Thoughts for navigating the accumulation and distribution phases of retirement planning.
Whenever Thomas Ackmann glances at his wrist to check the time, he gets a reminder of how times have changed in the world of financial planning for retirement.
Ackmann is vice president at SYM Financial Advisors in South Bend, and the wristwatch he wears was a gift that his grandfather received honoring many years of service as a Quaker Oats employee. Ackmann explains that his grandfather’s entire career was with Quaker Oats, and “never once did he have to put a dime into a retirement plan.” When his grandfather retired, the regular income continued, thanks to a pension plan that had been funded by the employer.
“I wear this watch he received from Quaker Oats, and I think about how different things are,” Ackmann says.
Pension plans are a rarity these days, replaced by such things as 401(k) plans. Employers often make matching contributions into those plans, but more and more, the burden of planning for retirement is on the person, not the employer. Ackmann’s grandfather didn’t have to worry about his income stream drying up as retirement progressed but, for today’s seniors and aspiring retirees, making sure the money doesn’t run out is a very real concern.
“The reality is that you have to rely less and less on employer contributions to retirement,” agrees Chip Mang, chief investment officer at Lakeside Wealth Management in Chesterton.
“Company pensions have gone away,” says Elaine Bedel, CEO and president of Bedel Financial Consulting in Indianapolis. “There are very few traditional company pensions left. They’re putting the impetus on the individual and saying, ‘You need to save.'”
When it comes to figuring out how to generate the right amount of retirement income, then make it last for life, it’s important to distinguish between the different phases of the process, says Greg Hammer, CEO and president of Hammer Financial Group in Schererville. “There’s the accumulation stage and the distribution stage,” he says. As the title indicates, the accumulation stage is all about creating as big a nest egg of wealth as possible, while you’ve got a steady source of employment income. “In the distribution stage, it’s less about how much you make and more about how much you get to keep.”
The Accumulation Stage
“We like to catch clients as early as possible and have them think about how much money they need,” says Bedel. One of the most important parts of successful investing is allowing yourself as much time as possible. That means starting to put away at least a little something as early in a career as possible.
If you’re like most people reading Retirement Living magazine, you’ve already moved past those early phases of life, and if you aren’t retired already, you’re at least at the point where you can imagine yourself in that place. Hopefully, you did start early, but as Ackmann points out, “It’s never too late.” The key is to do something, and not let yourself become overwhelmed with the complexity of retirement planning. “When people are faced with a choice, many feel paralyzed and think, ‘I’m not going to do anything.'”
One can lament the fact that pensions are for the most part a thing of the past, but there is good news, too–there are more ways to simplify your situation these days than there were back when the retirement burden was first shifting onto the shoulders of employees rather than companies. “When I first started participating in 401(k) plans, it was, ‘Here is a sheet of paper … tell us how much you want to save,'” Ackmann recalls. And then, employees would be handed a long and confusing list of retirement fund options from which to choose–that’s when the paralysis would start to set in.
Now, Ackmann says, you may have the option of picking from a list of target date funds, which essentially are retirement funds designed for retirement at various points in the future. “Instead of going over that long list, I can choose one that has a date close to when I plan to retire, and someone else can manage it for me.”
And as long as you have some time before retirement arrives, you can take advantage of the concept of dollar cost averaging. The idea is to pledge to put a specified amount of money away on a regular basis, regardless of whether the stock market is up or down. If it’s down, that contribution will buy more than it would if the market is up, but the point is not to worry about that–the discipline of regular investing is the most important thing, and time will take care of the rest.
“As strange as it may sound, you hope the market will be down sometimes when you are in your 30s or 40s, so that you can buy more shares,” Ackmann explains. “To be able to be OK with that, you have to have a long-term perspective. If you’re not going to retire in the next 10 or 20 or 30 years, don’t worry about the ups and downs of the market.”
