Money & Policy

3 Questions to Answer Before You Retire

Market cycles, taxes and cost-of-living should figure into your planning

(This article appeared previously on MarketWatch.)

It’s the question everyone asks as retirement draws near: Do I have enough money? But three additional questions — involving market cycles, taxes and expenses — need to be addressed as well.

The size of one’s nest egg gets much of the attention in retirement planning. And that’s certainly an important issue. But as Jonathan Clements wrote recently for MarketWatch, the figure is just one piece in a four-part puzzle. Would-be retirees also need to ask themselves:
1. Where are we in the market cycle? Bull markets are followed by bear markets, and so forth. If you’re thinking about retiring at a point in time where the bulls have been running for several years — as is the case with today’s equity markets — you need to be prepared for a correction, or something worse.
(MORE: Best and Worst Reasons to Retire Early)

Clements offers the example of a person who retired in October 2007 with savings of $500,000 with 60 percent of that money in a large-cap stock fund and the balance in fixed income. If that person had withdrawn 4 percent of his nest egg ($20,000) in the first year of retirement, his balance would have shrunk to less than $320,000 by February 2009.

The damage, of course, reflects the bear market of 2007-09 and is a good example of “sequence-of-return” risk, where a combination of collapsing markets and a retiree’s need for cash plays havoc with a nest egg.
If you’re about to retire — and if a bull market appears to be losing steam — you want to have sufficient cash reserves to ride out the coming storm: an amount equal to, say, five years of withdrawals. That way, you’re less likely to have to sell other assets while their prices are depressed.
2. What embedded tax bills do I face? Here, the issue is the source of your annual retirement plan withdrawals.
If the retiree in the example above taps a bank account or a Roth Individual Retirement Account, he should have $20,000 in spending money, with no taxes owed. But…if the person sells stocks held in a taxable account, he might have to pay capital gains taxes. And if the funds are withdrawn from a traditional IRA or 401(k), the entire sum will likely be taxable as ordinary income.

(MORE: Retirement Investors: Use a Tactical Strategy)

In short, possible tax bills should be factored into retirement budgets.
3. What are my fixed living costs? The key: having enough regular income to cover fixed costs — food, utilities, insurance and property taxes, among others — because you’ll have to pay them, no matter how bad markets get.
To start, calculate how much income you will collect annually from dividends, interest, Social Security and any pensions or income annuities. You can supplement that with occasional withdrawals from your portfolio’s cash reserve.

(MORE: What You'll Spend a Bundle On In Retirement)

If you won’t have sufficient regular income, you might delay Social Security to get a larger monthly check or purchase an immediate fixed annuity. A third option: trying to trim those fixed monthly costs. Here, the key expense you probably should tackle is housing.

Glenn Ruffenach edits The Wall Street Journal’s guide to planning and living the new retirement. Reach him at encore@wsj.com.

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