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- The Key Elements Of Retirement Planning
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- Catching FIRE: The Financial Independence Retire Early movement
Tax is triggered by income from government benefits, pension plan payments, portfolio profits of taxable accounts, and withdrawals from RRSPs. If you plan on dying broke, you will spend more than your portfolio returns - using untaxed capital. Otherwise, you will spend at lot less than your taxable income, especially at the start of retirement. These benefits make a huge difference for lower-income earners. The clawback of these benefits from increasing income creates a large difference in outcomes depending on whether you saved in an RRSP draws taxed or a TFSA not.
The image above shows the Canadian marginal tax brackets on the left. GIS benefits are not taxed. This is because things changed in the budget. These top-up amounts are created by budgets and subject to change. All these numbers increase in with inflation. Until a subsequent budget after changes things again, the existing These inflation-adjusting benefits are a relatively recent invention.
The chart above shows how they grew to their current values. How to treat them in your long-term planning is a personal decision. There is a lot of worry that their costs will not be supportable when the Baby Boomer bulge hits retirement. The rest of this page assumes only that government benefits and programs will offset your higher healthcare costs for drugs, physio, eyeglasses, hearing-aids, etc. It is better to err on the downside. It removes two unknowns from the model. Inflation is a variable input in both the saving spreadsheet and the spending spreadsheet.
Unlike all other public calculators, the inflation adjustment is applied only to living expenses, not including taxes paid. Long-term history indicates 2. Most commentary on investment profits quotes returns 'after inflation'.
This implies that stock markets will have higher returns in periods of high inflation and that you need not worry about inflation. But history shows there is NO correlation between returns and inflation. Look at the graph on Sheet Yes, over time businesses correct their pricing to compensate for inflation, but that correction takes time to implement.
Keep your assumptions of investment returns separate from inflation assumptions. Gold-plated pensions are indexed to inflation, but few people have those.
Rethinking Retirement in the 21st Century | HuffPost Life
Annuities that you buy from trust companies come in a version that increases with inflation, but they cost a lot more payments about a third lower. Most people do not feel the trade-off is worth it. Just because your annuity payments are flat does not mean you cannot deal effectively with inflation's erosion. You simply do not spend all the income of early years.
You set aside and invest a portion. You gradually build up a portfolio of value that will later be drawn down to cover your growing cost of living. This spreadsheet converts a flat payment to an amount you can spend that grows with inflation. The flat annuity benefits vs your increasing cost of living works well when you plan on an active and expensive lifestyle when newly retired, and a more sedate and cheap lifestyle in later years.
You buy the amount of an annuity that will cover your inflated cost of living at age say That annuity will pay benefits at the start that exceed your basic cost of living. So you use the excess for extras like travel, while you are healthy. Inflation experienced by retired people differs from that experienced by the general public or measured by the CPI.
The Key Elements Of Retirement Planning
Their spending is weighted more to the food, energy and housing factors. This means that benefits linked to the CPI may not really offset inflation's effects e. Owning your own home is a great hedge against inflation. The value of the rent saved will grow with inflation and the principal value of the home will also grow with inflation.
Even better if you have a rental suite to cover the increasing cost of your other bills. It is common to read that bonds do not generate an inflation adjusted income. It is true that the principal to be recovered at maturity does not increase with inflation except for RealReturn bonds. But the income you receive each year does include compensation for inflation. Your expectation of inflation is built into their yield. When you want a portfolio of bonds to grow with inflation you must reinvest that inflation portion of your interest each year.
Medical care for the last few years of your life can wipe out your savings. It cannot be ignored. There are five ways to deal with it. With a couple, the first to get sick can impose unintentional emotional blackmail on the healthy spouse. All the couple's assets may get spent, leaving none to support the survivor, who must pay for institutional care at the end of her life. It is unknown at the time of the first spouse's illness whether the survivor will need ANY additional care.
