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#FPW: Financial Guardrails For Retirement Planning

Written by Richard Rosso | Aug, 10, 2016

Financial-Guardrails-2

“Breaker, breaker.

Are you going to switch lanes already? You’re close to the exit.”            

The driver, close in the rear view, sounded tense. Serious.

Her voice was loud enough to bounce wildly within the cavernous interior of the baby-blue 1972 Cadillac Eldorado convertible. My father’s pride and joy. The strength of the signal overwhelmed the speaker of one of the finest CBs on the market – A Dynascan Cobra 29 CB radio.

The chrome-plated beauty with plenty of dials, bells, whistles and a red/green signal strength meter, was secured with a bracket that hung low beneath the dash.

Our female airwaves angel had been guiding us for miles to the nearest amusement park. We had a near miss with a guardrail as dad overcompensated and steered into the right lane too quickly.

It was scary enough for me to remember.

In the 70’s, when CB radio fever gripped the nation, it was common for truckers and four-wheelers (automobile drivers), to communicate across America’s highways, city streets, and country roads. There were songs written, movies created, clothes, books, t-shirts, belt buckles. You couldn’t go anywhere without a person talking about or on a CB.

It was a generation’s version of social media.

Similar to text abbreviations today like LOL (laugh out loud), or SMH (shake my head), a unique language and series of codes peppered the radio airwaves in the 1970s.

CB’ers embraced alter-egos, handles or nicknames which added to the mystique of the people behind the microphones. As a passionate CB’er then (my father owned and operated 2 CB radio stores), I was sucked in to the craze.

On a dusky 1978 summer afternoon, while navigating the Belt Parkway in New York, Sweet Pea was advising the Midnight Rambler to get into the granny (right) lane immediately otherwise he’d miss his exit.

Right-laners (as I call them), or pre-retirees 5 years from a retirement destination, should consider shifting gears. It’s close enough to a retirement date, but not too close. Just enough miles lie ahead to plan an easy transition and prevent a financial 10-42 (traffic accident).

This generous time frame allows pre-retirees ample time to alter course if necessary, assess and undertake specific actions to ensure a successful 10-99 (mission complete) and mentally prep for a smooth transition to a new life in retirement.

Unlike Midnight Rambler who nearly overshot his opportunity to exit, there are several ways to prepare against veering off course or worse – slamming into a financial guardrail.

The key to success is having enough time to smoothly shift and not be a gear jammer (a driver who speeds up or slows down with great frequency).

After nearly three decades of retirement planning conversations, I’ve found that 5 years is an opportune time to consider a transition to the right lane.

Here’s a road map to your ‘home 20,’ (home location) from 5 miles (years) out.

Consider three income lanes and know when to switch.

 

To re-create a paycheck in retirement, you’ll seek to prepare for a steady, middle lane approach to an income stream. In other words, a withdrawal rate that meets requirements to meet fixed expenses and reasonable discretionary spending, then tested through a simulation of real market returns over decades.

Unfortunately, when traveling retirement road there will always be unforeseen curves throughout the journey. Retirees must remain aware of bear traps (CB for police with radar guns), which I believe will be experienced often over the next decade.

Distribution portfolios may be in for an extended period of a sequence of low or flat returns for stocks and bonds. This will require a right lane shift to less income or a lower portfolio distribution rate for a sustained period. At the minimum, distribution portfolios will require ambitious monitoring.

Wade D. Pfau, Ph.D., CFA and professor of Retirement Income at The American College in a recent study titled Capital Market Expectations and Monte Carlo Simulations for the Journal of Financial Planning, outlines how sequence-of-returns risk can send your financial car into a ditch. He writes–

“…with less time and flexibility to make adjustments to their financial plans, portfolio losses can have a bigger impact on remaining lifetime standards of living once retirees have left the workforce.”

It’s recommended to assess withdrawal rates and spending habits over rolling three year periods. This ongoing exercise helps to identify cyclical trends and whether adjustments need to be made.

For pre-retirees, 5-7 miles out, this is a wake-up call or a ‘breaker-breaker’ (how CBers politely break the silence for a transmission) moment. Through some cycles, you will need to buckle in. Take less income for a time and adjust spending accordingly.

Thankfully, this works on the flip-flop (trucker CB lingo for U-turn or return trip), too. There will be periods when there’s a tailwind and you may coast to larger distributions. I refer to this as the left or fast-lane change. Through these periods, distribution rates may be increased. Retirees can give themselves a ‘raise’ or ‘bonus’ for a year or longer.

For those considering a right lane change, the concept of distribution flexibility should be understood and incorporated into an ongoing retirement planning strategy.

Never run out of ‘go-go juice’ the truckers’ CB jargon for fuel, by placing importance on Social Security planning long before you take your exit.

 

Do not underestimate the lifetime income that Social Security can provide. Future recipients should begin the integration of Social Security into their retirement planning as part of a right lane to exit mindset.

According to the recent The Nationwide Retirement Institute® Consumer Social Security PR Study conducted by Harris Poll, it’s not surprising to discover than ½ of a retiree’s fixed expenses are covered by Social Security benefits.

