Judith Ward: Planning Well at Every Life Stage

T. Rowe Price's senior financial planner shares planning and portfolio to-dos for 20-somethings, people in their 70s and beyond, and everyone in between.

Christine Benz , Jeffrey Ptak, CFA

Sep 25, 2019

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Our guest today on the podcast is Judith Ward, senior financial planner and a vice president of T. Rowe Associates. In her role at T. Rowe, Ward provides guidance on personal finance and retirement-related issues and is responsible for developing a broad range of financial-planning products and services. Additionally, she provides T. Rowe Price perspectives to individuals, institutions, and the media and contributes to T. Rowe Price publications. She has been with T. Rowe Price since 1983 and is a CFP certificant.

Background

Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance at Morningstar, Inc. My colleague Jeff Ptak is out today. So, I'll be conducting today's interview solo.

My guest today on the podcast is Judith Ward, senior financial planner and a vice president of T. Rowe Price Associates. In her role at T. Rowe, Judy provides guidance on personal finance and retirement-related issues and is responsible for developing a broad range of financial-planning products and services. Additionally, she provides T. Rowe Price perspectives to individuals, institutions, and the media, and contributes to T. Rowe Price publications. She has been with T. Rowe Price since 1983 and is a CFP certificant.

Judy, welcome to The Long View.

Judith Ward: Thanks for having me, Christine.

Benz: So, we decided to organize this conversation by life stage, because in your work, you do provide financial guidance to people at a variety of life stages, from people just getting going to people who are well into their retirement. So, we thought we'd take it age by age, basically, and start out with the first cohort: people who are just getting their plans off the ground, maybe new graduates from college. And a big question for people at that life stage, especially today, is many of them are coming out of school with these enormous amounts of student loan debt. So, they may have heard that they should get started investing for their retirements as soon as they possibly can, they should also build an emergency fund, but they also might have $50,000, $100,000 in student loan debt. So, let's talk about navigating that multitasking among those competing financial priorities. How should people approach that?

Ward: Sure. And we do see that all the time, as you said, with folks coming out of college with student loan debt. The average debt is maybe a little less than the $50,000. And the reason you take on the debt is for the propensity of higher income and higher earnings. So, hopefully, they're getting the jobs where they are earning a decent salary, perhaps at a company that offers benefits that they will benefit from, you know, a 401(k) plan. So, being young like that, one of the first things I would tell them is – and I'm going to use a dirty word here, but it's: budget – to really understand what are their income sources, what are their savings goals and what are they spending their money on? And it provides a framework to understand how you might manage all of these competing priorities at one time and also, can you attack things simultaneously or do you need to take things one at a time? Like, are you intent on paying down your student loan debt if it feels such a burden to you?

The problem with that is that it could take 10 years. And the greatest asset for young people is time…

Benz: In investing.

Ward: …in investing, right. So, there's an opportunity cost of not investing when you're young. And you can start with small amounts. We talk all the time about if your company has the match in the 401(k) plan to absolutely take advantage of that match, and then try to ramp that up over time. You might be auto enrolled in the plan. So, you have to make sure you still understand what's going on within the retirement plan. But if you can put a little towards your retirement, make the regular payments on your student loan debt, because typically, if it's a federal student loan, the interest rate is going to be a little more favorable. And also, try to work the emergency fund. And if you can do all of that simultaneously, that's great. I would say, if you have to prioritize, work on the emergency fund, because you need that cash contingency outside of your plan…

Benz: To keep you from resorting to unattractive forms of financing if you have an emergency of some type.

Ward: Right. Or you don't want to have to put everything on a credit card. That's another issue is credit card debt, to pay that down. I would say, that's what you would want to prioritize. But time-bound it. So, you do it in two to three years. So, you're not waiting 10 years before you start investing in your retirement.

Benz: So, am I kind of using the interest rates, or the expected rate of return on my investments to kind of be my compass in determining how to allocate my paycheck or my disposable paycheck across these competing priorities? So, if I have, say, really high interest rate, credit card debt, even my investments in my 401(k) are unlikely to beat that rate of return, right?

Ward: Right. I think that's a good way to look at how you want to prioritize, especially the debt side. And so, the biggest culprit is high-interest credit card debt. And so, that's where you want to really pay attention and try to pay that down, and then manage that moving forward. But again, time-bound it, so you're not just – you need to put a plan in place to get it done. And that's where a budget can help you. It can help provide that framework, so you know exactly where your dollars are going and then, what you're going to do with your next dollar once you've paid off the credit card debt, for example.

