Planning for retirement is something you’ve probably been doing for a good part of your working life. You’ve saved, invested, and mapped out your post-retirement life and goals.
As you get to the point that retirement becomes a reality, there are a lot of choices to make that will have an impact for years to come. The process can be complex at the best of times. For people taking the leap in the next year, there’s an additional layer of worry.
Bear markets, high inflation, interest rates that keep going up, and now the potential for a recession. All of these can add risk to your decision-making.
It might seem like the worst possible time to retire. But is that accurate? You can expect to experience challenging economic and market conditions throughout a two- or three-decade retirement. A good retirement financial plan is built to weather these circumstances and keep your portfolio on pace with your income needs.
When you break down the biggest challenges and get a plan in place to manage them, you have more control over the decision on when you step away from full-time work.
Sequence of Returns Risk
This phrase is an elegant way to describe the effect on portfolio returns when there is a period of low or even negative returns in consecutive years in early retirement. Even with a conservative withdrawal strategy (4% per year is standard), if combined with a market downturn early in retirement, those first withdrawals could potentially negatively impact your portfolio for the duration of retirement.
Liquidating assets, when the portfolio is at a lower asset value due to negative market performance, crystalizes the loss and the smaller portfolio then has a more difficult time recovering.
One way to help mitigate sequence of returns risk is by utilizing a time-bucket approach to retirement investing. Time-bucketing divides your assets by the timeframe in which you are likely to need them. Funds that will be needed in the immediate future say three years or so, are primarily held in cash or other short-term investments.
This helps the portfolio ride out a period of negative returns by avoiding selling off investments in a down market. Investment horizons are generally divided into intermediate-term assets, which are held in capital preservation strategies that also throw off income and long-term assets which are earmarked for growth. These longer-term assets have the longest amount of time to recover from downturns before they are needed.
Managing for Inflation
Inflation well under 4% has been a regular feature of our economy in the last several decades, and the chief goal of the Fed is preventing the current high inflation from becoming entrenched. It may take some time, but inflation will go down.
However, the goal of the Federal Reserve is no longer 2% inflation. Instead, the target is an average of 2% over the long term, and one of the stated goals of monetary policy is to encourage full employment and reduce income equality. This means that periods, when inflation is allowed to exceed 2% are part of the landscape that retirees need to plan for.
The current inflationary environment does have one benefit – the increase in social security payments is permanent.
Delaying Social Security is Always a Good Strategy
Delaying taking Social Security past your full retirement age results in an increase to your annual benefit that you keep for life. Whether you can delay or not depends on your income. Funding early retirement with assets drawn from tax-deferred 401(k) accounts reduces the amount of required minimum distributions you’ll have to take after age 72, because it reduces your account value. In a year with low asset values, it can also reduce the tax hit you’ll take now. It can also be a good idea to consider a Roth conversion this year or next year, before asset values recover.
The Bottom Line
Deciding to retire requires careful planning, no matter when you do it. It is a more complex environment now – but over the course of a multi-decade retirement, you’ll see a broad range of situations. Starting off with a plan that is built to smooth your path no matter what lies ahead is a good strategy.
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