Preparing for Retirement
If you have not started preparing for your “inevitable” retirement, now might be the time. Depending on what decade in life you are in (20s,30s,40s,50s) the aggressiveness you will need to pursue will be very different. In this article we will talk about three different ways to generate income in your retirement. as well as (depending on how early you started preparing for retirement) how much cash or value you can walk into your retirement with.
Before we get into those three methods, let’s talk about the risks you will face in choosing “retirement income” products and services (especially government services like Social Security). Next we will talk about some traditional retirement products, and briefly discuss what you will need when retirement comes. These days an overwhelming number of people are completely unprepared for their retirement. We will spend a few paragraphs talking about the risks related to social security and a little bit about the lifestyle you may have (using real examples) if you decide to use this as your safety net.
Looking at the Risks
Anytime you talk about finances, it is extremely important to talk about risks. It is also important to mention that this article should be considered as presented for information purposes only, and not a recommendation on what YOU should do. Our advice is to consult a licensed financial services provider. If you contact us we can connect you with the appropriate individuals, including members of our staff and connections we have made in the industry.
Risk #1 – Interest Rates Can Vary Wildly
Interestingly enough this was something that people in the finance industry did not often talk about. Before 2007 there was a common adage that values of homes increased 7% per year, about right in line with inflation, making them a great investment. Prior to 2007, people invested in homes (especially rental homes) like they were a bank account. History has a way to exposing risk in a brutal way. Come 2007, 2008, and 2009 many of those same people lost their shirts, filed for bankruptcy, and watched their retirements melt in the housing market crash.
This past few years we also watched inflation spike MUCH FASTER than 7%. Those who had investments that were earning less than that watch that money shrink in value, even if it was growing in quantity. That leads us into risk number two.
Risk #2 – Recissions Change the Rules
In 2019 came COVID-19. This worldwide pandemic created the perfect storm of financial issues and created an economic downturn that we have refused to call a recission, but regardless – it has changed the rules of traditional finance, and the rules of how investing, borrowing, and earning has worked for the past 30 years – including over some of our major busts like the Dotcom and Real Estate busts.
The best example has been how the Federal Reserve has continuously raised interest rates across the year. The price of basic commodities that support backbone services like fuel have fluctuated wildly. War in Eastern Europe has affected the prices of everything from wheat to corn. Tensions with China have caused insane swings in the costs of services, food, and shipping.
Risk #3 – Government Policy Changes
This one hurts. The government loves to close loopholes. They do not catch them all, and ones that they do, they do not always close (especially those that are being taken advantage of by members of congress). This includes a large number of things. Take NFTs for example. Congress is currently fighting about whether they are securities or commodities. It may seem simple, but there are major implications based on how this goes, and if it is determined they are securities it takes the potential of earning way out of the common person’s hands. This is just one example, but I assure you there are many more.
Traditional Retirement Products
#1 – The Good Ole’ 401k
Though I do not have any specific recommendations against this type of product, as pointed out by Investopedia there are some interesting risks. The biggest of course being that you carry all the risk of the investments value – or devaluation. It is simply a cash in, cash out program, there is no guarantee in place that protects your investment over time, so if the market crashes you may lose all or even a significant portion of your investment.
Of course the major issue is the fact that your investment is not easy to access, and is not liquid. What if you have an emergency? What is there is a better investment opportunity. Although in many cases there are employer matches, there can be some unknown pitfalls with this type of investment. Although they are generally considered safe if well managed, some of the risks we talked about above have the potential to affect the outcome of this particular product’s ability to create income for you in retirement.
#2 The IRA and Roth IRA
Let’s talk briefly about the Roth IRA. One of the important features of this product is that it is made with after-tax money. This of course means this product does not provide a lot of benefit for someone who is already advanced or in late middle age. It does mean that you can typically withdraw money from it (making it more accessible than a 401k) with no penalty, but only the principle amount, not the investment earnings, meaning it suffers from some of the same disadvantages as the 401k. After 59 1/2 you can start making withdrawals with no penalty, and of course your earnings grow tax-free, so there are some advantages.
A traditional IRA lets you make your contributions to it pre-tax. It also gives you some immediate tax benefits, but the money is essentially inaccessible, giving you the exact same problem you have with the 401k. There are also serious limitations on the amount of contributions for both types of IRA ($6,500 for those under 50, and $7,500 for those over 50 in 2022). With this one you also have a MANDATORY distribution age of 72, meaning if you are older and in good health you will still have to start withdrawing from this fund.
How do you know what you will need in retirement?
This is a question that financial experts the world over love to argue about. Live frugal, skip that coffee, don’t get that car. There is an ongoing debate about whether you should enjoy life as you live it, and risk being unprepared for your retirement in what can be some of the most difficult years of your life, or abstain from things while you are young so you can enjoy your twilight years. Both paths carry and obvious risk, for instance, what if you spent your life abstaining from risk, only learn that before retirement age you have fatal cancer, and will never be able to enjoy those golden years?
