I spent a lot of time traveling in October, which was good for my tan, but bad for my writing schedule. There’s quite a bit on the editorial calendar for November though, so stay tuned. In the meantime, below is a list of articles published at Intentional Retirement during October.
Thanks for reading!
Here it is:
Every year during retirement, everything you buy will cost more than it did the year before.
Such is the nature of inflation. In 1990 a stamp was 25 cents. Today it has almost doubled to 44 cents. A gallon of gas was $1.16. Today you can expect to pay triple that. A new home in 1990 was $149,800. Today it is…well, let’s just say housing has hit a bit of a soft patch.
Multiply those increases across all the goods and services you buy during retirement—dinner out, a new car, a vacation—and over a 20-year retirement, you can expect prices to more than double (assuming 4 percent annual inflation). That means you’ll need twice as much income later in retirement to buy the same goods and services you bought at the beginning of retirement.
How can you combat this nemesis of inflation? Most people’s retirement income comes from two different sources: Social Security and personal savings. Let’s look at ways to overcome inflation in each.
Social Security has a built in annual cost of living adjustment, so most people assume that it will keep pace with inflation. Unfortunately, that may not be the case. Social Security adjustments are based on the Consumer Price Index or CPI. For decades, the Bureau of Labor Statistics (BLS) calculated the CPI in a fairly straightforward manner. They looked at a basket of goods, and determined how much it would cost. The following year they would price out that same basket of goods and the CPI would go up or down based on the new price.
In the 90s, some in government began to argue that inflation was overstated. They argued that as prices increased people would substitute less expensive alternatives, so the “basket of goods” should be adjusted each year. If steak got too expensive, they assumed that consumers would substitute something cheaper like hamburger. So why not remove steak from the basket, put hamburger in and voila, inflation is under control. Rather than implementing this “variable basket”, the Clinton administration implemented a different process that essentially achieved the same results. The BLS began to weight items in the basket differently. Basically, items that were increasing in price were given less weight than items that were decreasing in price.
To make matters worse, the BLS went on to make another change based on what they called “hedonics.” In short, hedonics doesn’t simply consider the price of an item, but the value that you get from that item. So if the price of a new car increases 10 percent, but there are new features on the car like airbags or heated seats that increase the “value” to the consumer by 15 percent, then the BLS would essentially say that the price of that car had decreased by 5 percent even though you’re paying more for it.
Applying this to your Social Security check, you can see that the annual cost of living increase built into the program won’t necessarily help you to keep pace with inflation if it is based on the fuzzy math of the CPI. A case in point: there were no cost of living adjustments in either 2010 or 2011, even though prices for things like food, fuel, and medical care undoubtedly increased over that period.
The best way to overcome this hurdle is to build your own inflation factor into your Social Security benefits. How do you do that? Rather than waiting until full retirement age or later, the average person retires at 62 and takes a roughly 20 percent permanent reduction in benefits. Rather than following their lead, if you wait a few years you can retire on full benefits. Even better, retire a few years “late” and you can add as much as a third to your annual benefit (8 percent per year for those born after 1943 to a maximum age of 70). The annual cost of living adjustment will still be understated, but it will be based on a much higher benefit amount.
In the same way that inflation eats away at the value of your Social Security income, the purchasing power of your savings and investments are also constantly being eroded. Failure to keep pace will result in your money becoming worth less until it is eventually worthless. As we saw earlier, even a modest rate of inflation of 4 percent can wipe out nearly all of the purchasing power of your nest egg during a 20-year retirement.
To overcome this problem, you need to invest in things that have the possibility of outpacing inflation. Understandably, however, the volatility and uncertainty of the last few years has caused many to shift their investments into things like money markets, certificates of deposit (CDs) and other “safe” investments.
Unfortunately, safe can be risky.
Consider a day in the hospital. In 1980, a day in the hospital cost $344. Today that same day costs around $5,310 (according to statistics published by the Wall Street Journal). For the sake of our example, let’s assume that 30 years ago you wanted to start planning ahead for your retirement. You thought that someday you might end up in the hospital for an illness and you wanted to set aside enough money to pay for a two-week hospital stay. You didn’t want to risk losing the money however, so you just put the cash into your safe-deposit box.
