rate. If the goal is to get a fixed distribution that keeps up with inflation, the withdrawal amount can be based on the initial value of the portfolio with increases each year for inflation.

Another approach is the bucket approach, in which the portfolio is divided into multiple portfolios, each one meant to meet a specific retirement need. One form of bucketing creates three to five portfolios to meet income needs for different time periods in retirement. You might have a portfolio to provide income for the next five to ten years of retirement, another for the following ten years, and a third portfolio to provide you income for your remaining ten years of retirement. With this approach, the near-term bucket will have the most conservative investments, as more certainty is needed to meet the near-term need. As such, bonds and other secure income sources like annuities are used to help fund your first few years of retirement. The second bucket might have a mix of bonds and stocks, and finally the long-term bucket might include riskier assets. Utilizing a bucket approach can be helpful because it allows you to see the purpose of each of the portfolios you have and to recognize their place and value in your overall plan. It can also help you leave stocks alone so they can continue to grow in the long-term bucket because you have secure income sources for the near term. This can help avoid reactionary stock selling in bad markets because you know that the stocks are for a distant time period and not for your income today.

If you choose to take systematic withdrawals from your portfolio or use the bucket approach, a key question will be how much you can afford to withdraw each year. There is a lot of research on this question, starting with the work of a financial expert named William Bengen in the 1990s. His research determined that, with a 50-50 stock and bond portfolio, you could withdraw 4 percent of the initial portfolio value with adjustments for inflation each year and not run out of money during any thirty-year period in the United States since the 1920s. This 4 percent figure is referred to as the safe withdrawal rate and is considered a reasonable rule of thumb on how much you can afford to withdraw. For example, if you had $1 million today, under the safe withdrawal rule, you could take out $40,000 a year for retirement, adjusted for inflation each year, and expect that your resources could support this withdrawal for at least thirty years. It is important to understand that there is no certainty that your money will last this long, as the future may not look like the past. There are a number of studies questioning whether the 4 percent rule is still safe today, given the low returns on fixed-income investments.

What is most important to understand is that when you choose to take distributions from your portfolio, you are essentially self-insuring for the risks that could undermine your plan. It requires that you are very conservative in how much you withdraw to meet all possible market conditions.

When picking how much you can withdraw, the 4 percent rule of thumb is a good place to start. If you are more conservative, you may choose to lower the amount somewhat. You can also make adjustments based on a number of factors.

- If your retirement period is shorter than thirty years, you can increase the safe withdrawal rate.

- If you increase diversification by adding small cap and international stocks, you can increase the withdrawal rate somewhat.

- If you are willing to take the risk that you will have to reduce your spending later, you can increase the withdrawal rate. For many, this is a reasonable tradeoff as they may want to travel more or do other things in early retirement and expect to be less active later in retirement.

- If you are willing to reduce your withdrawals when the portfolio has negative returns, you can sustain a slightly higher withdrawal rate.

Action Steps: What’s the Best Retirement Income Strategy for You?

1. What are your retirement income priorities? The best strategy is the one that best suits your goals. You should start by asking yourself what is more important: making sure that your income does not go below a certain level, the possibility that you could spend more, or leaving a legacy to your family. When your most important concern is meeting basic expenses, solutions that involve building an income floor make the most sense. If you are more concerned about the possibility of increasing spending or leaving a legacy, then strategies that primarily involve taking withdrawals from your investments may be more appropriate.

2. How well funded are you for retirement? If you have more resources than you need to meet your income goals, you have more choice. Some choose to take more risk in this case because they can, while others choose to take less risk because they don’t need to. Unfortunately, many are more marginally funded for retirement, and now the choice in strategy really matters. Maybe the most important advice in this case is to defer Social Security benefits as long as possible and work to reduce spending. Arguably, retirees with limited resources benefit from a balanced approach, building an income floor with annuity income so that they feel more comfortable taking more risk on the investment side.

