Retirement Planning

Retirement Planning

The definition of retirement means different things to different people. Retirement is the point in life at which a person no longer engages in active employment which is commonly around 65 and has historically been driven by the time in which a person can begin to receive Social Security Benefits.

A more accurate definition of retirement is the point in life which you have attained the ability to not work if you don't want to. Many people in their early to mid sixties are still quite active and thus may wish to continue working or at least start working less. In addition, the age to which one can receive full benefits is increasing from 65 to 67 depending upon age and we may see this extend to later years in the future. Others may wish to cut back or leave employment before the typical age of 65. The most important factor for financial independence is whether you have enough money saved/invested to sustain your desired lifestyle without running out of money too soon.

There are three phases to Retirement planning which are accumulation, consolidation, and distribution. Each stage is marked by different planning techniques. Accumulation begins when you enter the workforce until about age 55. The consolidation phase, which occurs around age 50-55, means beginning to focus on the transition to retirement by reducing risk exposure, accelerating debt payoff, and accelerating savings. The distribution phase is where you shift from accumulation to building an income stream from your savings to support your desired lifestyle.

Retirement planning consists of determining where you currently stand financially, establishing when you wish to be financially independent, and figuring out how to get there. Many factors that influence one's ability to be financially independent including desired lifestyle, investment volatility and performance, risk tolerance, economic environment, tax environment, life expectancy, time to the goal, etc.

There are also many decisions that must be made in the context of retirement planning. Such decisions may include when you stop working or working less, how you will produce your desired income from your portfolio, how to access retirement funds in a tax efficient manner, when to take Social Security in order to maximize portfolio withdrawals, where you will live, etc. Understanding these decisions and how to integrate them into a cohesive plan is the purpose of retirement planning. In developing your retirement plan many assumptions must be made such as rate of return, inflation, taxation, savings rates, etc. Once the required information is gathered, a base analysis can be made given those assumptions.

Life is constantly changing and in order to make sure retirement is reasonable, several additional steps must be taken which include developing multiple retirement scenarios, stress testing your plan, and developing a probability of success analysis. An example of a stress test would be assuming that retirement begins just as a two year bear market begins. If this happens, it is critical to understand how your retirement plan would hold up in such a scenario. Scenario testing helps you evaluate whether you can retire or if you should wait until you have a greater cushion and higher probability for success.

A retirement plan must be flexible enough to adjust to changing circumstances that invariable occur. One-time retirement plans simply cannot account for the many unforeseen changes that will occur over time which is why a retirement plan should be monitored and updated regularly. To help you develop, monitor, and make informed decisions about your retirement plan, you will have access to the Wealth Management System.

Retirement planning is not only for those who are nearing retirement. Planning for financial independence can and should begin as soon as you enter the workforce and receive your first paycheck. Planning early allows you to benefit from Time Value of Money. For example suppose you started saving $5,000 per year as soon as you entered the workforce at age 23 and you were only able to save for ten years until age 32 or a total of $50,000 saved and never saved again. Assuming an average growth rate of 8%, these savings would be worth approximately $1,065,933 at age 65. Of the total savings, $1,015,933 was compounded growth or in other words just over 95% of the savings would be from growth.

If you waited until age 32 to begin saving the same $5,000 per year and continued to save this amount until age 65, you would have saved $170,000 of your own money however your savings would only have grown to approximately $883,596. While your growth would have been $713,596 in this case, you would have saved over three times more principal and have $182,337 less total dollars at the same age. If we add the loss in savings to the loss in growth, the total cost of waiting just 9 years would be $302,337!

Next suppose that you waited until age 43 to begin saving. In order to accumulate the same $1,065,933 that you would have by starting early, you would need to save approximately $16,110 per year until age 65. Total principal saved would be $370,531 with growth of $695,402. The cost of waiting in this case would be $320,531! To view the full comparison, click on Time Value of Money.

The longer you wait to save the more of your own money you need to save to make up for the lost time. Clearly the message is saving early gives you an advantage however it is never too late to start planning. Even small savings amounts can make a big difference in the long term!

Schedule a Discovery Consultation to learn more about developing your Retirement Plan.