This year, retirees and investors nearing retirement are under stress. The inflation rate has soared to multidecade highs, equities have plummeted, and bonds, often a haven, have declined. One of the worst years in a century has been experienced by the typical portfolio consisting of sixty percent equities and forty percent bonds.
No surprise pension investors are so pessimistic. A recent Northwestern Mutual survey revealed that Americans believe they need $1.25 million to retire comfortably, a 20% increase from 2021. According to a mid-November Fidelity survey, the average 401(k) balance has decreased 23% this year to $97,200. According to a Natixis poll, most high-net-worth investors anticipate working longer than they had initially intended.
According to Dave Goodsell, executive director of the Natixis Center for Investor Insight, retirees are feeling the squeeze. Prices are increasing, and the expense of living is a significant factor.
The retirement anxieties of investors are not unwarranted, but all is not lost. Instead of focusing on the last year’s losses, adopt a longer-term perspective and consider chances to earn and save more over the next decade. Whether you are on the verge of retirement or are already retired, studying new strategies and committing to smart preparation will help you take advantage of upcoming possibilities and possibly convert lemons into lemonade.
Individuals Nearing Retirement
Thanks to the Internal Revenue Service’s revised contribution limitations, if you are still gainfully employed, you will have plenty of opportunities to increase your nest egg. Due to inflation changes, investors can contribute up to $22,500 in 2023 to their 401(k), 403(b), and other retirement plans.
Employees 50 and older can save an extra $7,500 over the maximum. Additionally, Americans can contribute up to $6,500 to their retirement accounts, up from $6,000, and IRA catch-up contributions continue at $1,000. Brian Rivotto, a financial advisor with CapTrust located in Boston, encourages his customers to maximize their donations, stating, “You have to take advantage of that.”
It is anticipated that stock market returns will remain in the single digits for the next decade, allowing investors to buy equities at lower prices than they did a year ago. The bond yield is higher than in decades, allowing for secure yields of 5 to 6 percent. According to UBS adviser Brad Bernstein, the past year has been the worst for a 60/40 [stocks/bonds] portfolio. However, the following decade may be amazing because of current bond rates, he explains.
When Retirement Begins
Many individuals on the verge of retirement view their year-end account accounts with apprehension because they intuitively comprehend something that scholars have thoroughly studied: In the early years of retirement, when the nest egg is the highest and withdrawals begin, portfolio losses can considerably reduce the portfolio’s longevity.
This phenomenon is referred to as sequence-of-returns risk, and a case study from the Schwab Center for Financial Research highlights the magnitude of this risk. An investor who begins retirement with a $1 million portfolio and withdraws $50,000 per year, adjusted for inflation, will experience vastly different outcomes if the portfolio experiences a 15% decrease at different phases of retirement, according to the study’s findings. If the recession strikes during the first two years, the investor will run out of money in the 18th year, and if it occurs between the tenth and eleventh year, he or she will still have $400,000 in savings by eighteen.
Evelyn Zohlen advocates saving aside a year or more of income before retirement to reduce the danger of needing to use your retirement assets during a market downturn. This will prevent you from being forced to tap your accounts during a market downturn. The best defense against sequence of returns is to not be vulnerable to them, says Zohlen, president of Inspired Financial in Huntington Beach, California, a wealth management business.
Matt Pullar, a partner at Sequoia Financial Group in Cleveland, advises investors to explore a home-equity line of credit in addition to accumulating a cash reserve for unforeseen expenses. Your home’s value is probably at the highest it has ever been, he adds. If you have a short-term expenditure, you may be better off taking out a loan than selling 20%-depreciated stocks.
There are various tax strategies that investors might employ after retirement. Zohlen identifies donor-advised funds as a useful vehicle for high-net-worth investors with a charitable bent, particularly those who may receive a taxable sum from deferred pay, such as stock options, soon before they retire.
Investments During Retirement
Increasing interest rates may be a silver lining for investors, who may now earn a substantial income from their cash investments due to higher CD and money market rates.
Bernstein states that he has been utilizing bonds to create revenue for his retiree clients, a task that is now facilitated by increased interest rates.
According to Rivotto of aptrust, retirees may consider withdrawing from the fixed-income portion of their portfolio to allow equities time to recover. Even retirees need stocks to deliver the long-term portfolio growth required to maintain a 30-year or longer retirement. He prefers to be more 70/30 [stocks and bonds] due to longevity.
Roth Conversions Are Available at Any Age
Even though the markets have taken a battering this year, some bright spots exist for retirees. To begin with, it may be a good time to convert a conventional IRA (financed pretax but withdrawals are taxed as income during retirement) to a Roth IRA (financed after-tax and has tax-free withdrawals). Roth conversions are taxable in the year of conversion, but the prospective tax burden will be lower in 2022 due to the decline in stock prices. In addition, doing so before the Trump-era tax cuts expire in 2025 and individual income-tax rates return to pre-Trump levels will be advantageous.
An investor must possess sufficient funds to cover the taxes involved with a Roth conversion. Pullar of Sequoia recommends that customers convert to a Roth IRA while establishing a donor-advised fund, which “may alleviate that pain via the tax benefit.”
Another alternative is to perform a partial conversion. The immediate tax burden will be reduced, and the tax-free withdrawals from a Roth account may prevent you from sliding into a higher tax bracket in retirement, according to Zohlen.
A conversion may also be prudent for investors who want to give a Roth IRA to their children or grandkids as an inheritance, especially if they are in a higher tax band. Under the existing laws, heirs have ten years to take assets from a Roth account they inherited. Bernstein of UBS claims to have completed many client conversions this year. It’s fantastic to leave your children a Roth IRA that they can develop over ten years, he adds.
The combination of lower expected returns on stocks over the next decade and longevity risk has led some advisors to take a more conservative approach to withdrawal rates in retirement. In the first year of retirement, retirees can spend 4% and adjust for inflation in the following years without running out of money, which has been the gold standard utilized by financial planners in client planning.
Mark Brookfield, an advisor at Merrill Lynch, explains that over the past few years, 3% to 3.5% has been the safest withdrawal rate. For a 4% withdrawal rate to be successful, we believed equities would have to perform significantly better than anticipated over time.
Zohlen recommends establishing and adhering to a budget regardless of the withdrawal plan chosen. This can significantly influence the success or failure of a retirement strategy. Leaving the money in the account to work is what makes the 4% rule work, she explains. The question is not, ‘Does the 4% rule work?’ The question is, Does the client’s conduct permit us to rely on that?
Pullar of Sequoia advises investors not to become swept up in the market’s fluctuations. According to him, perspective is an overlooked aspect of retirement preparation. This is his third time seeing market volatility of this nature. He said that it is hard to see how the subsequent few years will be filled with excellent possibilities. Today’s retirement investors are likely to reach the same conclusion in ten years. Pullar observes that right now, it is difficult to see.