Not understanding when and how to take Social Security is like entering retirement running on rags. If you heard a trucker communicate “running on rags” over the CB radio airwaves, it meant you were driving with little tread on the tires. And that was dangerous.

Speaking of dangerous, according to the study, surprisingly few retirees have a financial advisor who provides advice on Social Security strategies. The total incidence of having a financial advisor who provided Social Security advice was a dismal 11%.

A 2015 study by the Consumer Financial Protection Bureau indicates that more than 2 million consumers choose when to begin collecting Social Security retirement benefits. Many make the decision based on limited or incorrect information.

Of those given Social Security advice by their advisors, roughly half or more had to initiate the discussion themselves.

Now with pensions all but going the way of the CB radio trend, per the study, Social Security is the only guaranteed monthly income for roughly 69% of older Americans.

Unfortunately, in 2013, 75% of retirees chose to start collecting before full retirement age which results in a permanent reduction in lifetime benefits.

According to Social Security expert Elaine Floyd, ignorance is the primary reason. The CFPB report outlines studies that represent how much people don’t know about claiming. One study for example outlined that only 12% of pre-retirees knew how benefits differed if benefits were claimed before, at, or after full retirement age.

A successful lane change requires a clear sight of the retirement exit, ears on (CB on) and open communication with an advisor proficient in Social Security planning.

If you’re having a difficult time finding the help required, it’s worth an investment in a comprehensive Social Security analysis tool. The one I suggest was created by Laurence Kotlikoff, Professor of Economics at Boston University. The tool will guide you to the highest benefit you or you and a spouse may receive from Social Security.

Maximize My Social Security will assess thousands of strategies before it suggests the one that maximizes lifetime benefits.

The output is easy to interpret. There’s the ability to run “what if” scenarios, too.

The $40 annual license for a household is good for a year and worth the cost.

The highest and best Social Security payout is income insurance and will help prevent a 10-34 (trouble at this station) in retirement.

Don’t overlook this 10-17 (urgent business) when you’re ready for right-lane thinking.

 

Imagine never being able to switch lanes as you head to the destination called retirement. Think about how suffocating it would feel to never be able to navigate away from a single-lane road.

You would feel trapped.

In the financial services industry, we live to trap you.

In the 70s, travelers with CB radios would warn their brethren of bear traps or stationary police with radar.

Consider the following a bear cave.

In the heart of the dogma of financial advice lies a dysfunctional concept – That a 401(k) is overwhelmingly beneficial to your financial health.

No matter what, just keep socking away money in pre-tax retirement vehicles and worry about the taxes later.

Until you’re down that road and realize those vehicles are grossed out – CB jargon for a truck with a maximum load.

You wake up one day, seek to switch lanes 5 years from retirement, and discover that the majority of your wealth has accumulated in accounts where every withdrawal is considered ordinary taxable income.

Congratulations -With the full support of the financial services industry you’ve created a personal tax time bomb.

As you assess the terrain for future distributions, tax diversification should be a priority.  Envision a retirement paycheck that’s a blend of ordinary, tax-free and capital gain income (generally taxed at lower rates than ordinary income).

The goal is to gain the ability to customize your withdrawal strategy to minimize tax drag on distributions throughout retirement.

Here are a couple of steps to consider with a right-lane mentality when 5-years from your retirement.

Stop contributing to a traditional 401k and begin contributions to a Roth 401k if your company has the option. Five years provides an opportunity to fill a tax-free bucket to tap in retirement.

Contribute up to the match in tax-deferred company retirement accounts and invest the remainder of savings in after-tax brokerage account vehicles.

A recent study by University of Arizona finance professor Scott Cedarburg along with two other finance professors—David C. Brown of the University of Arizona and Michael O’Doherty of the University of Missouri, used software to simulate optimal saving strategies for a million retirement scenarios over 30 years.

They concluded that most investors, regardless of personal tax situations, end up better off with assets in a mix of accounts – traditional and Roth.

So, between retirement and required minimum distribution age (70 ½) consider a ‘surgical’ Roth conversion strategy where tax-deferred assets are converted to Roth annually up to, but not breaching, the next highest household marginal tax bracket.

A surgical Roth conversion program can reduce required minimum mandatory distributions and thus minimize your overall tax impact including taxation on Social Security retirement benefits and the risk of increased premiums for Medicare Part B.

The CB radio fever has long disappeared into the annals of pop culture.

However, right-lane financial preparation will not fade away anytime soon.

Is your financial partner equipped for travel with a thorough understanding of Social Security and Medicare?

Have you considered a right-lane strategy?

It’s time you did.

Safe and profitable travels.


Talk with an Advisor & Planner Today!

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Richard Rosso, MS, CFP, CIMA is the Head of Financial Planning for Clarity Financial. He is also a contributing editor to the “Real Investment Advice” website and published author of “Random Thoughts Of A Money Muse.”  Follow Richard on Twitter.

2016/08/10
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