Retirement: 7 Ways to Stack the Deck in Your Favor

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

As we prepare for retirement, there are some variables we have no power to predict, such as how long we'll live or how the market will perform. But there are some easy steps you can take to stack the deck in your favor.

Joining me to discuss some of them is Jason Stipp. He is Site Editor for Morningstar.com.

Jason, thank you so much for being here.

Jason Stipp: Great to be here, Christine.

Benz: Jason, you have been compiling a list of best ideas from a lot of people around here, people we've interviewed and so forth, of ways that you can make your retirement go smoothly, even if you don't know exactly how it will play out.

One of them is coming into retirement without a big housing bill. Let's talk about why that can be so impactful.

Stipp: For most people, while they're pre-retired, their biggest expense, and over time their biggest asset, will be their home. If it's 15% or 20% of your pre-retirement income, if you can take that off the table, then you can really see how that begins to chip away at the [income] replacement rate that you need in retirement. If you're targeting an 80% replacement rate, and you can chip off that big expense, it becomes a lot easier, then, to just have your portfolio and Social Security cover the discretionary income [you need]. It's a big, important way to add some buffer space.

Benz: I know some people do that just by downsizing. If they're able to swap into a smaller home, they can get rid of that mortgage note and have those housing costs covered.

Another category is to simply delay retirement. Let's talk about why that can be so beneficial as you come into retirement.

Stipp: Folks we've talked to from T. Rowe have done a lot of great research around working a little bit longer. It might not sound like the most appealing option, but there are some really great benefits: three key ones.

First of all, if you work longer, that means you won't be tapping your portfolio. It allows your portfolio to grow for those one or two or three extra years that you're in the workforce.

Secondly, on the flipside, it will effectively shorten the duration that you need that portfolio to last. Your portfolio will shave off a few years [that it needs to fund]. As you work a little bit longer, your retirement will be a little bit shorter, so that's also a benefit.

For a lot of folks, they like to stay engaged. They want to be with their colleagues and they like the fact that they will still be out there in the workforce. There are some psychological benefits as well.

The one thing I would say, though, is you shouldn't depend on being able to work longer. It might sound like a great backup plan. A recent survey mentioned that 70% of pre-retired folks were counting on working in retirement, but only about 30% of folks in retirement actually were able to do so. So, it's a great option if you can take it, but don't necessarily depend on having to work longer.

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Benz: Spousal health or your own health, or just your own ability to hang on to a job could impact your ability to execute this strategy.

Let's talk about a related strategy, which is delaying Social Security. If you can stay in the workforce and delay that receipt of Social Security, that can be really powerful. Let's talk about that tactic.

Stipp: Social Security can be a complicated issue, when you take those benefits. There are a lot of factors that go into it. But this is a very important decision and here's why: If you can delay taking your benefits until age 70, that can mean over 70% increase in the amount of those Social Security checks when you do start to claim them. That's a big benefit. Now, you might say, well, that's true, but I have to wait eight years until I get that first check if I'm going to delay it. That's absolutely true. But you have to think about the flipside as well. Social Security will continue to pay that check as long as you're alive. That is very powerful inflation-adjusted income protection that provides a nice floor for your portfolio. If you're planning to lead a nice, long retirement, this is a powerful tool, just delaying if you can.

The one thing I would say, though, is this is a very complicated decision. If you're married, it gets even more complicated. It really pays to run the numbers, even get some help on this decision, because it's a really crucial one that can make a big impact on your total portfolio and [lifetime] benefit [value] from Social Security.

Benz: There are lots of tools out there, too, Jason, to help people with this decision-making. The Social Security website has some good ones, and some other private companies have offered them as well. I agree, this is an area where people should really take a hard look.

Another category where you think people should spend some time and strategize a little bit is in this area of taking withdrawals from your retirement portfolio. You think that you're sold on the idea of this dynamic withdrawal rate; rather than having that static 4% rate or whatever you're using, that you should think about changing it up periodically.

