Planning for retirement is a challenge that changes with each client, and there is certainly no one-size-fits-all solution. That said, you may — or may not — be surprised to hear how many truly core retirement principles your clients have never even thought about. Here are six time-tested rules that it’s worth repeating over and over and over again.
Lesson 1: It’s your responsibility to plan for retirement.
Unless your client plans to work until the end of life, someday he or she is going to retire — and it may not be by choice. No longer can any of us depend on our employers to save for our retirements. With the exception of the federal and state governments, few employers have a pension plan and now several states are cutting back on retirement benefits. Most corporations have changed to a 401(k) plan where the employee can contribute up to $17,000 and an additional $5500 (called catch up) once they reach the age of 50. The reason for the catch, quite obviously, is that most employees have not saved enough in their younger years. The catch-up gives them an opportunity to save more in the peak earning years.
While retirees today depend on Social Security, its future is in jeopardy. Most experts believe it will continue, but the amount paid may be less if it is determined by need. Therefore, in addition to funding a company retirement plan, your clients also should be saving in other tax deferred and taxable accounts.
You’ve heard it a 100 times: Most people don’t plan to fail, they just fail to plan. I see it every day and it is true. I often hear employees say, “My employer doesn’t match any of my contributions, so I’m not going to contribute either” or “I don’t trust my employer with my money” and the classic “I can’t afford to right now.” Successful retirees don’t make excuses; they take action. They enroll in their employer’s retirement plan as soon as they are eligible, even if the employer doesn’t match. Saving for retirement is a habit; therefore, they continue putting money away in other investments like a Roth IRA. Retirement is their No. 1 goal.
With the creation of Target Date Funds, investment selection has become simple. All your client needs to do is choose the date that they plan to retire, and fund managers will allocate their money according to the time remaining until retirement. For younger clients, the allocation has more risk; if you’re ten years away, it will be more moderate allocation.
Lesson 2: Develop a budget and live by it.
Successful retirees understand the difference between a need and a want early in life and on into retirement. They simply live below their means. While this has become more difficult with the temptation of credit, you just have to say NO! As a financial advisor, it may very well fall in your job description to emphasize this with your clients. Remind them that it’s not how much you earn each year that’s important; what matters is what percentage of those earnings you are saving. I’ve seen couples in their 50s who are making over $250K and have less than $50K in their 401(k), and nothing in savings. I see college graduates get a job, and the first thing they do is go buy an expensive car. Hey, I’m a car buff. I love cars. However, even I eventually realized that a car is a means of transportation rather than a status symbol.
The earlier you get started saving for retirement, the less you’ll have to save because time is on your side. So, don’t suffer from “excusitus” by creating a lifestyle that you’ll be paying for the rest of your life. Fund your retirement instead. Encourage every client to start out by saving at least 15% of their income for retirement until they reach the annual maximum contribution.
Lesson 3: Don’t have unrealistic expectations.
In the 1990s, the stock market was averaging returns of over 10% annually. Investors thought this would continue, and by the end of 1999 a large percentage of investors had moved all their money into aggressive tech investments that had made 70% the year before. Then the dot com bubble occurred. After seeing their 401(k) now equal to half the value it once was, they started calling their 401(k) a 201(k).
For fear of losing everything, employees began shifting their money into guaranteed investments. In this case, because you are making monthly contributions, you are taking advantage of buying when the markets are low. Encourage your clients to focus on share accumulation — buying more shares when the price is down — rather than how much the stock market has dropped.
One excuse I often hear is, “But I could lose everything.” That’s true if you put all your money in your company stock and it goes bankrupt, which does happen from time to time. However, if you diversify into different asset classes (which Target Date Funds do for you automatically), chances are you won’t lose everything. Our great country is based on capitalism and therefore every publicly traded company either produces a good or a service. While all companies go through good times and bad, as long as every working American gets up each and every morning to go into work, capitalism will prevail.
Another lesson that every client needs to hear: Do not borrow from your 401(k). Chances are they won’t pay it back. If they do pay it back, chances are they’ll borrow from it again. A retirement plan is to be used for retirement, which one day will happen. It is not an account to tap for a trip to Disney, your daughters’ wedding, a new car, a bigger house or a college education. These are all goals which should be planned for separately. Encourage your clients to establish an emergency fund of three to six months of living expenses that they can draw from if needed.
Successful retirees do not invade their retirement. When it comes to assisting their children financially, they set limits based on what they can afford rather than what everyone else is doing. If you end up going into debt or possibly bankruptcy because of supporting your children (who are capable of supporting themselves) what have you achieved? The truth of the matter is this: Children believe their parents have more money than they really do, and parents often don’t want to tell their children they can’t afford to help them.
Lesson 4: Take advantage of the tax savings your retirement plan offers and gain a basic understanding of our tax code.
In lesson two, I noted that the amount you save is more important than the amount you earn. There I was referring to saving vs. spending. In this lesson I am referring to the amount you get to keep vs. the amount you pay in federal and state taxes. Retirement plan contributions are tax deductible, which means you are saving both federal and state taxes on your contributions.
For example, suppose your client’s income is $50K, and he is saving 10% ($5000) annually. If he is in the 15% federal tax bracket and 6% state tax bracket, he will save $750 in federal and $300 in states taxes, for a total savings of $1050, all based solely on his decision to contribute to his company retirement plan. I remember a client who increased his contribution and his next paycheck was higher. He thought surely someone in payroll had made a mistake. After further review, we determined that by raising his contribution amount it reduced his taxable income, moving him from the 25% tax bracket to the 15%.
The difference between a long-term capital gain and a short-term capital gain can equal thousands of dollars. Suppose you are in the 25% federal tax bracket and the 7% state tax bracket, and you sell 500 shares of Apple stock that you paid $150k for, which is now worth $300k. If you make this move prior to holding the stock for one year, you will owe ordinary income tax on the $150k gain, so 25% ($37,500). If you sell the shares after owning them for more than one year, you will pay only the long-term capital gains rate, which is set at 15%, so $22,500. This is, of course, assuming that the stock is at the same value after one year. (Note that the state tax rate doesn’t change depending on long- or short-term capital gains.)