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One of the ironies of being a doctor is that too often caring for others takes away from the time we need to care for ourselves.
Frequently this deficit in self-care hours can cut into our quality of life and reduce our financial well-being.
An important strategy to make the best of your limited free time is to seriously consider retirement planning. Regardless of your age, this is a crucial path to safeguarding your future and assuring a lower level of future stress.
In this guest post, submitted by David Rosenstrock, the director and founder of Wharton Wealth Planning, learn about six critical areas of retirement planning to discuss and consider. David earned an MBA from the Wharton Business School and a B.S. in economics from Cornell University and is a Certified Financial Planner.
Whether you are a pre-retiree or retiree, there are several major areas you should think about to successfully plan for retirement. Retirement planning can reduce anxiety and increase happiness, security, and peace of mind. If you take the time to plan wisely, retirement can be a rich and rewarding time of life.
#1 Develop an Income Plan
First, develop an income plan. List all of your guaranteed sources of retirement income —pension, investment portfolio returns and income, retirement savings, investment accounts, such as a traditional IRA, 401(k), Roth IRA or Roth 401(k), Social Security, annuity income (if you have one), and any other sources of income.
Working past the traditional retirement age in any capacity is a great way to stretch and supplement retirement income. Delaying retirement can have a significant impact on retirement finances by giving your existing retirement savings more time to grow and shortening the period of retirement you will need to pay for.
Financial planners often refer to the 4% rule, a guideline stating that you should take out only about 4% of your retirement savings annually. Each person’s situation is unique but having some guidelines can help you prepare.
#2 Choose the Right Investment Strategy
Choosing the right investment strategy is involved in this component of your plan. There are many investment strategies available, from aggressive to conservative.
Generally, those who are younger are advised to invest more aggressively, tapering to more secure investments as they grow older. Safety comes at the price of reduced growth potential and the risk of erosion of value due to inflation. Safety at the expense of growth can be a critical mistake for those trying to build an adequate retirement funding strategy.
On the other hand, if you invest too heavily in growth investments, your risk is heightened. The other day I took my two kids out for ice cream and by the time they added their toppings and self-served themselves extra portions, the bill came to $20.
It’s easy to expect costs to remain what they used to be. We make assumptions but those may not be accurate and become outdated.
#3 Forecast Your Expenses
Forecasting your expenses is a critical financial building block for retirement. How much you want to spend in retirement is one of the biggest factors driving how much you need for a secure retirement.
Most of your money in retirement is spent on three major categories: housing, transportation, and medical expenses. According to a Bureau of Labor Statistics survey, for adults age 65 and older, housing represents 34% of spending, transportation 16%, and health care 13%.
Healthcare Costs
As doctors know so well, healthcare costs rarely decrease as we age. My father-in-law spent tens of thousands on surgeries and drugs for chronic migraines and tinnitus before finding that a simple chiropractic adjustment solved both problems for minimal cost. But not everyone is so lucky.
Healthcare costs pose one of the most serious risks to retirement security, so it’s important to understand how to plan for this major expense and navigate the system. How long you live and how much you need to spend on out-of-pocket healthcare expenses and long-term care are big factors in figuring out how much you will need. A study conducted by the Employee Benefit Research Institute estimated that a couple with drug costs at the 90th percentile throughout retirement would need savings of about $325,000 by age 65 to have a chance of covering their health care expenses during retirement.
Medicare Doesn’t Solve Everything
Even for those on Medicare, healthcare costs can still erode spending power. Out-of-pocket expenses for people in retirement have risen over 50 percent since 2002. Long-term care costs can be even less predictable than out-of-pocket costs. About half of people 65 and over won’t incur any long-term care expenses, and an additional quarter will pay less than $100,000. Fifteen percent, however, will pay $250,000 or more.
#4 Implement Tax Optimization Strategies
Another area that retirees and potential retirees need to think about is their tax strategies. Most will have less income after they retire so it is critical to be smart about what you can keep and how much you will have to pay out in taxes.
Tax-Advantaged Accounts
It is important to match different types of accounts (such as taxable or retirement accounts) with particular investment strategies. Not regularly contributing to tax-efficient accounts is a common mistake in financial planning. Making increased contributions to retirement accounts can help put you on track to be prepared for retirement.
Probably the best way to accumulate funds for retirement is to take advantage of IRAs and employer retirement plans. They combine the power of compounding with the benefit of tax-deferred (and in some cases, tax-free) growth. For most people, it makes sense to maximize contributions to these plans, whether it’s on a pre-tax or after-tax basis.
Physicians and medical professionals can be employed or self-employed. Depending on the type of employment, you can invest in different retirement plans. For employed doctors: 401(k) plans, 403(b) plans, government-sponsored 457(b) plans, non-government organization 457(b) plans are some typical options that may be available. For self-employed doctors, a SEP-IRA or Solo 401(k) plan are two popular options.
When possible, you should be maxing out your 401k/403b/457b each year, then your Backdoor Roth IRA, and then your individual/joint taxable account. If you have an IRA, you will not be able to complete Backdoor Roth IRAs each year (well, technically you can, but there are significant logistical complications due to the tax code).