3. How much complexity can you handle? The approach that you choose needs to be one that you can manage. If you are working with a skilled advisor, the plan can be more complex—but even then, complexity is a consideration. A plan that includes income annuities and equity-based mutual funds is relatively simple and is quite sound.

4. How much lifetime income do you already have? There are still many retirees that have monthly income from employer-sponsored retirement plans. When this is the case, monthly income may meet most or all of their income needs in combination with Social Security benefits. In this case, other assets should stay invested to meet contingent needs. A case can be made for investing these assets more aggressively as the monthly income is comparable to investing in bonds.

Rewirement Mindset Questions

What does financial independence mean to you?

Does the 4 percent rule appeal to you? Why or why not?

Do you currently place your investments and money in mental buckets for spending?

IV. Putting a Retirement Plan into Play

Step 10: Retire and Put the Plan in Motion

“I love it when a plan comes together.”

– Colonel John “Hannibal” Smith, The A-Team

The last part of the plan is to retire and to put the plan in motion. It is likely that you will need the assistance of an insurance professional, a financial planner that specializes in retirement planning, an attorney, a CPA, and an investment advisor at some point to enact a comprehensive plan. Be sure to look at their credentials to make sure that they are suitable and legitimate professionals. For financial planners, look for well-recognized designations that indicate a comprehensive knowledge level like the CFP, ChFC, CLU, or CFA. Furthermore, you will want to consider finding a financial planner who is a retirement income specialist holding the well-established Retirement Income Certified Professional (RICP) mark. Also, ask around. Word of mouth is a great way to find a good advisor.

While using an advisor will cost money, it is well worth the expense. However, only 52 percent of pre-retirees and 44 percent of retirees consult an advisor according to a Society of Actuaries report, Understanding and Managing the Risks of Retirement. The report highlights a variety of concerns faced by both pre- and post-retirees, including concerns about health care, long-term care, inflation, and running out of money in retirement. With roughly 96 percent of pre-retirees and 89 percent of retirees responding that they were concerned to some degree about their long-term financial future in retirement, it is troubling that only about 50 percent of people meet with a financial advisor. Confidence and peace of mind are just two of the more obvious reasons to seek the services of a financial advisor. Most people in the Baby Boomer Generation are not confident that they will have enough money for retirement. According to an IRI survey, baby boomers with financial advisors are twice as likely to feel confident about their retirement savings as those without an advisor.

Adding confidence to your retirement plan is not the only thing that advisors do. In fact, retirement advisors are well equipped to help America reduce its retirement income shortfall, which stands at nearly $4.3 trillion. For example, an international HSBC study, The Future of Retirement, showed that those with financial plans accumulated nearly 250 percent more retirement savings than those without a financial plan in place. Furthermore, nearly 44 percent of those who have a financial plan in place save more money each year for retirement.

Research attempts have been made to quantify into real numbers the value that financial planners can provide. A Morningstar research paper shows that making good retirement income decisions can help individuals generate roughly 1.82 percent excess return each year, creating roughly 29 percent higher retirement income wealth. This means even if an advisor is charging a 1 percent annual fee for the management of retirement assets, the financial advice provided still has a huge impact on the generation of additional retirement income.

Even if you have a retirement income plan in place, a retirement advisor can still add value. For instance, retirement advisors offer a tremendous amount of value by dealing with extremely complex tax issues, investment choices, and emotional decisions impacting one’s financial well-being. They make people more secure for retirement, increase their clients’ wealth, and help people feel more confident about their financial status. However, not all advisors are created equal, and a few tips should be followed when looking for a retirement planner.

First, retirement advisors are not just for the wealthy, but they do cost money. In fact, because of evolutions in the compensation models, there are advisors available for almost everyone. There are planners out there that focus exclusively on high-wealth, middle-wealth, or low-wealth individuals. However, it is still very important to pay attention to how your retirement advisor is compensated, as fees and compensation matter. If you are worried about how much a retirement planner costs, there are still other options. Many employers offer seminars and some basic financial planning presentations led by financial advisors that can provide valuable information and education to their employees.