While accumulating retirement wealth, it’s important to try to think ahead to imagine how much money you’ll need once you have to start living on that nest egg. Bedel observes that people’s perceptions and predictions about how much they’ll need aren’t realistic. “Many times, the amount of money people have saved will not be enough to continue their current lifestyle. People have this huge gap between what they think they need and what they really need.”
Mang agrees that wherever you are in the accumulation stage, you need to really pin down how big that gap is. He encourages clients to carefully plan a budget of what their living expenses will be in retirement–everything from housing and utilities to vehicles, entertainment, food and healthcare. The more specific they can be, the better. “I like to have something concrete in front of me. I want to see the numbers.”
Then, they explore what resources will be needed to create a sufficient, guaranteed income stream. The question becomes: Are there enough resources, or is there a deficit that needs to be addressed? Says Mang, “Ninety-eight percent of people have under-saved, by a large amount or a smaller amount.” The aim then becomes finding ways to plug that gap, because the alternative is revising retirement expectations.
The Distribution Stage
Simply put, the distribution stage begins when you start removing funds from your nest egg–whether that means withdrawing from retirement accounts, starting up annuity payments or beginning to take Social Security payments. When is that? It’s a very personal question.
In fact, it’s a question that doesn’t always have a solid answer, at least if you’re asking someone earlier in life. “A lot of people don’t know exactly when they want to retire,” Bedel says. How do you plan for retirement if you can’t pick a date when you’re going to retire? Bedel says the answer is to at least specify when you might want to start thinking of retirement as an option–if you get to that age and don’t yet feel ready to let go of work, at least you’ve had the luxury of choosing to work longer, rather than being forced to work longer because your finances are not yet ready. “We tell them to pick a time when they want to have that choice.”
Whenever that distribution stage begins, you’re faced with a whole new menu of choices with regard to which resources to tap into first, how much, and what kinds of implications your decisions will have in terms of taxes and dollar values. Truth be told, these kinds of decisions can be even trickier than the choices you have to make in the accumulation stage.
“When you start pulling money out, you need to decide whether you want to pull it out of an area where you have to pay taxes on it,” Bedel observes. That depends, in part, on what tax bracket you’re in. If you’ve dropped into a lower tax bracket, the bite will be less.
Add to those complexities the choices that impact the value of the investment. If you hold out longer on Social Security, for example, you’ll get a bigger monthly payment once you do tap into it. “Delaying Social Security can potentially have a huge benefit,” Hammer says.
And married retirees also need to think about what happens when one spouse dies. The plan needs to carefully consider the impact on the surviving spouse from a financial perspective. Income often declines, tax rates often increase, and expenses don’t shrink as much as you might expect, if at all, Hammer says. “What is your plan for not if but when that happens?”
Sorting through all of these considerations requires the help of a tax specialist, and that often is a different person from your overall financial adviser. You might need a lawyer, too. Hammer notes that your adviser might take on the role of a general practitioner, who can then tap into other sources of expertise. “When you enter the distribution phase, the most important aspect is to get somebody who understands these elements and how they play into one another.”
Finally, there’s the important matter of simply having enough money to last and keeping it safe. Hammer and others recommend thinking of your nest egg in different buckets: one for current expenses, one for those in the next few years, and one for those further down the road. The nearer the term, the safer the investment vehicles need to be.
Back in the day, Bedel observes, retirees would be advised to park all of their funds in safe, fixed-income investments, rather than riskier growth instruments. But with people living longer, that may be a recipe for running out of money.
“We always want to keep five years’ worth of funds in fixed-income side, where there is less volatility,” she says. That means if the market tanks, you’ve got five years’ worth of funds safe while your other funds have a chance to recover. Remaining funds can be invested in something that will continue to earn a greater return. “You want to keep some money safe. But you want to keep a portion of it growing so you won’t run out in the long run. You need to make a nest egg and let it grow.”
The best bet, of course, is to start saving early enough to allow yourself lots of flexibility as the distribution stage unfolds. As Mang notes, “I’ve been in this business since ’86 and I’ve never heard anyone say, ‘I’ve saved too much and wish I had spent more.'”