According to Citizen’s Bank the middle ground lays in a multiple of your annual income – if you wish to keep the same and potentially a slightly waning lifestyle as you grow older. The suggest at age 30 you have accumulated the equivalent of your annual income. By age 40 you should have 3 times your current income, and and by your desired retirement age you should have 10-12 times your current income. The goal here being that you can replace 60-100% of your pre-retirement income with these funds.
Retirement Income Sources
The question of course arises for many – what if I did not start early enough? What if I did not have my annual income saved by age 30, or even by age 40. For many people there are great ways to earn income, some that carry more risk than others, well into your retirement.
- Starting or Maintaining a Business – A business venture, especially those that produce passive income (think rental properties, affiliate marketing), near totally automated, or hired out with little supervision make great retirement income sources. If you were not doing this before retirement, it can be a great transitionary way to add income to your life and ensure that some of your income needs are taking care of into retirement or even allow you to contribute to your retirement plan before you reach retirement age.
- Contributing to Your Retirement Plan – It may seem like conflicting advice, but if you have the money for it (and the capability to make multiple investments) then if your employer has a retirement plan, contributing to this can help that same foundation, but as we said before, this should not be your only source of retirement income.
- Stock Market Investments – These can be risky, but investing in index funds has shown an upward trajectory over the course of many years. So when doing this think long term and invest in what you know.
- Social Security – We will spend a little bit more time on this particular one. If you were employed and paid taxes you will be entitled to social security. Entirely too many people think of this as retirement. Social Security, Medicare, and Medicaid are just not adequate. I have personally watched entirely too many people struggle when they believe this will be enough for them. This includes people who no longer have a house payment, and even a few who no longer have car payments. The inevitabilities of life often get in the way. Here is a list of “life issues” a person I know faced, that simply made their social security completely unlivable. This person owned their home and vehicles outright, but had little to no savings or other investments:
- Dishwasher broke, needed to be replaced
- Car had an engine failure, they opted not to replace the engine, but to purchase a used car – adding a new monthly payment to their budget
- Their eldest child had an accident and was in intensive care for several months, and needed some financial support while they were unable to work – draining what little savings they had
- A bad hailstorm damaged their roof, and the homeowners insurance did not cover everything, they had to take a loan to cover the difference, and that added yet another monthly bill.
In the end, each of these types of investments, services, and benefits carry some heavy risks, and have the potential to fail you in retirement. Take social security for instance, current estimates say it will run out of funding between 2032 and 2036. Though this has been a constant risk, it has been pushed back several times, we cannot expect that it will be fixed forever. Though it has been a long journey, this FINALLY brings us to the 3 ways to be prepared for retirement that consider mitigating risk, increasing income rates, and provide other benefits (like death benefits).
3 Ways To Be Prepared For Retirement
Keep in mind the purpose of this article is to simply provide you with some good information, and to encourage you to do the research into these products on your own, or to connect with professionals. Please reach out to us if you would like to connect with someone who can help you get answers.
Way #1 – Annuity Products
Annuity products come in many flavors – income annuities, fixed annuities, indexed annuities, and variable annuities to name a few. The ones we will focus on are Indexed Annuities. These group of products use a market index (like the S&P 500) and typically carry a maximum return, but also mitigate loses by having a floor. This may look something like guaranteed 1% return each year, with a cap of 13%, based on market conditions (ie if the market loses 3% you still gain 1%, but if the market makes 17% you only make 13%).
Many of these products even have a death benefit for a portion of the product’s life, that either dwindles or disappears as you benefit from the product itself. They also are much more accessible than products like a 401k or IRA. These can be good products to look at when in early middle age, such as your mid 40’s.
Way #2 – Universal Life Policies
Like annuity products these also come in many flavors, and the one we are going to shine a light on are Index Universal Life Policies. These policies carry the same benefits as the Indexed Annuity products, but are life insurance policies and have some other interesting benefits. One for instance is that after a period of time you can borrow against the cash value of these policies. This means that they can act as a tax-free source of income for you, while leaving the cash value in the policy itself to continue accruing interest and earnings.
These also (since they are a life insurance product) carry a death benefit and can allow you to leave a financial legacy for the next generation, and to ensure your end of life care and services are well taken care of and do not burden your survivors. They can leave behind funds to not only pay your bills, but benefit those survivors with a blessing of additional finances.
Way #3 – Income Generating REIT Products
Though this product is riskier, it can be very rewarding. By diversifying an investment portfolio of real estate products you can gain some shelter from market conditions, and there are no limitations on what you can put into these funds. While you do not need them dividends from these funds can be reinvested, growing your base, and when you retire the dividends can function as income for you, covering part of what you need as you retire and replace your primary income source.
As an example the Fundrise REIT program has worked will for me, and produced a return every month for the last six years, without fail – averaging between 8% and 12% annually. Minimal investments here have seen my portfolio grow about 50% in six years. A small disclaimer – I am not a partner of Fundrise and do not benefit in any way from the recommendation of their services, I am simply a happy user.
Where to go from here?
If the financial world – especially being prepared interests you, please contact us! Take a look at the World Financial Group website, and let us know how we can help you – or even how we can help you become a part of the exciting and rewarding world of financial literacy, financial preparedness, and helping others!
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