Saving for retirement is tough, but spending your nest egg may be an even bigger challenge for boomers.
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Drawing down your assets in an appropriate way is just as crucial to your retirement security as the decades of saving and investing. Planning for future expenses can help you create an appropriate withdrawal strategy that will help ensures your savings will last throughout your golden years, says Mike Greene, senior vice president of financial planning at Ameriprise Financial
Greene offered the following tips on how baby boomers can confidently switch from savings mode to spending mode when they enter retirement:
Boomer: What is the biggest spending mistake people make when they reach retirement?
Greene: The biggest mistake many new retirees make is spending too much too early. Timing is of the most crucial aspects of managing a retirement drawdown strategy. Pulling too much from a portfolio early in retirement can have catastrophic effects in later years.
For most retirees, essential expenses (food, housing, etc…) are fixed and must be met for as long as retirement lasts so being able to adapt discretionary lifestyle spending based on the returns you’re receiving throughout retirement is important to making a nest egg last.
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Boomer: How is budgeting in retirement different than leading up to it?
Greene: Some of the obvious differences regarding budgeting include the difference in taxes on income and transitioning from consistent saving and accumulating for retirement to drawing income from a nest egg.
I’ve noticed the biggest challenge for new or soon-to-be retirees is projecting how much they’ll actually spend in retirement. It’s hard to guess at what we have never experienced or can’t predict. I am a big believer in “practicing” retirement for one or two years leading up to it by tracking all costs--expected and unexpected. That way, pre-retirees have a much better idea of what their retirement budget will look like, including essential and lifestyle expenses as well as an idea of what potential unanticipated expenses might cost.
Boomer: What tax implications need to be taken into account when it comes to drawing down funds?
Greene: Generally, there are three kinds retirement accounts: taxable accounts, tax deferred accounts and tax free accounts. No one can predict how tax laws may evolve and change in the future, so flexibility and maintaining a healthy balance among all three kinds of accounts is key to being most tax-efficient in retirement.
It’s common for those preparing for retirement to misunderstand the tax impact of having a large amount of assets in tax deferred accounts with required minimum distributions. People should have the flexibility to manage marginal tax rates by being able to draw funds from all three kinds of accounts as needed. As always, it’s crucial that people seek the guidance of a tax professional as they work through these issues according to their financial situation.
Boomer: How should boomers adjust their retirement portfolio upon entering retirement and why?
Greene: Traditionally, aging people rebalance their portfolios to become more “conservative” by reducing equity exposure and adding more fixed income. But I think the rules have changed. That may have been a great strategy during a 30-year bull market in bonds and when retirements were relatively short. I think that more people are realizing that to keep pace with inflation over 30, 40 or even 50 years, exposure to equities is crucial.
It’s important that people create a pool of guaranteed or stable income that matches their essential expenses. They also need to build a stable pool of cash equivalents to cover one to three years of lifestyle expenses to be drawn down when the markets are down. Lastly, a balanced growth portfolio that yields income and delivers growth to keep pace with inflation.
Boomer: The Ameriprise Financial Tradeoffs study found that 43% of boomers have felt stretched by their mortgages and 10% have consciously cut back on their mortgage or rent payments in order to save more. How should boomers look at housing costs as part of their retirement expenses?
Greene: Ideally, people should plan to be mortgage free when they hit retirement. Unfortunately, the numbers show that simply isn’t the case for many people. Our standard of living is a very personal decision and housing is a part of that.
Most people would consider housing to be an “essential” expense, meaning that any ongoing mortgage or rental payment should be covered by guaranteed or stable income sources.
Boomer: What other tips can you offer to help retirees feel confident about drawing down their assets as they enter retirement?
1. Understanding their essential expenses and matching guaranteed or stable income sources to meet them.
2. Creating an investment strategy to support their lifestyle expenses that is durable enough to withstand extended market downturns and flexible enough to keep pace with inflation.
3. Dealing with the certainty of uncertainty by preparing for the unexpected, using insurance when appropriate