She may drop dead on the spot after being perfectly healthy. This prompts people to spend all the money they have on the first to get ill. The probabilities discussed below show that women who presumably care for their husbands' first for free have a higher probability of needing professional care. If the survivor is a second-wife and the assets get left in a testamentary trust there is also a problem.
Normally income earned by the trust goes to the second-wife during her life and the capital is distributed to the kids on her death. While the income from the trust may pay for normal living expenses, it most probably won't be sufficient for long-term-care costs. Even if the kids, from the first marriage who would receive the eventual principal, want to help out, they may not be able legally to touch the principal dollars in the trust.
Statistics on projected needs for care are hard to come by. Reverse engineering LTC premiums leads to the conclusion that insurance companies presume an average 5 years of benefits. But that would apply only to the subset of the population that buys insurance. Another study was also optimistic and found a high probability of nursing home stays, but for only short durations.
Working from a database of American experience, Crook and Sutedja modeled probabilities. This includes home care, assisted living, and nursing homes. The average age of first use is 80 years. But that overstates the risk because it includes use for even one day only.
It is the cost of nursing home care that will do most damage to any budget. It is not just big-ticket LTC and end of life care that drain finances. Even though Canada has 'free' health care, a Ontario HOOP analysis found significant out of pocket medical expenses at later ages. With boomers entering their twilight years, and government coffers predicted to run dry, many children are asking whether they have legal or moral obligations to assume the financial burden of their parent's care. There are provincial laws in place that answer 'yes'.
At this time they are rarely enforced, but it is reasonable to assume that will change in the future. Some reference websites from a web search of "filial support Canada" are Canadian Elder Law Duhaime. Investment returns are a huge unknown. The small returns from safe assets are not sufficient for most people to fund their retirement, so risky assets must be owned. Their variability of returns, and sequence of returns, will greatly impact the portfolio's sustainability. In retirement, sequence of return risk plays out like 'dollar-cost-averaging' in reverse.
Withdrawals after a market decline will remove a greater portion of the portfolio, than the same dollar amount drawn at market highs. Computer modeling with MonteCarlo or bootstrap simulations, have all shown that poor returns at the start of retirement destroy its sustainability. Returning to work might be the best decision if this is your reality. So do not burn your bridges behind you when you retire. There are ways to mitigate sequence-of-returns risk in retirement.
The Canadian government will help out in years of poor returns when investments are held in taxable accounts. The capital losses can be claimed against prior year's capital gains, and their taxes recovered. That cheque may be big enough to fund a year's expenses. You can maintain a near-cash account from which to draw your living expenses without triggering sequence-of-returns risk.
You top up this fund after years of high stock market returns, and draw it down in years of losses. Everyone agrees that reducing your spending in years of poor return - flexible draws - adds safety. You trade off the certainty of some available cash against the pain of a variable standard of living. The riskiness of your portfolio determines both. Dividends from steady stocks are one way to reduce portfolio risk. See the second sheet of this Dividend Vs Growth Portfolio spreadsheet. A high dividend portfolio will show less price volatility. That lower volatility will reduce sequence-of-returns risk.
Changing your Asset Allocation percentages as you age may help. Academics are reporting very contradictory conclusions, so read the section below on AA. Some show good results from spending debt assets first, or taking cash from the best performing asset class Spitzer,Singh paper. This allows equities time to recover from any poor returns soon after retirement. This is what the 'buckets' approach does. Other academics have found the opposite. Historical average returns don't predict your future returns and especially don't predict your sequence of returns.
There are two schools of thought - the random walk school and the reverting-to-the-mean school. Pfau has devised a simple math model that essentially predicts rates of return and determines the appropriate withdrawal rate, all in one fell swoop. Use the Pfau's spreadsheet at your own risk. Don't be fooled by market cycles into thinking you can retire early, or spend more in retirement just because your past returns have been exceptional.