High-income medical professionals do not qualify to make Roth contributions so make non-deductible traditional IRA contributions and then convert them to a Roth IRA. Beware, though, as having a SEP IRA removes your option for Backdoor Roth IRAs. This is why, for someone who is self-employed, a Solo 401k may be a better option than a SEP IRA.
Using Health Savings Accounts and Flexible Savings Accounts for medical expenses are also strategies that should be explored and utilized.
Unfortunately, the IRS code often makes retirement planning as complicated as possible, and failure to understand its complex rules can have devastating long-term consequences.
Taxable Accounts
Taxable brokerage accounts are also a great way to build up taxable investments. Because your risk of job loss is lower than that of other professionals, you can take more investment risk. But it must be smart, calculated risk. That usually means being broadly diversified. Additionally, most medical professionals have a high tax bracket so their investments need to be tax-sensitive. Two strategies: (1) keep turnover low and (2) keep tax-inefficient investments in retirement accounts (NOT in taxable accounts).
Conversions
One effective strategy that many overlook is converting tax-deferred funds to a Roth IRA or Roth 401(k). While the conversion amount is taxable in the year it is converted, the upside is these Roth accounts let your retirement savings grow tax-free and are not taxable when withdrawn (as long as you’re 59½ or older and have owned a Roth for at least five years).
It’s important not to let the upfront tax bill prevent you from moving your retirement funds from accounts that are taxed no matter when you take them out into accounts that are tax-free. The point is to not be shortsighted at the expense of being hit with large tax payments in retirement.
#5 Maximize Social Security Income
Maximizing your Social Security income is another building block for retirement.
United Income, a financial-planning advisory service, released an important study in 2019, “The Retirement Solution Hiding In Plain Sight.” Using government data and proprietary software, it calculates how much money retirees have lost, and are losing, by making mistakes about when to start claiming Social Security benefits.
This study found that 96% of retirees are leaving up to $111,000 per household behind by claiming Social Security at a suboptimal time. The majority of retirees choose to begin receiving Social Security payouts within a few months after turning age 62 or immediately after they stop working, even though it is generally beneficial to delay the benefits.
Because everyone has a different situation and there are many claiming strategies available, you should determine what’s best for you based on your age, life expectancy, income needs, and other retirement assets. A few small mistakes can take a big hit on your golden years.
The earliest age you can sign up for Social Security is age 62, but if you file before full retirement age (as defined by the IRS), you’ll be looking at a reduced benefit of approximately 75% of the amount you’re eligible for.
You can also delay your filing past full retirement age. For each year you delay your benefit, up until age 70, your benefit will grow 8% enabling you to receive a maximum of up to approximately 132% of your regular benefit amount.
Delaying your filing will clearly leave you with more money on a monthly basis but you need to consider whether it will mean getting the most money on a lifetime basis. If you don’t expect to live very long because of health issues or your personal family history, then it could make more financial sense for you to claim benefits at full retirement age or even sooner to receive the highest lifetime payout.
To maximize Social Security benefits for you and your spouse, you need to know which of the separate claiming strategies for married couples is right for you. Maximizing Social Security benefits isn’t easy as there are hundreds of rules governing payments alone.
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#6 Finalize Estate Planning
Planning your estate is the final area everyone needs to think about for successful retirement planning. Estate planning will ensure that your physical assets, investments, cash, etc. are transferred to your beneficiaries with minimal legal and tax complications. Estate planning is also essential to protect your estate from creditors and unnecessary family feuds.
Trusts
To ensure that your estate does not go through probate, you need to create a will and consider the option of using a trust. You could look to establish a few trusts as part of your estate plan, such as disclaimer trusts (protects parents), dynasty trusts (protects kids), and IRA trusts (protects kids).
Most of us understand why minor children and young adults shouldn’t inherit property outright. Someone with more maturity and experience needs to manage the assets and make spending decisions. That’s why for minors and young adults, inheritances routinely are left in trusts at least until the minors are older.
Too often, however, people overlook the benefits of leaving assets in trust for adult children instead of having them inherit the property outright. There are risks to leaving wealth outright even to grown children and there are benefits of using inheritance trusts to hold bequests for them. Reaching a particular age doesn’t mean someone is financially sophisticated. It is important to make an assessment of the ability of each of your children to manage the property, and then decide whether to leave the bequest outright or in trust.
Advance Directives
Estate planning also allows you to make decisions that your loved ones carry out while following legal directives in your estate plan.
An advance healthcare directive, also known as living will, is a legal document in which a person specifies what actions should be taken for their health if they are no longer able to make decisions for themselves because of illness or incapacity. In a power of attorney (POA), the principal (you) names one or more agents (often an adult child) to act on your behalf.
You need a POA because someone needs to manage your assets, pay bills, and make decisions if you become incapacitated. The alternative is for your loved ones to ask a court to declare you incompetent and appoint someone to act on your behalf, known as guardianship in most states.
One of the primary goals of estate planning (in addition to minimizing estate taxes) is giving the surviving family members and beneficiaries less stress and some privacy.
The Last Word
Retirement can be a time of freedom, enjoyment, and security without significant stress and distractions, but in order to achieve these things retirement needs to be planned for. Those who follow a specific financial plan can expect to have better average returns and long-term success in retirement than those who do not.