Stipp: There's been some great work on this topic by our colleague, David Blanchett. Michael Kitces, who [has been] a guest here on Morningstar.com, has also done some great thinking about withdrawal rates.

There are a lot of nice things about [the 4% rule]. It's 4% of your portfolio in that first year of retirement. It gets adjusted for inflation in the following years. It's a nice and consistent way to withdraw the portfolio. But the fact is, things will change. You'll change. Your expenses will change in retirement. The market will change. Your portfolio will certainly change depending on performance.

It just makes sense to check in on how are you doing--how is the sustainability of the portfolio doing? Where is the portfolio value? Do you even need to take 4%, or whatever your withdrawal rate was, anymore? All of these factors can be recalculated and you just run the numbers again. You may need to make a small adjustment, a tweak. It doesn't have to be a dramatic shift that would suddenly change your life, but it's just keeping track of how things are going along way.

We found, and studies have found, that if you make small changes, maybe forego an inflation-adjustment during a bad year, it can actually have a strong impact on the sustainability and longevity of your portfolio.

Benz: Another best practice in your view, Jason, is to plan to have some money left over at the end. Don't plan to have that last breath, last dollar, but actually plan to leave an estate of some kind. Why do you think that's such a good idea?

Stipp: If you just plan for the idea that you want to leave some kind of an estate to your children, or for charity, or some other kind of legacy, it just builds in a little bit of extra buffer. It will inform the way that you save, how much you save, where you invest, and it will inform how you draw down your portfolio when you reach retirement. The benefit is, if you do reach a nice, ripe old age, or you have some medical issues, or you just need some income later in life, you can tap that if you need to. It's just a little bit of extra breathing room for your portfolio.

Benz: One other best practice in your view, and certainly this is right in Morningstar's bailiwick, is this idea of keeping your investment costs nice and low. Let's talk about the benefits that that can deliver throughout retirement.

Stipp: I sometimes wonder if readers are sick of hearing us saying this…

Benz: I think they are.

Stipp: You wrote about this recently, but it's a very, very important point.

The expenses that you pay on your mutual funds will come right out of the yields or the capital gains of that portfolio. It's just skimmed right off of your returns. Especially when you're in a bond fund or at lower-returning asset class, it can become a pretty big percentage of your overall return. If fixed income, for example, may be under some stress in years to come, it's all the more important.

These little expense amounts might not seem like a lot, but they compound over time. They can really have a huge impact over dozens of years and decades in what your final outcome is for that investment. We've also seen, and you wrote about this, some data that funds with higher expenses will sometimes take on more risks to overcome that expense hurdle. Those are risks probably don't need to be taking, especially if you're in fixed income, where you're trying to play it safe anyway.

We'll say it again and again and again, but expenses are really important and a great way to add some buffer for your portfolio.

Benz: Also a guaranteed return on your money if you're able to save a little bit in expenses.

Stipp: That's right.

Benz: You also say--your last tip here, Jason--is to just try to save a little bit more--that can greatly improve your odds of success during retirement. Let's talk about what the strategy is there.

Stipp: Run the numbers, whether you use the 80% rule, or even better, if you do a forecast for what your retirement expenses might be. Figure out how much you need to save, how long, your asset allocation. And once you get a plan for covering those expenses and what you need to do today, just add a little bit, just add a little bit to it. You don't have to go crazy. You don't have to really live a spartan life now if you don't need to. But just add a little bit of extra buffer.

To me, the benefit today is, the money that I do end up spending, that truly discretionary money after I've saved for retirement and covered my expenses, I feel better about that, because I've taken care of business and then a little bit more.

The markets are going to do what the markets are going to do. We don't know where taxes are going to go. Social Security may get trimmed at some point along the way. If you have a little bit of extra breathing room, it will be a big peace of mind now and certainly will benefit you when that retirement day does come.

Benz: Great advice, Jason. Thank you so much for being here to share it with us.

Stipp: Great to join you, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.