You must take control of your retirement plan and that means becoming informed

This Frontline documentary will enlighten you in many ways: http://www.pbs.org/wgbh/pages/frontline/retirement-gamble/. Do not underestimate how many forces are trying to get a piece of your money. Educate yourself so you can avoid the many pitfalls of the financial industry and their “helpers.”

There are defined benefit plans (pensions) and defined contribution plans (401k, 403b, 457, and TSP).

Pensions are going away. Most people will never see a pension. Pensions have been replaced with contribution plans that YOU must fund if you want a decent retirement. They come in different names based on the kind of organization where you are employed. When you get hired, review your benefits package carefully (go online where the information should made available to you by your employer) and look for broadly diversified stock and bond index funds with low expense ratios (below .30% and preferably below .10%).

You may be offered a Roth or a Traditional retirement plan. 

The traditional places your money in your investments before taxes. The Roth does it after taxes. Which is better? It depends. Here is a basic rule of thumb to consider. If you (single person) make under $60,000 (gross income before taxes are withheld), select the Roth version (pay taxes now and no taxes later). If you make over $60,000, select the traditional (pay taxes later and get the tax benefit now). This is not a perfect science, but that number can be used to get you started. Consider the Roth version if your family income is below $100,000. You can put in up to $19,000 in 2019 ($24,000 for 50 year old and beyond). Strive to maximize your retirement account as you reach for financial freedom.

Have an investment policy statement that provides clear guidance today and long into your future. 

All this really means is that you know what your desired asset allocation is (how much in stocks vs. bonds and cash). Once that is identified (70% stocks vs. 30% bonds and cash for example), then you simply select funds within your plan to meet your desired allocations.  Big Point: Make sure you consider all of your investments you have outside of your retirement plan (include any spousal investments as well) when allocating between stocks vs. bonds and cash within your retirement plan. Do not make decisions in a vacuum. Consider the big picture.

Understand the words vesting (when you get full control of all of the matching money the company provides) and the default fund (where your initial investments go). 

Many companies have a 5 year vesting period, which means you will not get all of the money they have promised you in matching funds until you have been there 5 years. Identify exactly what your company’s vesting period is. It varies by company/organization. The default fund is usually a very safe fund that will grow little over time. Get out of that and select those index funds that are invested in stocks and bonds that diversify you all over the world. A target date or lifecycle fund that owns an assortment of index funds may be the right answer for many.

If you receive matching money (free money from your employer) in individual stock, sell it as soon as you are allowed and buy index funds that own thousands of individual stocks. 

DO NOT place your retirement savings in the hands of one company. Hit on Enron for an example of what not to do. Stay far away from individual stock in your company. You are placing all of your eggs in one very fragile basket when doing so. Owning entire markets is the wise way to go to reduce risk within your portfolio. Diversify, diversify, diversify.

Do not borrow from your retirement accounts and do not listen to people who tell you it’s okay. 

You are stealing from your future self when you borrow money for some “big thing” today. Paying yourself back with interest is not a good idea and don’t let others tell you otherwise. P.S. If you leave a company while you have taken out a loan on your retirement plan, you will have to pay it back in full immediately or you will end up paying a 10% penalty by receiving an early withdrawal AND you will pay tax on the full amount of borrowed funds. Avoid this at all cost. This is why you have an emergency account outside of your retirement accounts to deal with crazy stuff that happens in life. Retirement accounts are for long term investing, not emergencies.

It is so very important to become informed on this issue as early in life as you can

These are big decisions that will have long term consequences either on the plus side or the negative side. Your education and your ability to act on that education will set you apart from the crowd. Understand your options and that requires a bit of digging and soul searching. Focus on index funds or target date/lifecycle funds that own them. Get every matching dollar the employer provides. Automatically save each and every month (pay yourself first) and stay the course.

Upon retirement, consider moving your money at work to a Traditional IRA (if you own a traditional pre-tax account) or a Roth IRA (if you own a Roth after tax account) to Vanguard and into one or more funds that own index funds.

It is wise to consolidate your money in one place as time goes on so you don’t leave retirement funds “out there.” This can be done online by going here: https://investor.vanguard.com/401k-rollover/. Here is an example someone who is now ready to retire and consolidate their money. Their desired asset allocation has dropped to 50% stocks and 50% bonds with a portfolio equaling $1,200,000.

Stocks: $600,000

Traditional IRA: Vanguard Total Stock Market Index Fund: $350,000

Traditional IRA: Vanguard Total International Stock Index Fund: $150,000

Roth IRA: Vanguard REIT Index Fund: $50,000

Roth IRA: Vanguard Small-Cap Value Index fund: $50,000

Bonds: $600,000

Traditional IRA: Vanguard Total Bond Market Index Fund: $540,000

Emergency Savings: Vanguard Short-Term Bond Index Fund outside of retirement: $60,000

Your ability to save consistently over time (20% of your gross income is our recommendation) into your retirement plan at work, a Roth IRA at Vanguard, and taxable accounts when necessary will serve your needs well in retirement. 

Become the great saver and great investor! Take this time to better educate yourself on your retirement plan. It will certainly pay you back many times over as you make informed decisions that will have real consequences decades down the road.

Strive to get rid of your debt prior to retirement. 

It would be wise in many cases to reduce and/or eliminate your debt (the mortgage could be one exception) prior to hitting the escape button. Identify the total debt you have, the interest rate on that debt, and then design a plan to pay it off prior to retirement. Opportunity cost may come into play here, which means saving into retirement accounts at a greater rate could trump paying off debt when the interest rate is low on that debt (below 3% for example). Know your options and make an informed decision. Every situation is unique. Know yours!

Spend plenty of time considering your projected fixed income (pension, part-time income, Social Security, immediate annuity, etc.) in retirement. 

