When it comes to planning for your retirement income, it’s easy to overlook some of the common factors that can affect how much you’ll have available to spend. If you don’t consider how your retirement income can be impacted by investment risk, inflation risk, catastrophic illness or long-term care, and taxes, you may not be able to enjoy the retirement you envision.
Different types of investments carry with them different risks. Sound retirement income planning involves understanding these risks and how they can influence your available income in retirement.
Investment or market risk is the risk that fluctuations in the securities market may result in the reduction and/or depletion of the value of your retirement savings. If you need to withdraw from your investments to supplement your retirement income, two important factors in determining how long your investments will last are the amount of the withdrawals you take and the growth and/or earnings your investments experience. You might base the anticipated rate of return of your investments on the presumption that market fluctuations will average out over time and estimate how long your savings will last based on an anticipated, average rate of return.
Unfortunately, the market doesn’t always generate positive returns. Sometimes there are periods lasting for a few years or longer when the market provides negative returns. During these periods, constant withdrawals from your savings combined with prolonged negative market returns can result in the depletion of your savings far sooner than planned.
Reinvestment risk is the risk that proceeds available for reinvestment must be reinvested at an interest rate that’s lower than the rate of the instrument that generated the proceeds. This could mean that you have to reinvest at a lower rate of return or take on additional risk to achieve the same level of return. This type of risk is often associated with fixed interest savings instruments such as bonds or bank certificates of deposit. When the instrument matures, comparable instruments may not be paying the same return or a better return as the matured investment.
Interest rate risk occurs when interest rates rise and the prices of some existing investments drop. For example, during periods of rising interest rates, newer bond issues will likely yield higher coupon rates than older bonds issued during periods of lower interest rates, thus decreasing the market value of the older bonds. You also might see the market value of some stocks and mutual funds drop due to interest rate hikes because some investors will shift their money from these stocks and mutual funds to lower-risk fixed investments paying higher interest rates compared to prior years.
Inflation is the risk that the purchasing power of a dollar will decline over time, due to the rising cost of goods and services. If inflation runs at its historical long-term average of about 3%, the purchasing power of a given sum of money will be cut in half in 23 years. If it jumps to 4%, the purchasing power is cut in half in 18 years.
A simple example illustrates the impact of inflation on retirement income. Assuming a consistent annual inflation rate of 3%, and excluding taxes and investment returns in general, if $50,000 satisfies your retirement income needs this year, you’ll need $51,500 of income next year to meet the same income needs. In 10 years, you’ll need about $67,195 to equal the purchasing power of $50,000 this year. Therefore, to outpace inflation, you should try to have some strategy in place that allows your income stream to grow throughout retirement.
(The following hypothetical example is for illustrative purposes only and assumes a 3% annual rate of inflation without considering fees, expenses, and taxes. It does not reflect the performance of any particular investment.)
Equivalent Purchasing Power of $50,000 at 3% Inflation
Long-term care expenses
Long-term care may be needed when physical or mental disabilities impair your capacity to perform everyday basic tasks. As life expectancies increase, so does the potential need for long-term care.
Paying for long-term care can have a significant impact on retirement income and savings, especially for the healthy spouse. While not everyone needs long-term care during their lives, ignoring the possibility of such care and failing to plan for it can leave you or your spouse with little or no income or savings if such care is needed. Even if you decide to buy long-term care insurance, don’t forget to factor the premium cost into your retirement income needs.
A complete statement of coverage, including exclusions, exceptions, and limitations, is found only in the long-term care policy. It should be noted that carriers have the discretion to raise their rates and remove their products from the marketplace.
The costs of catastrophic care
As the number of employers providing retirement health-care benefits dwindles and the cost of medical care continues to spiral upward, planning for catastrophic health-care costs in retirement is becoming more important. If you recently retired from a job that provided health insurance, you may not fully appreciate how much health care really costs.
Despite the availability of Medicare coverage, you’ll likely have to pay for additional health-related expenses out-of-pocket. You may have to pay the rising premium costs of Medicare optional Part B coverage (which helps pay for outpatient services) and/or Part D prescription drug coverage. You may also want to buy supplemental Medigap insurance, which is used to pay Medicare deductibles and co-payments and to provide protection against catastrophic expenses that either exceed Medicare benefits or are not covered by Medicare at all. Otherwise, you may need to cover Medicare deductibles, co-payments, and other costs out-of-pocket.
The effect of taxes on your retirement savings and income is an often overlooked but significant aspect of retirement income planning. Taxes can eat into your income, significantly reducing the amount you have available to spend in retirement.
It’s important to understand how your investments are taxed. Some income, like interest, is taxed at ordinary income tax rates. Other income, like long-term capital gains and qualifying dividends, currently benefit from special–generally lower–maximum tax rates. Some specific investments, like certain municipal bonds*, generate income that is exempt from federal income tax altogether. You should understand how the income generated by your investments is taxed, so that you can factor the tax into your overall projection.