Second, make sure you have the right retirement advisor for your unique situation. While there are many qualified advisors out there, some might be better trained, better educated, and more suited for your particular needs. Some advisors focus on wealth accumulation while others focus on retirement income planning. Additionally, some advisors specialize in working with widows, same-sex couples, clients with special-needs children, or veterans. In order to find an advisor that suits your needs, use a tool like DesignationCheck.com, which can help you locate a certified advisor in your area. For instance, you can search for professional advisors based on your area, or you can even search for advisors who focus on retirement or health care.

Lastly, do some homework on specific retirement planners before you agree to work with anyone. For example, the CFP Board provides a way to verify CFP certifications and allows consumers to see any disciplinary action taken against a CFP certification holder. Asking your friends, work colleagues, and family members can also be one way to find a financial planner. Do not be afraid to ask your financial planner for a client recommendation or testimonial. Financial advisors can add a lot of value for their clients, and if America is going to reduce the retirement income shortfall for baby boomers, financial advisors will definitely be part of the solution for many years to come.

You or your advisor will also have to coordinate all of these different decisions and members of your retirement income team. If you want long-term care insurance, an annuity, stocks, mutual funds, and a risk assessment, you will need help. As such, you might find yourself with a whole army of advisors handling different aspects of your life, your finances, and your future. But are your attorneys, accountants, financial planners, investment brokers, money managers, insurance agents, and retirement advisors all on the same page when it comes to planning for your retirement? In many cases, the answer is simply no. That is, your many different advisors typically do not take the initiative to coordinate their efforts and often do not have all the information they need to effectively develop an integrated, holistic retirement plan for you.

Someone will have to manage this team to help build a coherent and cohesive retirement income plan. Do not let the fact that you might have to work with multiple people scare you away from getting help. In fact, each type of professional is often an expert in a specific area that needs specialized attention. However, it is crucial that you or your representative perform certain tasks to better ensure the assembly of a successful retirement advisor team.

1. Pick the right advisors. Assembling a successful team of advisors starts with choosing the right people. First, you should check into the advisor’s credentials and make sure they are up to date with their designations, professional service groups, and other professional requirements, and ask for references. The client should have a very clear understanding of the advisor’s specialty area, what services the advisor will be providing, and how the client will be charged for these services.

2. Have the right number of advisors. All of your advisors should serve a specific purpose by providing you with valuable advice and services. When planning for retirement, you might want to consider having an insurance agent, an investment professional, an attorney, an accountant, and a financial professional to coordinate your retirement plan. However, a client should not be too hesitant to replace an advisor who is not performing. Additionally, while relationships are important, employing family members or close personal friends can become unpleasant if the business relationship turns sour.

3. Identify a coach. Your financial advisor will often be the “coach” of your advisor team. They will help implement your retirement plan, assist you in developing a strong team of advisors, monitor your plan, and set forth a strategy to update your plan in case of unforeseen problems or changes. Without a good coach, your retirement advisor team could be left without the proper direction and guidance to successfully develop, monitor, implement, and coordinate a unified retirement plan tailored to meet your goals and needs.

4. Prioritize your goals. In order for your advisors to be effective in meeting your retirement objectives, you need to know what you want in retirement. One great way to prioritize goals is to “test-drive” retirement by phasing into it slowly instead of retiring “cold-turkey.” By previewing retirement, you can start to do some of the things you want in retirement, enabling you to fine-tune your plan to meet your priorities. Previewing retirement also gives you an opportunity to select the activities and goals that are most important to you in retirement.

5. Verbalize your goals. After you determine and prioritize your retirement goals, you need to communicate these goals to your advisors. This also means keeping your advisors up to date on your priorities, as your goals will likely evolve as you enter different stages of your life. Your advisor team cannot help you meet your goals if they are not clearly defined and communicated.

6. Inform your advisors of one another. Your advisors need to know you are working with other advisors. If you do not make sure your estate attorney knows you are also working with a retirement advisor, you could undermine certain aspects of his or her work on your retirement plan. It is not a bad idea to have some or all of your advisors at a meeting together to ensure everyone knows their unique role in your retirement planning process. This could be difficult to coordinate, but it could be extremely valuable.

