This article is the second in a series, please start with part 1.
6) Don’t Hold Too Much Cash
Some investors become more risk averse as they age, fearing they lack the time to recover from market selloffs. This fear leads to holding too much cash or cash equivalents, like certificates of deposit. The problem is cash loses its purchasing power over time due to inflation.
For example, $100,000 in a savings account earning .04% annually, grows to $100,400 after a year. But, if annual inflation is 3% the purchasing power of this money declines to $97,388. As the years progress, the purchasing power of this money continues to erode due to the low interest rate being earned and inflation.
As we discussed in part 1, tracking your spending properly and sticking to a withdrawal strategy can reduce the fears that leads to hoarding cash. It is reasonable to hold some cash for expenses, but holding more than four to six months of expenses will expose your portfolio to inflation risk.
An alternative to holding cash is to set up a home equity line of credit (HELOC) loan on your home. With a HELOC loan, borrowers only pay interest on the loan funds they drawdown. For example, your home is paid off and worth $400,000. You could arrange a HELOC for $60,000 to draw on, if necessary, but not pay any interest until the funds are used. Hence, the HELOC is a cash reserve to tap in the event of an emergency, without exposing cash to inflation risk.
7) Be Strategic on Taking Social Security Retirement Benefits:
Those of us born in the year 1960 or after, will reach our full retirement age for Social Security Retirement Benefits at age 67. We can take benefits earlier, starting at age 62, but retirement benefits are then permanently lower. Alternatively, delaying benefits until age 70 will increase monthly benefits by 8% for each year you delay until age 70. There are no benefits for delaying beyond age 70. Many personal finance advisers encourage clients to wait until age 70 to file for Social Security Retirement Benefits for these higher benefits, especially for clients who do not have other retirement savings.
However, depending on your personal situation including, life expectancy or family medical history, it may be preferable to take benefits earlier. If you are concerned you will not live much longer than your early 70s you may want to take benefits as early as age 62. It may also be strategic to take benefits early while your spouse takes benefits later. There are retirement calculators on the Social Security Administration website to work through various options of taking benefits. When it comes to benefits, just keep in mind that it is not always prudent to wait until you are age 70.
8) Take Advantage of Tax Reduction Strategies
One of the best ways to help retirement savings go further is to reduce your taxes in retirement. We are all required to pay Federal taxes but State taxes can be optional. The state you live in has a big impact on your tax bill. Living in Kentucky means you pay a 5% flat tax on your income, but moving next door to Tennessee means paying no state income tax. This results in significantly lower taxes over a ten or twenty year retirement. Currently, there are nine states with no income tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
For those that served in the military or the Federal government there are also a number of states that do not tax your retirement pension. Currently, the states that do not tax Federal government pensions include the nine states above plus Alabama, Illinois, Hawaii, Mississippi, Pennsylvania, Kansas, Louisiana, Massachusetts and New York. There are also a few states that give an exemption for a portion of Federal government pensions including Kentucky, Michigan, North Carolina, Oklahoma and Oregon.
9) Other Big Expenses: Adult Children and Grandchildren
As you navigate your future retirement factor in any expenses related to adult children or grandchildren. This might include helping to pay for college, weddings or purchasing a home. Do not let your generosity towards your children jeopardize your retirement, paying their expenses is a common pitfall for retirees. Remember that drawing heavily on your savings for big expenses will deprive you of future retirement income. You may then find you need to return to the workforce when you are older and less prepared to do so. Estate planning can help leave assets to your heirs, without putting your retirement plans at risk.
10) Pay Attention to Broader Economy: Volatility and the National Debt:
The U.S. economy has been in a long expansionary period since the global financial crisis of 2007-08. Except for a brief recession caused by the pandemic in 2020, the stock market has been in a bull market since March 2009. This has provided historic returns for retirement accounts. Similarly real estate investors have seen high levels of appreciation for their holdings. But this may not continue. The economy works in cycles, think of story of the seven fat years and the seven lean years. Every retiree should expect this expansionary period to draw to a close and move to an economic contraction. This is all part of a normal process, but it is something that investors need to factor into their future planning. Do not expect the returns of the last decade to continue.
Another factor to consider is the excessive U.S. national debt levels, which currently sit at $28.5 trillion. The debt is now higher than the total value of goods and services produced by the U.S. economy in a year. Historically, when countries cross this debt to gross domestic product threshold it is an indication of greater economic challenges to come. To put this debt in simple terms, each tax payer owes about $225,000. For a working couple their share of debt is nearly $450,000 which is equal to a nice home in many communities. Think about how long it takes to pay off a $450,000 home and you begin to see the cause for concern, particularly as government debt levels continue to rise rapidly due to excessive Congressional spending.
There are a few things investors and retirees should expect as a result of these high debt levels. The first is tax hikes in future years. We are already starting to see higher tax rates. We may also see reductions in Social Security Retirement Benefits, a topic covered in detail in the book Become Loaded for Life! Retirees would be wise to prepare for slightly lower benefits than expected. We could also see higher inflation rates, similar to those in the 1970s, which are discussed in this article on inflation risk. As we saw above, higher inflation rises have a significant impact on the purchasing power of your retirement savings, particularly for assets generating a low annual return. Pay attention to these factors as you plan your retirement to protect against unpleasant surprises.
As you reach age 50, keep these ten factors in mind to help you plan for a stable and successful retirement.