CNBC Commentary by Ron Carson, Founder and CEO of Carson Wealth Management Group
Many investors prepare for retirement by putting money in company-sponsored 401(k) plans or personal individual retirement accounts and working with their financial advisor to come up with a plan for retirement.
But how do you budget the wealth that you’ve amassed to help get you through retirement? When is enough really enough, and how are you going to spend it? Creating a proper financial plan before and during retirement is an important tool for all investors.
Let’s break this down into two segments: planning before retirement and planning during retirement.
Planning before retirement
Budget. It is difficult, if not impossible, to start any financial plan without the B word: budget. Your budget is a necessary part to responsible cash-flow planning both before and during retirement.
Many people view budgeting as a negative or onerous process. However, it is crucial that analysis be done to determine how much cash is needed to maintain the lifestyle that you and your family have grown accustomed to living.
This will help you arrive at your Family Index Number, the long-term rate of return that your portfolio needs in order to pursue your desired standard of living.
You must treat your personal finances just like a business: A responsible business knows how much cash it is going to need to continue operating. What are the expenses going out the door, and how much money is coming in?
Once your budget is in place, it should be reviewed at least annually, if not monthly, to determine if additional funds are needed to continue your lifestyle or if adjustments should be made. A budget will also help to project long-term retirement savings needs.
Emergency fund. The fact of the matter is that through the course of your life prior to retirement, there will inevitably be a time for an emergency fund. The catalyst for that need may not be known, but it’s good to have those funds set aside for whatever purpose that might be.
“The most important thing to keep in mind when planning for retirement — and preparing to spend your savings during retirement — is that your plan is a road map that you should put in place.”
Your emergency fund should be set aside in the most risk-averse and liquid manner because, again, you never know the timing of the need for those funds.
The total amount needs to be decided by you and your family. Determining the amount needed is all about your comfort level. Some will say $5,000 or $10,000 is more than enough, while others will prefer to have a much higher amount at the ready for when they least expect it — but need it most.
Risk management. One area that is often overlooked or omitted in financial planning is risk management. So many people focus on saving as much money for retirement as possible, they completely forget the need to protect against potential risks.
Risk management runs the gamut from car insurance, homeowner’s insurance, short-term and long-term disability, health insurance, long-term care insurance, life insurance and more. It is important these policies be considered for your risk-management portfolio, not treated as onetime decisions, and are part of an ongoing portfolio that needs to be monitored, reviewed and updated as needed.
Planning during retirement
Budget. During retirement, your plan should once again start with a budget. While the income needed to cover your expenses in retirement will most likely dramatically change, the important exercise of monitoring your cash-flow needs stays intact throughout retirement.
This goes well beyond the idea of just balancing a checkbook and reviewing budgeted expenses — it involves analyzing your recurring expenses throughout the year to identify places in which you might be able to find less-expensive options or plan for a major expenditure.
While budgeting often takes on a negative connotation, it can help you plan for a dream family vacation or determine how you are available to spoil children or grandchildren around the holidays.
Taxes. For most people during retirement, tax planning takes on a greater importance in terms of analyzing the sources of funds that you will use to maintain your lifestyle and their tax consequences.
In our current tax code, one type of account may have different tax consequences when funds are withdrawn than another. Retirement savings, or qualified accounts, are taxed at ordinary income levels, while nonqualified accounts are taxed at capital gains levels.
In some cases, this can represent a +/- 15 percent to 25 percent swing in tax liability. When specific funds are needed to maintain one’s lifestyle in retirement, it is important to be mindful of the tax consequences of the accounts funding your retirement.
Taxes should not be the only consideration when making your financial plan, but it should be combined with other aspects of your overall financial picture.
Estate planning. While basic estate planning is an important component prior to retirement, post-retirement estate planning takes on a more important role. The fact of the matter is, as we get older, we begin to come face-to-face with our own mortality.
It is crucial for you to determine how you and your family want your estate settled. This is certainly an individual or family decision, and there is no one right answer.
What is crucial is that your approach to your estate plan should be similar to your approach to risk management; your plan should be reviewed and updated regularly.
The most important thing to keep in mind when planning for retirement — and preparing to spend your savings during retirement — is that your plan is a road map that should be put in place.
It needs to be updated and changed, as needed. Nothing is set in stone, but with a solid plan in place, you are putting yourself in a position to be successful.
Note: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional.