Consider these four often overlooked
factors to help keep your retirement on track.
If you are in retirement or nearing it, you know that
making this transition isn’t as easy as packing up your
desk and flipping a switch on your portfolio from
“saving” to “spending.” Of course, retirement
has never been the black-and-white transition often
portrayed in TV ads. But with interest rates currently near
historic lows, tax rate changes looming, and financial
markets volatile, planning for—and living through—a long
and comfortable retirement has become even more challenging.
But it doesn’t have to be overwhelming. You already
know the basics: As you enter into retirement, consider
gradually moving your portfolio into more conservative
investments, keeping a portion invested for long-term
growth. There’s a lot more to consider, though, that’s
often overlooked, such as how to allocate and manage your
assets, which saving and investment vehicles may be most
helpful, and how to transition smartly from a savings to a
withdrawal strategy. Taxes and Social Security are also big
factors in your retirement, though they’re often
considered as an afterthought. Instead, they should be
addressed squarely in the context of your overall portfolio
and retirement plan.
Here we lay out four key factors to consider to help you
avoid some of the biggest pitfalls on the retirement road.
- Position your portfolio
- Prepare for taxing times
- Make the most of Social Security
- Plan for tax-smart withdrawals
1. Position your portfolio
Recent stock market volatility has thrown into disarray
even the most carefully allocated portfolios. If you yanked
money out of stocks during the bear market and were slow to
get back in, you may be short on risk assets, such as
stocks, which you will need to help keep your portfolio
potentially growing over a retirement that could last 30
years or longer.
Begin by evaluating your asset allocation over the full
course of your retirement. Some people find themselves
overly invested in stocks as they approach retirement,
especially if they’re nearing retirement at a time when
stocks are doing well. Other retirees go too conservative
too early. For a 60-year-old nearing retirement, a 50% or so
allocation to stocks may be appropriate. But the right mix
is personal. You’ll need to consider your risk tolerance
as well as investing time frame. You’ll also want to
balance your need for income now (or soon) with the need for
portfolio growth, to help ensure you don’t run out of
money.
That, of course, is easier said than done. Inflation
poses a great risk to a portfolio that’s overly invested
in fixed income and cash. Even a relatively low inflation
rate can have a significant impact on a retiree’s
purchasing power. For instance, $50,000 today would be worth
just $30,477 in 25 years, assuming a relatively low 2% rate
of inflation. If we assume inflation ticks up to 3%, that
purchasing power drops to an equivalent of $23,880.
Some retirement income sources, such as Social Security
and some pensions and annuities, track inflation
automatically through annual cost-of-living adjustments or
market-related performance. If any of these sources can
cover most if not all of your essential expenses, you’ll
have more flexibility in choosing more growth-oriented
investments elsewhere in your portfolio to help you try to
cover your remaining expenses.
Early in retirement you may want to consider “locking
in” part of your nest egg by purchasing an annuity.
Especially if you don’t have a pension or Social Security
payments that will cover your fixed costs, an annuity large
enough to provide income for those necessities could be
worth thinking about.1
Next steps:
2. Prepare for taxing times
Tax rates are scheduled to increase—unless Congress
acts. All those tax rate cuts introduced in 2001 are going
to expire at the end of this year. So, unless new
legislation is passed, income, capital gains, dividend, and
estate tax rates are all set to rise beginning next year.
While nothing may be certain but death and taxes,
there’s still some wiggle room with the latter. Some smart
strategies may help minimize your tax burden and maximize
your savings. Here’s a rundown of what to expect and some
strategies to consider.
Income taxes
Federal income tax rates are scheduled to increase for
all taxpayers. That’s because the 10% bracket is set to
disappear in 2011. So the first $8,375 of income for singles
and $16,750 for married couples would be taxed at 15%, not
10%. Plus, the other brackets would nudge higher, with the
top bracket hitting 39.6%.
To potentially save taxes in the near future, consider
tax-advantaged accounts. If you’re still working, saving
in an employer retirement plan such as a 401(k) or 403(b)
will reduce your current-year taxable income, lowering your
tax bill. For 2010, the maximum contribution is $16,500. And
if you are 50 or older, you can make catch-up contributions
of an additional $5,500 to boost your tax-deferred savings
and lower your taxable income.