This number must be identified going into that next phase of your life. How much of your fixed income will cover your monthly and yearly living expenses? Go to socialsecurity.gov to review your Social Security statement to identify your benefits at different ages (hit on retirement estimator). Also, identify your life expectancy based on your current age and gender by going here.  Once that is known, you move on to the next question. How much will you need from your investments to supplement your fixed income to make up the difference? Know your numbers!

Asset allocation will play a very important part in how long your money will last. 

It is critically important that you educate yourself on this matter regarding how much to have in stocks vs. bonds and cash. Remind yourself of this key fact: There is no risk-free investment. People overemphasize market risk (the ups and downs of the daily stock and bond markets) and underestimate the very real risk of inflation (money in the bank shrinks when the return is lower than the inflation rate). Inflation risk is that monster that hides in the shadows. Learn more about asset allocation and historical returns here.

Remind yourself that lower costs are directly related to higher returns when it comes to this investing game

And design an asset allocation that is right for you now and going forward. At the end of the day, it comes down to doing it, avoiding fee-based advisors, life insurance agents, insurance products that are part investment, individual stocks and bonds, the media and their predictions, speculation on commodities like Gold and Silver, family and finally, the crooks.

Withdrawing funds in retirement must be done with great care and consideration. 

Keeping your withdrawal rate under 4% should help your investment money last beyond 30 years. Withdrawing more than 4% in any given year could put your investment portfolio at risk of running out of money if you time horizon is 30 years or more. It is worth your time to review how different allocations have done in the past based on your expected time horizon (when the grim reaper shows up at the door). See the 4% next egg calculator here. Play with this calculator a bit to better understand what the past has provided based on what assets you held over the different time periods. Keep in mind, these PAST numbers reflect results that do not account for expenses. It is VERY important to get those costs low to make these numbers reflect something close to reality. An all index portfolio with a cost of .2% or lower will do that.

When withdrawing funds, consider the two year option, the one year option, the monthly option, and/or the ”on occasion” option.

The two year option: Put two years of living expenses aside in your bank or a short-term bond index fund (initially) and then replenish that account each year with one years’ worth of expenses.

The one year option: Choose the one year option instead of two if you want to keep more of your money working for you in the stock and bond markets.

The monthly option: Set up an automatic withdrawal each month as your investments “pay” you just like your employer did.

The “on occasion” option: Take money out on occasion based on one time needs (buying a new vehicle, vacation, gifts, etc.). Weigh your options carefully and pick the right approach that fits your “new” life.

Let’s look at a real life example.

• The 2 Year Option: You need $1,000 per month to supplement your fixed income. The two year option goes like this: You would sell $24,000($1,000 x 24) from your portfolio of investments initially and place that money in your bank or a short-term bond index fund. You would then live off that money for the next year. One year later you would sell another $12,000 from your investments to replenish that amount (you would add a bit more if your living expenses went up over the past year), bringing you back up to 2 years of living expenses in the bank or short-term bond index fund. If the markets tanked during the year, you might consider waiting a few months or year before replenishing the spending account.
• The 1 Year Option: The one year option has you selling $12,000 (instead of $24,000) from your portfolio of investments as you place that money in the spending account. In that case, you would live off the $12,000 you have saved up and replenish it at the end of the year as you prepared for the next one year period of time. This option does not allow for a bad year in the markets. Every year you will need to sell $12,000 from your portfolio no matter what to provide for your next year’s living expenses.
• The Monthly Option: The monthly option has you getting a paycheck each month ($1,000 in this example) from your investments (this money should come from the less risky part of your portfolio like a short-term bond fund or total bond market fund for example). This is the only money you would receive (except for the “on occasion” withdrawal to pay a one time bill or vacation for example). You can hit on the automatic withdrawal option at Vanguard and they will send you the monthly “paycheck” like clockwork. This method would feel very much like it did when you received direct deposit on your monthly paycheck from work.
• The “On Occasion” Option: This option would have you taking money out of your investment accounts on occasion to pay for a trip, one time bill, or some other big ticket item. This option is used when your fixed income (pension, Social Security, part-time work, immediate annuity, etc.) is enough to pay the bills on a monthly basis. This option is also available (combining when needed) with all of the other options as well.

When pulling money out of your investment funds in retirement, look at your accounts as employers.

Have your retirement and non-retirement accounts pay you in retirement just like your employer did when you had a job. As a rule of thumb, pull money first from your taxable non-retirement accounts (examples would be savings accounts, taxable mutual funds, non-qualified annuities, etc),then your pre-tax retirement accounts (examples would be traditional 401k, 403b, 457, and TSP), finally, your after tax retirement accounts (examples would be Roth 401k, 403b, 457, TSP and Roth IRA). Sitting down with a trusted accountant would be wise as you consider your options as they relate to your particular tax situation. There will be times when you will choose to change the order of withdrawals based on that year’s tax situation and/or other variables. Education will show you the way!

Rebalance your portfolio over time with your current contributions, future withdrawals, and adjustments within your retirement accounts as needed. 

The rebalance piece is easy to explain, but not so easy to do. It simply means you want to keep your asset allocation at a desirable level as time and markets go rolling along. Contributions, withdrawals and adjustments over time can accomplish this feat, which will in most cases, reduce the risk of your portfolio. Here is the hard part: You must sell your winners and buy your losers when rebalancing. Psychologically this can be very difficult. We prefer to buy winners and avoid losers, but that is called chasing performance and that is a very bad idea. If your desired asset allocation is 60% stocks vs. 40% bonds for example,once a year or so, review your portfolio and rebalance the assets to replicate your desired numbers. Sometimes it takes nerves of steel when markets have tumbled. Education will give you the courage you will need to make this happen!