Benz: OK. So, monitor it for a month or two, see where you're spending your money, see how much is going to restaurants and bars…

Ward: Exactly.

Benz: …as is often the case in your 20s…

Ward: Right.

Benz: …but take stock of what you're spending today and then try to guide it to the savings rate that you're looking for.

Ward: Right. And also, to consider again with the 401(k) plan, the company match, because that is free money that you want to take advantage of. So, if you can do that at minimum, and then work to the other kinds of debt, I think that's a great start.

The other thing I would talk about the budget is, there is technology to help you do it and make it easy. And sometimes it's just small adjustments that you need to make in order to make things work. But once you kind of get into the tune of tracking what you're spending, it becomes a habit. And then, later on in life, you may not have to use a budget. You can wing it at that point, but at least you've taught yourself how to manage your money responsibly. And I kind of liken it to health. Everyone knows for a good health you need to diet and exercise. If it was that easy, then a lot of us wouldn't have weight issues, right?

Benz: Right.

Ward: So, it's the same thing. We say, well, spend below your means. Well, what does that mean? And I've been trying to lose some weight. And it wasn't until I actually started to count and track my calories that I actually knew what I was eating. And it's the same thing with finance. You really need to track and see what you're spending your money on so that you know, because you could easily go through a day of, "Oh, I forgot about that chocolate chip cookie or mayonnaise on my sandwich or that second glass of wine; that's 300 calories." And we do the same thing when we're spending money. We just don't keep track of it. And you have to do that if you really want to be intentional and try to take care of these competing priorities.

Benz: OK. And the good news is, is that there are software programs, things you can put right on your phone to track your expenditures.

Ward: Absolutely. Yeah, use technology to help you do it.

Benz: OK. So, you mentioned investing in the 401(k) plan, and that taking advantage of the matches is really important. But it seems like people should do a little due diligence on the 401(k) plan before really shoving a lot into that plan. So, let's talk about some of the key things that you want to look at when evaluating the quality of your plan and whether you should invest the most you can possibly invest there, or maybe look outside of the plan for an IRA, for example.

Ward: Right. So, with the plan, you definitely want to look at the investment options. A lot of plans now they might auto enroll you typically at some kind of starting deferral rate. So, you want to check that out to see what the deferral rate is. A lot of times, they might use a target-date fund, which is a fund that's already diversified and becomes conservative over time, which I think is a great option…

Benz: I do, too.

Ward: …especially for younger people that just don't know, and at least it helps you get started. You can always change later. But you're already deferring, you're in a target-date fund, which I think are two good things. What you do want to look at, I think, for younger people especially, is there's the Roth option within the 401(k) plan. So, with the Roth option, you don't get that tax benefit today, but your money grows tax-deferred, and then, when used in retirement, it's tax-free, which I think is a great option for young people and for a lot of people, quite frankly. So, you'll want to look at those components. And also, another thing that plans might have is something called auto escalation, where you can start at a certain deferral rate, say, they started maybe 3% or 6% of your salary, and then they'll increase that 1 percentage point. And that's a great way to increase your savings very easily. But a lot of times you have to opt into it. So, you want to check that, too. So, there are some great features within plans that can help you get on that retirement-savings track.

Benz: So, let's go back to this Roth versus pretax or traditional 401(k) contribution decision. What are the key things that I want to be thinking about? Let's say, I think I'm fairly early in my career trajectory, and I think that my earnings will ramp up significantly, because I'm taking taxes out of my contributions, if I make Roth contributions, that might be good, because my taxes may be at a lower rate than they may be in the future. Is that how I want to think about it?

Ward: Yeah, I think that's the primary way people think about it. And when I describe it, I say, it's kind of simple math. If you are in a higher tax rate now when you're putting money in, and you think your tax rate is going to be lower when you take the money out, then you want that tax benefit today. So, that would be pretax contributions.

Benz: Right.

Ward: On the flip side, if you are putting money in at a lower tax rate today and think when you take the money out in retirement, you're going to be at a higher tax bracket, then you want that benefit in retirement. So that's the Roth option. You don't get the tax benefit today, but you get the tax benefit in retirement. Simple, right?