Fast forward three decades and you’re hospitalized with pneumonia for two weeks. When the bill arrives, you remember the cash that you stashed away so many years ago. You make a trip to the bank, open the box, and find exactly $4,816. Looking at the bill, you realize you’re about $70,000 short. By not outpacing inflation, your money lost almost all of its purchasing power.
Now let’s assume that instead you invested that $4,816 into the S&P 500 back in 1980. Even with all the ups and downs, it would have grown to nearly $135,000 by 2011. That’s enough to pay your entire hospital bill with plenty to spare.
So what are some ways to preserve the purchasing power of your nest egg? First, as we just saw, you should resist the temptation to be too conservative. You aren’t doing yourself any favors by having a portfolio dominated by “safe” investments like cash, government bonds and CDs. These investments are less likely to outpace inflation and could even lose a significant amount of their value during high inflationary periods. Most investors should keep at least a portion of their investments in quality stocks.
Second, consider investments in real estate, commodities or precious metals. These types of “intrinsic value” investments tend to do well during inflationary times. As we have seen with the current downturn, however, they can also be more volatile and less liquid than stocks and bonds, so keep that in mind.
Finally, consider investing in a real return mutual fund. These funds invest in a wide range of investments that are designed to battle inflation, such as inflation protected treasury bonds, real estate investment trusts, floating rate bonds, non-U.S. debt, natural resource stocks, high yield bonds, currencies and commodities.
Clearly, a fixed income retirement strategy in a rising cost world is a recipe for running out of money. By investing in a well balanced portfolio that is designed to keep pace with inflation, you can help ensure that your money not only lasts for your lifetime, but also provides you with the income necessary for security and independence during retirement.
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Retiring in the place you want, with the people you want, doing the things you want, for as long as you want takes money, good genes, and a bit of luck, to be sure. But perhaps what is more important is the role that good decisions play. One of the earliest lessons in life is that actions have consequences and boy is this true in the final third of life. If you’re at or near retirement, the decisions you’re about to make will have consequences for you and your family for decades to come. Unfortunately, it only takes one bad decision to ruin a lifetime of good ones. So what are the biggest mistakes to avoid as you approach and enter retirement?
Retiring based on your birthday instead of your bank account.
Imagine that I wrote the name of a city on a piece of paper and sealed it inside an envelope. Giving you the envelope I said: “Without looking inside, drive to the airport and randomly buy a plane ticket to anywhere in the world. When you arrive at your destination, open the envelope and see if it matches with the destination that I wrote on the paper.” What are the odds that you would end up in the right city? Not good right?
As ridiculous as it sounds, that is how most people plan for their retirement. Don’t get me wrong. People save; they just don’t do it with a great deal of deliberation or a clear understanding of the end goal. Instead they do it via a completely random series of 401(k) and IRA contributions. Much like traveling without knowing your destination, saving for retirement without knowing your end goal will likely leave you far from where you need to be.
If asked when you want to retire, your answer should be a dollar amount, not a year. Retirement is about independence, not simply age, and money is critical to independence. You should know exactly how much you need to save in order to fund the type of retirement you want. Without that knowledge, there is no guarantee that your efforts will get you to where you need to be. In fact you are almost guaranteed not to reach your goal. Doing so would be more the result of dumb luck than anything else.
Retiring with too much debt.
I’ve written about debt here before, but it bears repeating. Too many have gotten caught up in the debt frenzy and now, as they approach a time that is supposed to be about enjoying life and living their dreams, they instead find themselves beholden to their jobs and struggling to make ends meet.
An increasing number of people are entering retirement with no pension, inadequate savings, a big mortgage (sometimes two), an average of about six credit cards, and debt on one or more cars. Work is not a choice at that point any more than it’s a choice for the thirty-year-old with all the same obligations and a growing family to feed.
Having debt adds risk and reduces cash flow, two things that are especially troublesome for a person at or near retirement. Your primary goal should be to retire debt free and have your income at your disposal. If you retire with debt, you will spend precious years of your retirement paying for the purchases of yesteryear instead of using your income to live the life you’ve always dreamed of.
Fumbling your distribution strategy.
Farming and cooking are two different things. One is about creating and the other is about consuming. Likewise, saving for retirement and turning that savings into an income stream are very different tasks. When converting your savings into an income stream, taking too much, too soon from the wrong account or in the wrong markets could be the difference between retirement bliss and retirement blunder.