Taxes can impact your available retirement income, especially if a significant portion of your savings and/or income comes from tax-qualified accounts such as pensions, 401(k)s, and traditional IRAs, since most, if not all, of the income from these accounts is subject to income taxes. Understanding the tax consequences of these investments is important when making retirement income projections.
Have you planned for these factors?
When planning for your retirement, consider these common factors that can affect your income and savings. While many of these same issues can affect your income during your working years, you may not notice their influence because you’re not depending on your savings as a major source of income. However, investment risk, inflation, taxes, and health-related expenses can greatly affect your retirement income.
Have a wonderful weekend!
*Interest earned on tax-free municipal bonds is generally exempt from state tax if the bond was issued in the state in which you reside, as well as from federal income tax (though earnings on certain private activity bonds may be subject to regular federal income tax or to the alternative minimum tax). But if purchased as part of a tax-exempt municipal money market or bond mutual fund, any capital gains earned by the fund are subject to tax, just as any capital gains from selling an individual bond are.
Note also that tax-exempt interest is included in determining if a portion of any Social Security benefit you receive is taxable.
Tax season will soon be here. We often get questions about filing taxes and paperwork, so we wanted to provide some guidance to consider in preparing your documents to provide to your CPA.
* Please be very careful filing before March as all information may not have been received. *
- March 5, 2022: Most 1099s should be received; however, some may be outstanding and/or in process of revisions.
- March 10, 2022: We recommend that our clients wait until at least March 10th to complete simple tax returns.
- March 25, 2022: We recommend that our clients wait until at least March 25th to complete more complex tax returns.
- April 18, 2022: Individual Tax Returns Due for Tax Year 2022.
*Please note that corrected 1099, K1, and other documents may necessitate you waiting beyond the dates listed above; consult your tax advisor for more information.
Golf Tip of the Week
How to Control Speed on Downhill Putts
The common mistake when putting up or down a slope is to adjust the force applied in the stroke. In other words, giving the ball a whack when you need to get it up on another tier, or gently tapping it when it’s all downhill to the hole. If you’re adjusting how hard you hit the ball from putt to putt, you’ll lose your rhythm, and getting the speed right becomes a matter of luck, not skill.
Here’s a way to take control of these uphill and downhill putts so that even when you do miss, the next one is a tap-in. Let’s start with the downhill one I’m hitting here. When you’re in a similar situation, before you take the club back, imagine the hole is closer to you than it is. How close? Depends on the severity of the slope but get your imagination working as you make a practice stroke at the same pace you would for any other putt. You’ll find your stroke is shorter, but the club smoothly accelerates.
The opposite works with uphill putts. Just think the hole is farther away than it really is. The only thing that should change is the length of the stroke. Keep the tempo the same, and you’ll have much better control on the slopes.
Tip adapted from golfdigest.comi
Recipe of the Week
One Pot Stove-Top Mac and Cheese
- 1 pound short-cut pasta
- 1 head broccoli, chopped
- 3/4 cup canned coconut milk, heavy cream, or whole milk
- 3 ounces cream cheese, cubed
- 1 medium zucchini, grated (about 1 cup grated)
- 1 tablespoon Dijon mustard
- 2 cups shredded sharp cheddar cheese
- 1 cup shredded Monterey jack cheese
- 1 teaspoon garlic powder
- 1 teaspoon onion powder
- 1 teaspoon paprika
- 1/4 teaspoon cayenne pepper
- 1-2 tablespoons salted butter (optional)
- Kosher salt and black pepper
1. In a large pot, bring 4 cups of water to a boil over high heat. Add 1 1/2 teaspoons salt, the pasta, and broccoli. Cook, stirring occasionally, for 8 minutes. Do not drain the water. Stir in the milk, cream cheese, and mustard, and cook until the cream cheese has melted and the pasta is al dente, about 4-5 minutes more. Stir in the zucchini.
2. Add the cheeses, garlic powder, onion powder, paprika, cayenne, and butter (if using), and stir until melted and creamy. Remove from the heat. Season with salt and pepper. If the sauce feels thick, add ¼ cup milk or water to thin.
3. Divide the mac and cheese between bowls. Top with black pepper.
Recipe adapted from halfbakedharvest.comii
Health Tip of the Week
How to Get Things Done
Does it feel like your to-do list just keeps growing? Use these tips to make the most of your time and accomplish your goals.
- Figure out your goals
- Keep track of how long regular tasks take to complete
- Put to-dos in 4 groups: Urgent, Not urgent, Urgent nut not important, Neither urgent nor important
- Schedule your day
- Do the hard stuff first
- Write it down on a to-do list
- Ask if it is worth your time
- Don’t cheat
- Just start it
- All your time counts
- Your computer can help
- Set time limits
- Email: The black hole of time wasting
- Take a lunch break
- Schedule good stuff
Tip adapted from health.comiii
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