For tax-free growth potential, consider a Roth IRA
conversion. Starting in 2010, there’s no income limit on
converting a traditional IRA or eligible workplace savings
plan to a Roth IRA. Unlike a traditional IRA, Roth IRAs
offer no tax deduction for contributions. This means
you’ll owe income tax on any amount you convert that has
not been previously taxed. That might result in a big tax
hit in the short term, but your account potentially grows
tax free and, assuming you’re at least 59½ and the
account has been open for five years, you can withdraw your
earnings tax free.3 (Contributions can always be
withdrawn tax free.) In addition, this year the IRS will
allow you to elect to include all the taxable income
generated from a Roth conversion in 2010, or spread the
payments out evenly over 2011 and 2012, which is the default
option.
While a conversion does finally allow many high-income
investors the opportunity to have a Roth, it's important
that you analyze your situation and are comfortable with
your decision. (See the Viewpoints piece "Would
you benefit from a Roth IRA conversion in 2010?"
for a summary of some of the common situations where an
investor may benefit from a Roth IRA conversion.) It does
ultimately come down to your assessment of the tax cost. How
much tax will you pay if you convert now versus what you
expect to pay when you withdraw the money during retirement?
The decision to convert, however, needs to be made with
care—and in consultation with your tax advisor.
Capital gains and dividend taxes
The federal long-term capital gains rate (on securities
held for more than one year) is scheduled to increase to 20%
from the current 15% for many taxpayers. The current 0% rate
for taxpayers in the 10% and 15% federal income tax brackets
would jump to 10%. Plus, all dividend income would revert to
being taxed as ordinary income.
Consider tax-advantaged investments for your taxable
accounts. Muni bonds provide income tax free (from federal
and most state taxes), and can be purchased individually or
through mutual funds and exchange traded funds (ETFs).
Separately, some mutual funds are managed with tax-sensitive
investing in mind.
You can also save through a tax-deferred annuity, in
which assets can grow and compound tax deferred until
withdrawn, with higher contribution limits than those of
workplace savings plans. After maxing out your 401k, 403b,
and retirement accounts, a tax-deferred annuity could offer
you an additional opportunity to save while deferring on
taxes.
Consider income-producing investments for tax-deferred
accounts such as IRAs. You won’t owe any tax on
dividend-paying stocks or bonds if they’re held in an IRA
or 401(k). Instead, all gains will accumulate tax-deferred.
(You’ll incur income tax when withdrawn, though.)
Estate taxes
The federal estate tax has dropped to zero for 2010 but
it's scheduled to return in 2011 with a $1 million
exemption. If Congress does not act, applicable estates over
the $1 million exemption amount will be taxed at a rate of
55%; that’s up from a top rate in 2009 of 45% with a $3.5
million exemption.
This uncertainty means your current will or trust may not
be sufficient to protect your assets under changes to the
estate tax. So you may want to speak with a professional.
Next steps:
3. Make the most of Social Security
One aspect of your retirement is certain: Social
Security. But certainty doesn’t mean it is easy. The
decision about when to take Social Security needs to be made
in conjunction with your overall portfolio planning. Whether
you take Social Security as soon as you’re eligible, at
age 62, or wait until your benefits accrue as much as
possible, by age 70, could mean the difference of more than
a hundred thousand dollars over your lifetime.
But waiting isn’t always the best option, especially if
you don’t have a pension or other guaranteed income and
will instead need to rely heavily on your portfolio to
provide income. This can cause you to drain those assets
more quickly than you otherwise would—an especially acute
problem during times of poor market performance, when your
accounts won’t replenish themselves and could, in fact,
run dry.
Take a hypothetical balanced portfolio of 50% stocks, 40%
bonds, and 10% short-term investments and see how it would
have fared over the 37 years from 1972 through 2008. That
period included an 18-year bull market (from 1982-2000),
three bear markets, six recessions, and the rampant
inflation and tight monetary policy of the late 1970s. Using
the actual, historical returns of that period, a portfolio
of $500,000 that began withdrawing 6% a year in 1972 would
have exhausted its money by the late 1980s. A 5% withdrawal
rate could have extended income from the portfolio for
nearly 25 years. That’s why we generally recommend holding
withdrawals to 4% to 5% of the portfolio for someone aged
65.