Rewirement Mindset Questions

Who was the best coach or mentor in your life?

What can you do to take a lesson you learned from them and apply it to your retirement plan?

How many advisors are on your team currently? Who do you still need to add?

V. Concluding Thoughts

“Jumping to conclusions is efficient if the conclusions are likely to be correct and the costs of an occasional mistake acceptable.”

– Daniel Kahneman, Nobel Prize Winning Behavioral Economist and Psychologist

Rewirement is all about changing the way you think about planning for retirement. It is about breaking down misconceptions, taking affirmative planning steps, and overcoming behavioral biases. However, in many cases you can’t do it alone. And that is perfectly normal, perhaps even rational behavior.

Planning for retirement is extremely difficult and can feel daunting at times. There are so many considerations that can make it overwhelming. Use the help that is available. An entire industry and profession developed to help you with this journey. A comprehensive retirement advisor can add a lot of value to your plan and help you make good financial decisions that will improve your retirement. An advisor can also help you maximize your income sources and make adjustments over time. Retirement planning is not a one-time event but a continuous process that needs to adjust to changes in your life, the market, and legal standards.

Retirement is not all about finances and money, but good financial decisions allow you to pursue the many activities that will make your retirement enjoyable. Making good retirement income decisions for yourself can also help your spouse, your children, and your friends, enabling you to live a financially independent life without becoming a financial burden. Running out of money in retirement is a real risk, even for wealthier individuals who do not plan for their future. While failing to plan does not guarantee you will run out of money, it does increase the odds that you will not be able to meet your retirement goals. Don’t throw away decades of hard work by making ill-informed decisions that could cost you your financial security in retirement.

If there is one thing to take away from this book, it is the powerful impact of planning. When you are armed with a comprehensive and actionable plan, you can make a huge difference in your retirement happiness and financial success. Make the right Social Security decisions, pick the right investment strategy, understand the risks you face, get insurance when it fits your plan, take the right distribution option from your qualified plan, create a tax-efficient withdrawal strategy, and don’t be afraid to get professional advice. If you take these steps, you can improve your retirement security, create peace of mind, and live the kind of retirement you have always hoped for. Remember—rewire the way you think about retirement planning to have a happier and more financially secure future.

Rewirement Mindset Questions

What was the biggest lesson you learned from this book?

Which behavioral bias affects you most?

What is a positive action item you can take today to improve your life?

VI. Index

401(k) 22, 25, 27, 29, 30, 31, 32, 33, 60, 62, 63, 64, 65, 69, 78, 121, 122, 132, 133, 134, 139, 157, 158, 166, 171, 172, 177, 179, 181, 182, 183, 184, 199

adjusted-expense method 150

anchoring 17, 22

anchor points 10, 17

annuity 69, 70, 85, 86, 87, 88, 89, 100, 101, 115, 121, 130, 132, 157, 158, 170, 181, 190, 191, 200, 203, 208

back-door Roth 65

behavioral bias 3, 6, 17, 21, 38, 45, 71, 116, 211

Behavioral Bias Alert 13, 17, 18, 19, 20, 21, 24, 30, 47, 56, 71, 99, 104, 116, 141

behavioral finance 4, 15, 30

behavioral science 15

bonds 25, 30, 78, 79, 85, 115, 116, 139, 159, 172, 173, 176, 197, 199, 200, 201, 204

