A Rough, General-Purpose Retirement Plan

For a few years now I’ve been talking about a basic “cookie cutter” sort of Social Security plan (i.e., an approach that works reasonably well in most cases) and about factors that would suggest that a person or couple should make adjustments to such a plan.

I’ve been thinking recently that it might be fun/useful to extend that same type of thinking to a broader range of retirement planning areas. So here’s my attempt to do just that.

And just to be super clear about something that is hopefully obvious given the brevity of this article: there are many, many cases in which the suggestions below would not be the best approach for an actual person, due to their personal circumstances. I have mentioned some of the circumstances that would suggest alternative approaches, but in each of the topics below there are plenty of potential factors that I have not mentioned.

Social Security

If you’re single, delay claiming benefits until somewhere in the 68-70 range. If you’re married, the spouse with the higher earnings record files at 70, and the spouse with the lower earnings record files as early as possible (62 and 1 month in most cases).

Some of the circumstances that would suggest an adjustment to such a strategy include:

• You are single and are in very poor health (in which case you should file earlier),
• You are married and both spouses are in good health (lower earner should file somewhat later) or very bad health (higher earner should file somewhat earlier),
• The lower earning spouse is working beyond age 62 (in which case they should usually wait to file until they quit work or have reached full retirement age),
• You have minor children or adult disabled children (may be a reason for the higher earner to file earlier), or
• You or your spouse will be receiving a government pension (could affect the decision in either direction).

Tax Planning (Retirement Account Distributions)

Try to “smooth out” your taxable income over the course of your retirement.

For example, if you retire at age 60 but don’t plan to take Social Security until 70, you have a 10-year window during which your income will be markedly lower than it has been in the past (because you’re retired) and lower than it will be in the future (because neither Social Security nor RMDs have started yet). So it’s likely wise to spend from tax-deferred accounts and likely do some Roth conversions during that 10-year window — with the goal being to shift income from future years (which would otherwise be higher-income years) into the current lower-income years (i.e., smoothing out your taxable income over time).

To be clear, that’s somewhat of a simplification. In reality you want to try to smooth your marginal tax rate — rather than taxable income — over time. That is, if your marginal tax rate now is lower than it will be later, try to shift income from future years into this year. (And it’s key to remember that your marginal tax rate is often quite different from your tax bracket, especially during retirement.)

Spending Rate

Firstly, set aside (in something safe, such as a short-term bond fund) enough money to fund any Social Security delay that will be happening. For example, if you are forgoing $150,000 of Social Security benefits by waiting from 62 until 70, set aside $150,000 in something safe in order to fund the extra spending necessary until age 70. Then, from the remainder of the portfolio, use the IRS RMD table (i.e., “Uniform Lifetime table“) to calculate a spending amount each year. And for years prior to 70, use the same overall age-based approach — with a lower rate of spending the younger you are.

We discussed this overall strategy last year, and you can find a paper here from Steve Vernon that discusses it in more depth. Broadly speaking though, basing spending on RMD percentages has two main advantages:

• It adjusts spending over time based on portfolio performance, rather than spending a fixed inflation-adjusted amount each year of retirement, and
• It adjusts spending based on your remaining life expectancy (i.e., it accounts for the fact that you can afford to spend a larger percentage of your portfolio per year when you are age 90 than when you’re age 60).

Circumstances that could suggest an adjustment to such a strategy:

• You have an unusually long or short life expectancy,
• Real interest rates are very high or very low,
• Market valuations are very high or very low, or
• Your portfolio makes up a relatively small part of your overall financial picture. (For instance if you have a government pension that covers all of your major needs, you can spend from your portfolio at a faster rate, if you so desire — because, unlike many retirees, you would not be in an especially bad situation if you depleted, or nearly depleted, your portfolio.)

Asset Allocation

There’s a huge range of asset allocations that could be reasonable for a retirement portfolio (i.e., the portfolio that does not include the fixed sum that is set aside for the purpose of delaying Social Security).

• Want a 70% stock, 30% bond portfolio? Go for it.
• Prefer a 30% stock, 70% bond portfolio? That’s cool too.
• Want to exclude international stocks completely? Sure.
• Prefer to have a heftier 30-50% international stock allocation? Knock yourself out.
• Want to use only Treasury bonds for your fixed-income holdings? That’s reasonable.
• Prefer to use a “total bond” fund instead? Super.

One key point — something that surprises many people — is that a higher stock allocation (or any allocation decision that shifts things toward more risk and more expected return) tends to result in only a relatively modest increase in the amount you can safely spend per year early in retirement. The higher expected returns are, to a significant extent, offset by the increased unpredictability. (For related reading, here’s Wade Pfau’s 2018 update to the Trinity Study — though of course that has to be considered with all the usual caveats about using historical returns to try to plan for the future.)

The more dramatic impacts of higher-risk, higher-expected return allocations are that they tend to mean more volatility (duh) and a greater chance of either a) leaving a large sum to your heirs or b) increasing spending later in retirement.

Insurance

If you are retired, you probably don’t need life insurance, as it’s likely that you have no dependents anymore. One noteworthy case in which you likely would want life insurance as a retiree would be if you still have minor children or if you have an adult disabled child. Another case in which a retiree might want life insurance is if they’re married and a major portion of their total income comes from a pension with a small survivor benefit amount.

If you are retired you almost certainly don’t need disability insurance. Disability insurance exists to replace income that you’d be unable to earn if you’re unable to work. But if you aren’t working anyway (i.e., you’re retired), you don’t need it.

Health insurance is a must-have. If retiring prior to Medicare eligibility, make sure you have a very specific, well-researched plan for health insurance. The Affordable Care Act makes it possible to get insurance, but make sure you have a good idea of the cost, and make sure you have researched plans to know what they cover — though of course it’s subject to change every year.

Long-term care insurance is a genuine predicament, regardless of what decision you make. If you don’t buy it, you could potentially be on the hook for huge costs. If you do buy it, you might be faced with premiums that rise rapidly and unpredictably. (Other related products to consider are “hybrid” long-term care annuities or long-term care life insurance, but those both have their problems as well.)

Having proper liability insurance (including an umbrella policy, in many cases) continues to be important. In fact, it’s likely more important than at any prior point, given that during retirement you are more dependent on maintaining your assets than you are at earlier stages.

As far as longevity risk (i.e., the risk of outliving your money, because you live well beyond your life expectancy), lifetime annuities (whether immediate or deferred) can provide protection. The downside is that they reduce your liquidity/flexibility, reduce the amount you’re likely to leave to your heirs, and usually come with significant inflation risk. Delaying Social Security provides the same type of protection at a much better cost — and with an inflation adjustment. So purchasing such an annuity generally only makes sense if you are already age 70 and still want additional longevity protection (or if you are already planning to delay Social Security to 70 and still want additional longevity protection).