A distribution strategy typically occurs in two phases. Phase 1 involves moving the money from pre-retirement accounts (e.g. your 401k) to post-retirement accounts. Phase 2 involves creating an income stream from those post-retirement accounts. The ideal time to begin working through your distribution strategy is with a year or so to go before retirement. You should be thinking about how much you need, where it’s going to come from, and whether your nest egg is up to the task.
When you retire, your portfolio takes over the job that the payroll department handled during your working years, namely to send you a paycheck every month. If you retire when you’re sixty-five and live until you’re eighty-five, it needs to cut you 240 monthly paychecks. There are a host of variables that will affect its ability to do that, such as the distribution rate you choose, investment returns, inflation, how long you live, and good old-fashioned luck. Some of those things you can control and others you can’t, but having a well conceived, sustainable distribution strategy will help ensure that you don’t outlive your money.
Retirement is a major transition. That transition is not always easy and is often fraught with potential risks and pitfalls. By diligently completing each necessary task and avoiding the mistakes that ensnare so many, you can head confidently into what will surely be one of the most fulfilling and rewarding periods of your life.
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Note: Portions of this article were excerpted from my book The Bell Lap: The 8 Biggest Mistakes to Avoid as You Approach Retirement. Visit the Resource Page for more information.
Just in case you missed something, below is a quick summary of the articles I published at Intentional Retirement during September. There are plenty more on the way for October, so stay tuned.
Thanks for reading!
Quick Summary: The things you want to do are only difficult until you really decide to do them.
One of the things I write about here at Intentional Retirement is pursuing big goals. If you’re anything like me, sometimes staring a big goal in the face can be challenging, scary, complicated, and overwhelming.
Because of that, it’s sometimes tough to get started. I’ve found that the easiest way to overcome this “beginner’s inertia” is this:
~Actually decide to do what it is you want to do.~
It sounds simple, but deciding is the hardest part. I don’t mean hoping or dreaming that you’ll do it. Those are vague and passive. I mean actually deciding. Deciding is specific and active.
Until you decide, you can’t plan; you can’t act. Let me give you a small example. I’ve written before about my goal to get our daughter to all 50 states before she graduates. A few weeks ago we found out that she had a three day weekend coming up due to some teacher meetings. We kicked around the idea of getting out of town, but nothing really came together.
Fast forward to Tuesday of last week. I woke up that morning and said “We’re going to Colorado this weekend.” That simple decision shifted me into tactical mode. I looked at three different areas I had been talking with a friend about and decided on Colorado Springs. I went to www.avis.com and rented a car (ours are a bit small for road trips). I went to www.vrbo.com and rented a house for our stay. I made reservations for several things that we wanted to do, like a train ride to the top of Pike’s Peak. Wednesday night each of us packed a bag and when we picked up our daughter from school on Thursday we hit the road.
If you look at that sequence of events, the most important thing I did was decide that we were going. After that, everything was logistics. Most dreams die for lack of a decision. Keep that in mind as you plan your adventures for retirement. Dreaming is one thing. Deciding is another.
Practical Application: The 100 Day Challenge
I’ll give you a practical application to test your new decision making powers. As of today, there are exactly 100 days left in the year. Think about the goals you had for the year. Think about things you’ve dreamed about doing in the not so distant future. Pick something off your “to do” list and make the decision to do it before year end. If your goal is travel related say to yourself “I’m getting on Expedia today to buy a plane ticket to ____________.” If your goal is to save more for retirement, call the human resource department today and increase your 401(k) contribution. If your goal is to get in shape, decide that today is the day that you’re joining the gym.
Take the challenge and I think you’ll discover what I did. Deciding is the hard part. Once you do that, you’ll be amazed at how easily everything else falls into place.
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Quick Summary: Key documents everyone needs to successfully navigate retirement.
When planning for retirement, most people focus on saving, and rightly so. Having enough money to fund your retirement dreams is a key element to any plan. Often overlooked, however, is the importance of obtaining and organizing important documents. Here are ten essential documents you will need to successfully navigate retirement.
Defined benefit pensions have become less common over the years, but there are still many people covered by them. If you have a pension at work, the details of the plan will be spelled out in the plan’s Summary Plan Description. In addition, you should receive an Individual Benefit Statement that details the specific benefits that you have earned and are eligible for. Make sure to review those documents as you approach retirement so that both you and your spouse have a good understanding of how much income you can expect from the plan and what will happen to that income if the primary pension holder dies. Make sure to contact your employee benefit’s department with questions or concerns. Also, the Department of Health and Human Services offers help and advice to pension holders through its Pension Counseling and Information Program. Visit www.aoa.gov for more information.