call option 117

caretaking 10

charitable remainder annuity trust 110

collar 116

CRAT. See charitable remainder annuity trust

deferred annuities 86, 87, 88

defined-benefit pension 27

dollar-cost averaging 89, 116

donor advised funds 111

downsizing 10, 45, 48, 49, 120, 166

early-withdrawal penalty 63, 133, 182

efficient markets 15

elder abuse 103, 106, 190

employer-sponsored retirement plans 60, 157, 203

excess-withdrawal risk 86, 89

financial literacy 21

flooring approach 86

frailty 103, 104, 105, 106

Frailty 103, 104, 105, 106, 193

go-go 12, 145, 146

HECM for Purchase 51, 52

home equity 25, 46, 47, 48, 49, 50, 51, 52, 53, 60, 79, 85, 155, 158, 161, 166

home equity loan 49, 50

HSA 93, 94, 139, 171, 177, 180

income annuities 70, 88, 162, 203

income tax 28, 31, 34, 42, 63, 100, 122, 171, 181, 183

indexed funds 19, 22, 38

inflation 46, 53, 75, 76, 77, 78, 79, 80, 81, 85, 86, 115, 120, 129, 142, 150, 151, 156, 158, 165, 169, 170, 174, 189, 190, 191, 192, 197, 201, 202, 206

inflation risk 77, 79, 80, 129, 189

Inflation Risk 75, 192

investing 6, 15, 22, 37, 38, 41, 49, 79, 115, 116, 191, 197, 204

Investment Risk 191

IRA 20, 27, 29, 30, 31, 32, 33, 34, 60, 61, 62, 63, 64, 65, 70, 72, 122, 123, 132, 133, 134, 139, 155, 161, 162, 166, 171, 172, 176, 177, 179, 180, 181, 182, 183, 184, 187

life annuity 70, 87

life cycle investment theory 200

life insurance 22, 25, 41, 42, 43, 99, 100, 101, 105, 126, 132, 139, 162, 171, 187

life settlement option 99

linked-benefit products 99

liquidity 32, 53, 87, 89, 115, 117, 130

Longevity Risk 67, 191

long-term care 5, 7, 12, 13, 43, 50, 71, 94, 95, 98, 99, 100, 101, 102, 103, 104, 105, 106, 120, 129, 132, 139, 145, 146, 147, 159, 162, 169, 170, 171, 176, 189, 190, 191, 194, 206, 208

lump-sum distribution 69, 122

managed accounts 19, 38

manage payout mutual funds 19

Medical Expense Risk 193

Medicare 5, 32, 46, 56, 91, 92, 93, 94, 98, 193, 194, 197

Medicare Supplement Insurance 93

Medigap 93

mental accounting 18, 63

Mental Accounting 19

modified adjusted gross income 181

mutual funds 22, 30, 38, 139, 203, 208

Net Investment Income Tax 181

no-go 12, 146

overconfidence 21

overreacting to short-term changes 19

pension 25, 48, 121, 129, 132, 136, 157, 183, 200

power over 77, 150, 157, 169, 190

property and casualty insurance 43, 125

prospect theory 20

Public Policy Risk 194

purchasing power 70, 75, 76, 77, 78, 80, 116, 150, 157, 169, 190, 192

QCD. See qualified charitable distribution

qualified charitable distribution 110

ratio-of-income replacement method 149, 150

required minimum distributions 29, 32, 64, 70, 72, 179, 183

retirement 1, 3, 4, 5, 6, 7, 9, 10, 11, 12, 15, 16, 17, 20, 22, 23, 24, 25, 27, 29, 30, 32, 34, 37, 38, 45, 46, 47, 48, 49, 50, 51, 52, 53, 55, 56, 59, 60, 61, 62, 63, 65, 67, 68, 69, 71, 72, 75, 76, 77, 78, 79, 80, 81, 82, 85, 86, 87, 88, 89, 90, 91, 93, 94, 98, 101, 103, 104, 105, 106, 107, 115, 116, 117, 118, 119, 120, 121, 122, 125, 126, 127, 129, 130, 131, 132, 134, 135, 137, 138, 139, 140, 145, 146, 147, 149, 150, 155, 156, 157, 158, 159, 160, 161, 162, 163, 165, 166, 167, 168, 169, 170, 171, 172, 173, 174, 175, 176, 177, 178, 179, 180, 181, 182, 183, 184, 185, 187, 189, 190, 191, 192, 193, 194, 195, 196, 197, 199, 200, 201, 202, 203, 205, 206, 207, 208, 209, 211, 212

