Drawbacks or opportunities could be shifting your retirement plans

The plans for many people have been altered and may never get back on the same trajectory. Many companies suspended 401(k) matches, reduced compensation, laid off people, or demoted them. People stopped contributing to retirement plans and moved assets to cash.

Entire industries have come to a screeching halt during the COVID-19 pandemic and are slowly crawling back from the ashes. Conversely, a small segment of the population actually did very well during this time frame.

You may fall into one of those aforementioned camps. For many people, COVID has presented an opportunity to rethink, redesign, and envision what retirement should be and how it should look.

Know your monthly and yearly expenses

The most valuable asset we have is our ability to work. We have the freedom to do what we want, when we want, and with whom we want. But the lockdowns presented an opportunity to stop the routines and get off the roller coaster of daily life. Life actually slowed down in so many ways. Remote work replaced the commute, giving many people a sense of freedom and time to reflect on what was important and what we missed most.

In the process, a good number of people took the opportunity to look deeper at their spending habits and credit card bills. Lifestyle in retirement becomes one of the most important factors in a successful retirement plan.

But after 30-plus years in my career, I am still shocked by how many people really don’t know how much they spend monthly, quarterly and annually.

So, a client says they need $10,000 per month in after-tax income for retirement and they want to build a plan that produces that number. On the surface the advisor says, “Okay, subtract the Social Security and pension, and find the gap.” Let’s say $5000 per month or $60,000 per year is what they need to fill the gap. Divide by your favorite withdrawal rate and you come up with a number. Let’s say 4% is the rate. But is that 4% pre- or post- tax? What is the tax rate when you withdraw? How is capital tax allocated?  If the tax rate is 20%, you need more capital.

What is the right number?

For many, we missed the big picture. What is the client currently earning, currently saving and currently living on?

The client says x amount is what we spend now. With a little digging you may find a big gap. Example: the client and their spouse earn a combined $300,000. They pay $22,000 FICA/Medicare, $15,000 in state tax and $60,000 in federal tax. They each max the 401(k) out at $19,500 for a combined contribution of $39,000.

They are feeling good. You look at their assets, but there isn’t much in their savings account, or in college savings or in non-qualified brokerage accounts. The majority of the money is in the company retirement plan.

You pause and pull a Columbo question on them. “I am a little confused. Perhaps you can help me understand, if you make $300,000 and subtract the $97,000 for taxes and the $39,000 for the 401(k), that leaves you with $164,000, and you said that you spend $120,000 a year. Where is the $44,000?” Client says, no way are we spending $13,600 per month. It can’t be.

Most people have trouble living on what they are currently bringing in, somehow. In their minds, in the future they will spend less.

We get one chance to do this right. We don’t get a reset button and get to redo the time again. If we make the wrong decisions today, they compound over time.

So, if we are helping the client build wealth, what is the real gap we need to live our lives? It may not be $5,000 per month, but $10,000. How far are we from retirement, what is inflation, how long will I live and what will tax rates be? Where are the financial leaks hiding in their plan? Let’s find them and help them get to the proper savings rate so when they retire, they have the potential to have a successful outcome.

Consider the possibilities

The Social Security Administration recently updated what is known in the industry as the “100 Man Story.” Out of 100 people who enter the workforce in their early 20’s, how many have a successful retirement?

I first learned this in 1989 when I started selling life insurance and disability insurance. Despite the access to information, the access to financial tools, books, etc., the results are still depressing. One of the 100 will be wealthy, four will be financially secure, and five will continue working – not because they want to but because they have to. Another 36 will be dead and 54 will be living on Social Security but having to rely on family for help.

If you think about a 50 to 65-year-old person today, they are most likely at the top of their game, the most creative, the most resourceful they have been. If they could get rid of a few annoying aspects of the daily routine and job crap, they love what they do.

COVID has allowed many organizations to see the value of the team and to see the unique abilities of key team members. If you get bigger results consistently, the organization needs and wants you to stay. But it has also become very clear who is dead weight.

If you can work remotely from your favorite place and free up three hours a day from not commuting, you now have time to enjoy your hobbies, family and friends. You may be able to put an extra four or five years of income and savings in your plan, and the probability of a successful outcome goes up.

Or you may say, “I looked at my lifestyle, did a complete overhaul, and see very clearly that we only need to spend $8,000 per month. Now over the next five years I can increase my savings rate from $39,000 (13%) to $107,000 (35%).” This is your choice.

This may be a point to pursue a completely different path and start a fresh new career in a different location with new rules. The possibilities are endless.

Protecting and growing the earned income stream should be your primary focus for the next five to 15 years.  We have never had more potential financial pressure than we have now. If you can push the retirement day out 10 to 15 years, maybe we will find ourselves in more balanced economic times.

The stock market is at all-time highs, and the P/E Ratio is almost double the normal level for many of the most successful stocks. And that perhaps increases the risk that prices will fall. Interest rates on bonds, CDs, and savings accounts are at 50-year lows.  I have been saying that interest rates will rise for the last 13 years and I have been dead wrong, but I will stick to my prediction with hope!

In 1989, when I started in the industry, CD rates were over 8%. One million dollars in the bank produced $80,000 in interest income. Today you are lucky if you get 1% or $10,000 in interest income. What we did in 1989 was easy, and withdrawal rates were not an important factor.

Today we have to be creative to generate income. We have to help people increase their savings rate, we need to help our clients create balance in our allocation to tax- advantaged strategies, and we have to help them reduce risk and increase the protection of their wealth.

There is hope on the horizon as people recalibrate and plan their retirement. I am excited about the medical advances that have been discovered as vaccines and new ideas have been tested. And when the pandemic ends and people around the world go back to this new adjusted reality, the opportunities for growth will be incredibly bright.

John L. Smallwood, CFP is a senior wealth advisor (www.johnlsmallwood.com) and president of Smallwood Wealth Management and affiliated companies, providing investment consulting and financial plan design for corporate executives, entrepreneurs, and professionals. He is the author of It’s Your Wealth – Keep It: The Definitive Guide To Growing, Protecting, Enjoying, And Passing On Your Wealth, and a previous book, Five Ways Your Wealth is Under Attack.