Many Baby Boomers are learning about retirement readiness first-hand during the Covid-19 pandemic. Factors such as layoffs, health, disability, and technology are why Baby Boomers are retiring in their early 60’s. Decisions in retirement around Social Security, (long-term) health care, and taxes need careful planning. The pandemic’s effects continue to ripple and are still unknown despite vaccine rollouts. The world will look very different on the other side. This means that careful retirement planning is even more important than ever.
Covid is Making Baby Boomers Rethink Their Retirement Date
Federal Reserve Chairman Jerome Powell recently cited a surge in the number of retirees. Many Americans are leaving the workforce sooner, contributing to labor shortages. As a matter of fact, 3.2 million more Baby Boomers retired from 2019 to 2020 than in the previous year.
The Covid-19 pandemic has made many Baby Boomers reflect on their plans. Surging asset prices are making the decision easier for those that own homes and stocks. The health scare from the pandemic has spurred many to reevaluate what matters to them.
The shutdowns caused many businesses to go into survival mode by reducing labor costs and increasing dependence on technology. The New York Fed reported a record low percentage of people planning to work beyond age 67.
Many data points support this, including the recent Census Household Pulse Survey. It shows that 2.7 million people over the age of 65 plan to apply for Social Security Benefits. This compares with only 1.4 million stating that they will continue working.
Employers may not be able to afford the cost of all their employees returning to the workplace. Entire industries have undergone a decade’s worth of change in a year. Remote work has opened the world up to new ways of doing business and has given workers a glimpse of retirement.
The advancement of technology is also providing more avenues for part-time work. Yesterday’s hobbies are quickly becoming today’s income. In a digital economy, the very definition of retirement may look different.
Covid accelerated the move to a digital world and is still transforming the global economy. It is still too early to understand how it all plays out. But it underscores the importance of careful retirement planning now more than ever.
Late Boomers are Unprepared for Retirement and Aging
Unfortunately, many prospective retirees face financial shortfalls despite surging asset prices across the economy. This is especially true for “Late Boomers” who were 55-60 in 2020. This demographic is worse off on average, as reported by the Center for Retirement Research at Boston College.
The reason for this is that they were the hardest hit by the Great Recession of 2008-2009. Unemployment, underemployment, and early retirement were all contributing factors.
Workers in their 50’s forced to search for jobs find it more difficult than younger people entering the labor force. Many of them settle for less pay, as we saw in 2008 and more recently in 2020. Thus poor labor market outcomes from the last crisis left many ill-equipped for this one.
The Late Boomer demographic has contributed most to 401(k) plans but has the least amount of defined contribution assets compared with other generations. Those that sold assets at the bottom of the market crash realized losses at the worst possible time. The housing crash in 2008 also affected home equity values for Late Boomers the worst.
Retirement Age Expectations Clash with Reality
For those over the age of 60, 40% of them are no longer working full-time and rely primarily on Social Security, averaging $17,000 per year. A Stanford study in 2014 found that 30% of all Baby Boomers had no money saved in retirement plans.
Life expectancy has also increased by about a decade since 1960. Too many have to fund longer lives with lower asset levels and shorter careers.
Thus, many plan to keep working into their golden years, yet the data does not bode well for this. The annual Retirement Confidence Survey indicates that half of the retirees surveyed retire earlier than expected.
The study underscores the importance of honest assessments and avoiding unrealistic expectations. Half of those surveyed expected a gradual transition to retirement. In reality, 73% experienced a full-time stop.
Seventy-five percent of Baby Boomers expected to earn extra income in retirement while only 30% did so. This statistic has been consistent throughout the survey’s 31-year history. Studies also show that most retirees who planned retirement at age 65 are retiring closer to age 62.
And those planning to retire earlier than age 65 end up retiring later. The main takeaway: many people are unrealistic, overconfident, and underprepared for retirement.
Planning Your Retirement Lifestyle
What makes retirement different than other stages in life is that you gain an extremely valuable non-financial asset – control of your time. You no longer have to answer to your boss. And if you are the boss, you no longer have to oversee the business.
Children are close to or have reached adulthood in most cases. And of course, you can’t take your financial resources with you after retirement. It’s a great time to reflect deeply on your values and goals that will lead to your most fulfilling retirement.
So get that bucket list out and start prioritizing your goals. What does that have to do with creating retirement income? You have to know how much you need to spend each year to reach your goals. Here are some common lifestyle goals that newly minted retirees need answers to:
- Feel confident and secure while transitioning from saving to spending what they’ve earned
- Have the confidence to explore new opportunities in retirement
- Provide gifts to children and grandchildren during your lifetime
- Spend your life doing what you love to do, not what you have to do
- Retire to your dream destination
- Have plenty of money every month to support your desired lifestyle
- Leave a legacy and support future generations
- Enjoy total financial independence
- To have the same feeling of security you had while working
- Donate to charitable causes and organizations
Once you have determined how much you need to spend (and this changes every year in retirement), you can construct a plan to maximize your financial resources.
The Conversations that Couples Need to Have Before Retiring
It’s important to begin talking to your partner now about potential retirement dates. The majority of couples have different ages, which means that Social Security Benefits, Pensions, Medicare, and RMD’s begin at different dates for each spouse.