Most of the dollars spent in retirement come from profits earned after retirement, and good markets are followed by poor ones. Unless you crystallize your good fortune by buying insurance, you should expect reversals. A paper A Case of Myopic Extrapolation shows that purchases of annuities vary widely depending on very recent stock market returns that the naive investor presumes will continue.
Good stock returns result in low sales, and vice versa. This has the irreversible effect of crystallizing stock losses. This is the risk of running out of money because you live longer than planned. You can find many longevity calculators on the web. Look up your expected remaining life span.
Why $5 Million Is Barely Enough To Retire Early With A Family
Compare your longevity to the longevity of your savings, using the 2nd tab of the spending spreadsheet called "Longevity of My Savings". There are ways to deal with longevity risk. This is the biggest decision to make. You certainly won't have a pot of money left for long-term medical care. Investment returns may be lower than expected, tax rates and inflation may be higher and your lifespan may be longer than predicted. What, exactly, do you plan to do then?
Milesvky paper has found that 'outliving your expected death' ranks with 'poor initial market returns' as by far the biggest risks facing retirees. Common sense says you should never PLAN to die broke. It may turn out that you Do, but it should only be because the gods have conspired against you. You can see that the difference in Safe Withdrawal Rate between the two choices is very small on the spending spreadsheet.
Planning to maintain your wealth is a far less risky strategy because it removes the lifespan risk. At retirement you spend only what is left from your investment returns after taxes are paid and after the amount of inflation in retained and reinvested. You may leave a legacy to your kids or charity. You can self-insure against unknown investment returns.
You maintain the ability to make large purchases like real-estate. You can self-insure against unknown health costs. As you get older, replacing inflation becomes less critical, and eventually dipping into the principal is also safe. Asset allocation depends on how rich you are, compared to your spending. They choose to tell the rich to satisfice - be content with low but safe returns because they don't need the extra income to finance their lifestyle.
Advisors choose to tell the poor to assume more market risk, ignoring the obvious outcome of risk that is beyond their tolerance. They will sell after market crashes. In contrast the rich can AFFORD to take more risks because they would still have 'enough' even after losing half their wealth. It is a bad idea to opt for the 'hail-Mary-pass' hope to salvage the plan.
Highly variable, risky returns can easily make a bad situation much, much worse. Asset allocations during retirement also depend on the chosen draw-down strategy. But flexible spending, that chooses a high-priced treat only after a year of high returns, will face little sequence of return effects. The portfolio does not need the low-return, but safe, Treasury bonds because normal spending is kept low.
Age In Bonds : There is widely repeated advice that a retired person's portfolio allocation in common stocks should equal or minus his age. The percentage allocation in debt should equal his age. It increases over time. This advice dates back to an era when men retired at 65 and died 10 years later. The unstated presumption is a die-broke situation where living expenses come from maturing or selling bonds, and so their value must be predictable within short time-frames.
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Retirement now stretches out 40 years. It is much more important that portfolios grow to compensate for inflation and longevity risk. When you plan to live off a portfolio's income instead of its principal, the certainty of liquidation values becomes less important. Glidepath : Mutual funds and ETFs that are classified as Target-Date-Funds provide investors with a portfolio that is managed to change its asset allocation as it approaches a stated retirement date. Much like the Age-In-Bonds strategy they increase the allocation to bonds as retirement approaches, although some decrease subsequent to retirement.
This strategy is consistent with their investors' preference for downside protection rather than upside potential as they near retirement.
Catching FIRE: The Financial Independence Retire Early movement
It is agreed by all that in early retirement a few years of poor returns have a very large destructive force on the portfolio. This is the sequence of return risk. And interesting paper discusses the glide paths chosen for different benchmarks. Increasing Risk : Some research on target-date-funds shows negative benefits from lowering your allocation to equities in the accumulation phase before retirement. See the Saving Money page. As retirement approaches the portfolio is at its biggest size. The returns it earns then have the largest impact on its size.