retirement planning 1, 27, 137, 211

retirement income 5, 6, 10, 11, 25, 30, 46, 47, 49, 50, 51, 52, 53, 55, 56, 59, 61, 68, 71, 75, 76, 77, 78, 79, 80, 82, 86, 87, 89, 105, 115, 126, 127, 129, 130, 131, 132, 135, 136, 137, 138, 145, 146, 149, 155, 156, 157, 158, 160, 161, 165, 166, 167, 170, 171, 172, 173, 175, 176, 179, 180, 181, 183, 189, 190, 191, 192, 194, 196, 197, 199, 203, 205, 206, 207, 208, 212

retirement risks 78, 103, 130, 191

reverse mortgage 45, 47, 49, 50, 51, 52, 53, 71, 85, 102, 150, 159, 171, 187, 194

reverse mortgages 49, 50, 51, 71, 159

Rewirement Alert 12, 22, 25, 29, 34, 49, 50, 61, 63, 70, 76, 79, 85, 88, 92, 93, 98, 117, 120, 127, 134, 142, 151, 157, 159, 167, 172, 183

risk capacity 189, 190

risk tolerance 173, 189, 190

RMDs. See required minimum distributions

Roth IRA 20, 27, 30, 31, 32, 33, 34, 61, 62, 63, 64, 65, 72, 133, 161, 177, 182, 184, 187

sequence of returns risk 71, 82

SIMPLE IRA 27

slow-go 12, 146

Social Security 5, 10, 18, 25, 32, 43, 46, 48, 52, 53, 56, 60, 64, 69, 71, 73, 77, 86, 92, 120, 121, 123, 126, 127, 130, 135, 150, 155, 156, 157, 161, 162, 166, 168, 170, 178, 179, 181, 183, 184, 185, 191, 192, 194, 195, 196, 199, 203, 212

stocks 20, 30, 32, 53, 79, 81, 85, 115, 116, 117, 133, 139, 173, 192, 201, 202, 208

stress test 190

substantially equal periodic payments 182

target date funds 19, 22

taxable income 33, 150, 171, 181, 185, 186

tax-efficient withdrawal strategy 179, 180, 183, 184, 212

tax-loss harvesting 20

tax rate 32, 34, 64, 170, 171, 172, 181, 182, 184, 187

timing risk 89

Timing Risk 197

traditional IRA 27, 29, 32, 33, 60, 61, 65

viatical settlement 100

withdrawal benefit rider 87, 88

withdrawal benefit riders 88

About the Author

JAMIE P. HOPKINS, ESQ., MBA, CFP®, LLM, CLU, CHFC, RICP, is a nationally recognized financial planning author, researcher and educator. He serves as the Managing Director of Carson Coaching and Director of Retirement Research at Carson Group, a national wealth management firm and coaching program for financial advisors. Hopkins is also a Finance Professor of Practice at the Creighton University Heider College of Business and was formerly a professor in the Retirement Income Program at the American College of Financial Services and director of the American College New York Life Center for Retirement Income.

Hopkins has educated thousands of financial services professionals and continues to move the needle for retirement income planning. He was instrumental in the development and creation of the Retirement Income Certified Professional (RICP) education program, and is one of the most widely recognized speakers on retirement planning.

Hopkins is a regular contributor to some of the top research publications in the U.S. and has been featured in Forbes, the Wall Street Journal, New York Times, Barron’s, The Economist, and many more financial planning publications and research journals.

Hopkins was selected by InvestmentNews as one of the top forty financial services professionals under the age of forty and was also recognized by the American Bar Association (ABA) as one of the top forty young attorneys in the country.

Hopkins received his BA in political science at Davidson College, his JD from the Villanova School of Law, his MBA from Villanova University Business School, and an LLM from Temple University. He holds the industry’s most recognized designations, including Certified Financial Planner (CFP), Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC), and Retirement Income Certified Professional (RICP).