In some cases, one spouse may retire while the other continues working. Or one or both spouses has the option of continuing to work part-time in retirement.
Another challenge that some face is having a dependent child enter college at the same time the couple plans to retire. The cost of college continues to rise at a rate greater than normal inflation and can contribute to higher income shortfalls in retirement.
The danger is that large withdrawals from retirement funds earlier in retirement can significantly increase the risk of outliving assets.
Spouses should coordinate their retirement dates to maximize their financial resources and ensure a smooth and gradual transition. Think hard about the kind of life you want and what you will need to realize it.
Discuss your goals with a fee-only financial advisor so you have an actionable plan to accomplish them. Leave no stone unturned. Don’t forget to factor in costs like dependent expenses and health insurance until you reach the age for Medicare eligibility.
The Biggest Decisions Baby Boomers Need to Make in Retirement
Retirement brings about a number of complicated decisions. It causes serious contemplation around finances, quality of life, legacy goals, and health concerns. Couples want to know the financial ramifications of the passing of a spouse or the need for long-term care.
According to The Center for Medicare Services, annual health care spending reached $11,582 in 2019. Americans now spend 17.7% of Gross Domestic Product on health care. In addition to rising healthcare costs, there are many other retirement decisions that need to be coordinated between spouses:
- Retirement dates
- When and how to take Social Security Benefits
- Determining the optimal pension payout option
- Which retirement accounts to withdraw from in retirement
- How to create the retirement income that you need as expenses continue to rise
- Reducing taxes
- Planning for RMD’s
- Having adequate life insurance for your heirs
- Planning for a long term care event
- Formulating an investment strategy both spouses are comfortable with
Let’s face it, there is a lot to consider when making your permanent exit from the labor force. But all of these decisions tie into the most important decision -replacing your paycheck after you retire.
Replacing Your Paycheck When You Retire
Once you identify how much annual income you need, the next step is to figure out how to maximize any income sources in retirement. The most common types of income streams in retirement are Social Security, pensions, and rental income.
There are a number of different payout strategies when it comes to Social Security and pension payout options. It’s important to perform some careful analysis to determine which option provides the maximum financial benefit.
After you know how much income you will receive each year, subtract that number from your total expenses. You are left with either a surplus or a shortfall. A shortfall represents the amount of “income” that you need to generate for yourself.
It’s time to finally start tapping into your nest egg for income. A good understanding of how taxes work is needed at this stage to make optimal financial decisions.
Know How Retirement Distributions are Taxed
There are three main types of accounts you can withdraw from to satisfy your income needs in retirement. The primary differentiator between them is how distributions are taxed:
- Taxable (Joint, Trust, or TOD Accounts) – In these accounts you pay taxes as you go along. There is no special tax treatment like there are in IRA’s. So it’s to important to pay attention to how this account is invested. Avoid investments that aren’t tax-efficient and understand how capital gains work.
- Tax-deferred (IRA’s, 401k’s, pensions, etc) – These are accounts are where deductible or pre-tax contributions are made. This means that you never paid tax on any of the contributions or growth in the account. When you make distributions, the entire amount is income taxable to you. The percentage of tax you pay depends on your federal & state marginal tax bracket.
- Tax-free (Roth IRA & Roth 401k) – When you contribute to a Roth, you forgo any current tax benefit. That means you contribute after-tax monies to these accounts. Therefore, all distributions from these accounts are 100% tax-free, with a few exceptions.
Since distributions from these accounts have different tax ramifications, it’s EXTREMELY important to understand the tax consequences for each. The decision of which account to withdraw funds from depends on other factors like your current income.
Of course, the ultimate goal in determining your withdrawal strategy comes down to paying the least amount of tax possible.
Ultimately, deciding to take Social Security or pension benefits needs to be coordinated with your withdrawal strategy and tax reduction plan. Since income fluctuates year-to-year in retirement, there are often plenty of unique tax planning opportunities available to retirees.
Final Thoughts on Why Baby Boomers Will Retire Sooner
The Covid-19 pandemic has jolted our collective interpretation about what matters. For Baby Boomers at the end of their careers, these feelings are more pronounced.
There are many strategies and investment vehicles available to implement an optimal retirement plan that accomplishes your goals. If you plan to do it by yourself, it’s extremely important to know your limitations. Thorough knowledge of the tax code and time value of money calculations are just the tip of the iceberg.
The challenge with retirement planning is that changes in one area often impact other areas. As an example, a large capital gain realized in a taxable account can push your other income into a higher marginal tax bracket. It can even subject a greater portion of your Social Security Benefit to taxation!
The average retirement timeline is about 30 years. Mistakes made today can be very costly over such a long timeframe.
If working with a financial advisor, your plan should be custom-tailored to your goals and circumstances. Avoid a “one size fits all” approach to your retirement plan. A good plan is centered around your needs and goals first.
The good news is you don’t need to do it alone. An experienced fee-only Certified Financial Planner™ can help reduce uncertainty and avoid mistakes. Nowadays, you can even find a fee-only CFP® that specializes in retirement planning.
Above all, you want to make financially optimal decisions to turn your uncertainty into confidence to make the last chapter of your life the best chapter.
Danny G. Michael is the founder and CEO of Satori Wealth Mangement, Inc. He has 20 years of experience in retirement planning working with individuals, families, and business owners.