Beneficiary designation forms
Many accounts, such as Individual Retirement Accounts (IRAs), 401(k)s, annuities, and insurance policies allow you to name a beneficiary who will receive those assets when you die. Many people don’t realize that those designations take precedence over their will, even if the will is more accurate and up to date. Because of this, it is important to review the beneficiary designations on all your accounts (as well as those of your aging parents if you are helping them with their finances) prior to retiring to make sure that they accurately reflect your wishes. Meet with your financial adviser and estate planning attorney to ensure that your designations not only pass property to the correct people, but also minimize expense and taxes.
Documents needed when applying for Social Security
The Social Security Administration will need you to provide certain documents when filing for retirement or survivor benefits. Documents they may request include your Social Security card, a certified copy of your birth certificate, proof of citizenship if you were not born in the U.S., military discharge papers, a copy of your marriage license or divorce papers, and a copy of your W-2 form (or self-employment tax return) for last year. Having these documents readily available will help speed the process along.
Most people’s assets are divided into many different types of accounts. Some may be tax-deferred, others may not. Some might have restrictions or requirements on withdrawals. Some, like annuities, might give you different options for turning the account into a guaranteed income stream. When transitioning into retirement, it is important to have current copies of your account statements as well as options or restrictions associated with each account so you can craft a distribution strategy that meets your needs while minimizing expense, hassle and taxes.
Health care paperwork
Your health benefits during retirement will likely come from multiple sources. Those could include a former employer, Medicare, Medicaid, a Medicare supplement policy, or a long-term care policy. Be sure to retain benefit summaries, contact information, and policies associated with each. If you have not filed for Social Security benefits by age 65, you will need to apply for Medicare. You can do this up to three months prior to your 65th birthday. When applying, you will likely need to provide them with the same documents mentioned earlier for Social Security applicants.
Many house fires or burglaries occur when the homeowner is away. When you retire, you will likely spend more time traveling or at a second home than you did during your working years. Because of that, it is important to inventory the contents of your home (either make a list or do a quick video walk through) so that you can more easily make insurance claims and rebuild your life if the unexpected happens.
Many retirees have life insurance policies in order to replace income in the event of a death, as a vehicle to build cash value, or for estate planning purposes. Make sure to have current copies of your policies as well as contact information for the insurance company so you can easily access cash value during life or so that your heirs can easily claim benefits if something happens to you.
Most people need a will, regardless of the size of their estate, to control the passing of property at death. Another tool to accomplish this while at the same time avoiding probate is a Revocable Living Trust. As you enter retirement, you should meet with your attorney to put a plan in place that passes your property to the correct people, designates the correct people to take charge, and minimizes expense, hassle and taxes.
Durable power of attorney for finance and health care
A durable power of attorney for finance is a simple and inexpensive legal document that authorizes a person you have chosen to step in and manage your day-to-day financial decisions if you become incapacitated. Everyone needs this document to provide for the ongoing management of their financial affairs if they cannot make decisions for themselves.
Similar to the power of attorney for finance, the health care power of attorney is a legal document that authorizes a person you have chosen to step in and make health care decisions for you if you become incapacitated and can no longer speak for yourself. You can also include a health care directive which provides written instructions to your agent that communicate your wishes regarding the withholding or withdrawal of certain life support equipment or medical procedures.
If you plan on moving to a different state when you retire, meet with your attorney to make sure that your will, trust, and powers of attorney will be valid in your new state of residence and make any necessary revisions.
In many ways life becomes easier after you retire. Unfortunately, this is not the case with your taxes. In fact, because your employer is no longer automatically withholding from your paycheck, tracking and paying your taxes may become more complicated. To make matters worse, different states tax income and spending differently. Will you owe tax on Social Security? How about pension and annuity income? How much should you withhold from IRA distributions? The short answer is “It depends.”
Because of this you should work closely with a trusted tax adviser and then maintain your tax returns and supporting documents for seven years. The IRS can look back three years for basic errors and six if you underestimated income by more than 25 percent.
As you can see, obtaining, understanding, and organizing your key documents will not only help you to make informed decisions, but will also facilitate a smooth transition into a rewarding and meaningful retirement.
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