It’s a delicate balance: The less you have in assets,
the slower the growth potential, and the higher your
expenses, the more likely it is you’ll need to take Social
Security earlier, even if it means sacrificing any benefits
that would accumulate by delaying.
Advanced Social Security strategies
There are more advanced strategies. In some cases, it may
make sense to start taking benefits early, then pay them
back years later and begin collecting again at a higher
rate.
Married couples have even more strategies available to
them. You can claim benefits based either on your own
earnings or on your spouse’s. Spousal benefits are equal
to 50% of what your spouse gets if you begin drawing them at
your full retirement age, less if you start taking them
earlier. The ability to delay your own benefits while taking
spousal benefits can become a significant part of your
larger retirement income and portfolio strategy.
Next steps:
Read "When
to take Social Security."
4. Plan for tax-smart withdrawals
Once you’re ready to start tapping your retirement
accounts, it’s not as easy as hitting the ATM. You’ll
need to take your tax situation and your portfolio
allocation into account.
One strategy is to have funds in different types of
accounts with different tax consequences upon withdrawal.
This sort of tax diversification can help minimize your tax
bill in retirement.
Any money withdrawn from a traditional IRA or 401(k), for
instance, will be taxed as income. If those withdrawals are
made in addition to other taxable income (from, say, a
pension), they may increase your tax bill and possibly push
you into a higher tax bracket. It also makes your income
more susceptible to higher tax rates down the road. It also
makes your income more susceptible to higher tax rates down
the road, if Congress raises them.
Withdrawals from a Roth IRA, however, are not federally
taxed, provided you’ve followed the rules regarding your
age and how long the account has been opened.4
Having more options will allow you to consider the potential
tax benefits of the different accounts before making
withdrawals—and that can mean a lot to your savings.
If you don’t expect to exhaust your retirement accounts
in your lifetime, Roth IRAs may be advantageous for your
heirs. Roth IRAs are not subject to minimum required
distribution (MRD) rules during the lifetime of the original
owner, which means you’re never forced to take withdrawals
you don’t need. (Generally, you’re required to take
IRS-mandated minimum distributions from IRAs and 401(k)s in
the year you turn 70½.) With a Roth IRA, you can leave the
assets in place for as long as you live, with the potential
to generate tax-free growth for your beneficiaries.
Your heirs will have to take a minimum amount each year
after they inherit the account, but they generally won't be
taxed on those distributions if certain conditions are met,
which potentially increases the value of your bequest. But
remember, while Roth IRAs are generally not subject to
income tax, they are still potentially subject to estate
tax, so it is important to plan accordingly.
Next steps:
Of course, there is no one-size-fits-all
roadmap to a successful retirement. You have to create a
path that’s right for you. So, begin by talking with your
family about your personal goals for retirement. Consider
our four key factors as you fine-tune your plan. And for
help along the way, call a Fidelity representative at
1-800-544-4774.
Before investing in any mutual fund,
please carefully consider the investment objectives,
risks, charges, and expenses. For this and other
information, call or write Fidelity for a free prospectus
or, if available, a summary prospectus. Read it carefully
before you invest.
Past performance
is no guarantee of future performance.
The views and opinions expressed herein are not necessarily
the opinions or recommendations of Fidelity Investments.
This material is provided for informational purposes only
and should not be used or construed as a recommendation for
any security.
All indexes are unmanaged and performance of the indexes
includes reinvestment of dividends and interest income,
unless otherwise noted. The indexes are not illustrative of
any particular investment and it is not possible to invest
directly in an index.
1. An annuity is a contract issued by an insurance company
and purchased by a consumer for long-term investing. An
annuity is not a mutual fund. There are various fees and
expenses associated with annuities and, in certain
situations, withdrawal penalties may be applicable.
2. Ibid.
3. A distribution from a Roth IRA is tax free and penalty
free provided that the five-year aging requirement has been
satisfied and at least one of the following conditions is
met: you reach age 59½, suffer a disability, make a
qualified first-time home purchase, or die. The decision to
convert should always be made by the customer in full
consultation with a tax professional.
4. Ibid.
Retirement Income Planner is an educational
tool developed and offered for use by Strategic Advisers,
Inc., a registered investment adviser and a Fidelity
Investments company.
Portfolio Review is an educational tool, is not
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