Choosing to own low-return bonds when the portfolio is large means much growth is missed. That cost can be bigger than the sequence of returns effect. Start saving. For most retirees, there are other sources of retirement income besides savings, Social Security being chief among them. The common assumption is that some savings, in addition to Social Security and a less expensive lifestyle no more kids in the house, no more commuting costs will all add up to financial security in our sunset years.
For some, that may turn out to be true, but such success stories are more a result of good luck than a sound retirement strategy.
That phrase — sound retirement strategy — is where many of us lose interest. It is loaded with negative connotations: expensive investment advisors, large stacks of documents and complex spreadsheets, to name a few. It can be boiled down to one simple question: How much do I need to save to retire?
By putting away a percentage of your income every month from now until you retire, you can do away with the financial anxieties far too many seniors find themselves facing. A retirement calculator can help. Do you hope to travel? To Paris, or someplace a little cheaper? How often do you want to eat out? Go to the movies? The beach? Do you want to move closer to the beach? The grandchildren? The important thing is to be realistic.
While some costs will likely go down in retirement, others may go up. Specifically healthcare costs are likely to rise in retirement. Plus, retirement is your reward for decades of hard work: treat yourself accordingly. Think of this figure as a mountain summit, reachable by several different paths. The answers to those questions will determine how much work you have to do to reach that mountaintop.
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After thinking it over, you decide that you would be comfortable living a lifestyle similar to your current one in retirement. Not bad! Getting an early start on retirement savings can make a big difference in the long run. You also plan on living fairly modestly once you retire, and think your budget will be a bit trimmer than it is today. This Pittsburgh resident is right on track for a happy retirement.
This Los Angeles couple put off the important retirement decisions for too long. In the above scenarios, our hypothetical subjects kept their savings in one of a variety of retirement savings options, in either a savings account, a k or a traditional IRA. There are many ways you can invest the money you set aside for retirement, depending on your goals. The rate of return your money earns depends on the risk you are willing to take on, the success of your particular investment strategy and, to a certain extent, luck.
For example, an economic downturn can hurt your investments, at least in the short run. So too can changes in the inflation rate, and other economic events. All of which is to say: the unexpected can happen, and often does. The best you can do is to develop a solid plan based on the information you have now. Don't let retirement savings statistics get you down. A retirement calculator can help you see how you are doing so far and what you need to change to make your retirement goals. By setting goals and meeting them, you give yourself the opportunity for a rich and rewarding retirement.
Wondering where to retire? Zoom between states and the national map to see the best places to retire in each region, or look specifically at one of three factors driving our analysis: tax-friendliness, medical care and social life. Methodology A happy, healthy retirement depends a lot on location. To find the best places to retire, SmartAsset gathered data on three separate regional factors that affect the quality of life for retirees. First, we looked at state and local tax rates, considering two types of taxes: income and sales. Finally, we found the number of seniors in each area as a percentage of the total population.
In our final analysis, we ranked each county and city on these three factors. Then we calculated an average ranking for each area, weighting the three factors equally. The areas with the lowest average ranking are the best places to retire. What is an Index Fund? How Does the Stock Market Work? What are Bonds? Investing Advice What is a Fiduciary?
What is a CFP?
Your Details Done. My Details. Location is used to figure out the taxes you will pay in retirement. Do this later Dismiss. Annual Income. We'll use this to calculate your taxes and needs in retirement. We'll use this to calculate your Social Security income in retirement. Monthly Savings. We automatically distribute your contribution optimally among different retirement accounts. What do you estimate your annual expenses will be during retirement?
We'll use this to figure out how much income you'll need to generate from your retirement savings. We'll take care of inflation so tell us based on today's dollars how much you think you'll need to support your lifestyle. This is used to figure out the years you have to save, and your benefits from social security. Add the type of retirement accounts available to you and the current balances. Start Year. Add your IRA accounts and the current balances. IRA Account Details.
Account Balance. Add your Pension type and amount. Pension Information.