Benz: Well, not really, because people might say, I have no idea.

Ward: Exactly. I mean, just look at the tax code over the past however many years, what's going to happen in a few years, we just had a tax cut, it could reset in a few years. So, not only is the tax code uncertain, but your own situation is uncertain as well. I mean, you could be on a great career trajectory, you could have a difference in household with two incomes at some point. So, it sounds simple when you just think about it that way. But it is not that simple. However, I do think that for a young person if they can, because the chances are, that tax benefit is going to be a lot more valuable to them in the future, because they're probably in a low tax bracket now. I just think the idea of Roth is great for them, but also for other people the idea of what we call tax diversification…

Benz: So, let's talk about what that is.

Ward: Yeah. So, tax diversification is that you have some pretax monies. So, you're going to – when you take that money out in retirement, you're going to pay taxes on it. The Roth option is where you will have tax-free income in retirement. And so, a mix of that, along with maybe some taxable investments, or some money that's outside of any retirement or qualified plans could be beneficial too. But the benefit is, it just gives you a lot of flexibility once you get into retirement. You have the advantage to now look at years in retirement where you might have low-income years where you can take the pretax money, high-income years when maybe you can draw from the Roth. So, it just gives you more flexibility in retirement, and it's kind of a hedge against the uncertainty of tax rates.

Benz: Yeah. It's the ultimate delayed gratification though, especially for people at this life stage. So, I guess, that's a question like, I think potentially there's a benefit with the pretax contributions, where because that is pretax money going in, you can maybe get excited by looking at that larger sum, seeing that faster growth. So, that's something to be considered too, right? Not exactly rational, but…

Ward: Yeah, I mean, with the Roth, you would get the same growth. I guess, I'm thinking that you're going to put in the same amount, whether it's pretax or Roth, the pretax might give you the opportunity to invest a little more, because you're getting that break on taxable income. So, that's the big consideration.

Benz: Yeah.

Ward: The other thing I was going to say is that in the 401(k) plan anything that the company puts in, so whether they do a company match, or they might have a discretionary contribution, that's all going in pretax. So, the only way to get the Roth exposure is for your own personal deferral. And I know for someone like me, you know, we didn't have access to the Roth and the 401(k) plan. So, we might have amassed a lot of pretax savings in.

Benz: Right. I was the same.

Ward: Yes.

Benz: So, as soon as Morningstar added the Roth option, I was all over it for that tax diversification reason that you just mentioned.

Ward: Yeah. So, I think that there is a benefit to having some Roth exposure, and especially for those who have already been saving quite a bit in their 401(k) plan, we've amassed a lot of that pretax money already.

Benz: Right. And as you said, all the matching contributions are going in that way, too. So, let's talk about how much I want to target in terms of my savings on an ongoing basis. So, T. Rowe Price has generally argued that 15% is a good benchmark for people. Let's talk about how you arrive at that and what would cause me to need to go higher than that or where I might maybe, in some situations, maybe a dwindling number of situations, be able to go lower than that.

Ward: Yeah, the way that we arrived at the 15% savings rate, and that includes anything your company puts in, was basically thinking, you know, looking at the end and coming backwards, or not the end, but in retirement and coming backwards. So, we looked at generally how much income are you going to need of your preretirement income in retirement. And again, that's just a rule of thumb. Our number is, 75% of preretirement income that you would use in retirement, and then, how much of that might come from Social Security, and assume the rest would have to come from your personal savings. So, it's just a mix of personal savings and Social Security. And so, bringing that back, we found that 15% generally was a good deferral rate to get you to that point at retirement.

Now, if you're a high earner, Social Security is not going to make up as much of your retirement income. So, you might have to save more if you want to maintain that lifestyle in retirement. On the flip side, there might be times where you may not have to save as much. Social Security makes up more for lower-income people. But we still think it's a good number to strive to. I would say the benefit for younger workers or younger folks that we were just talking about is, they can start out – if they're starting to save in their 20s, they can start out at a lower amount, ramp up and be well on track for retirement. So, they don't have to start out at 15 from day one. They can really ramp that up and be in a good spot.

Benz: OK. So, you have also created these savings benchmarks by age, which I think is super helpful, because people have no idea what their investment portfolio for retirement should look like at various life stages. So, for 35-year-olds, the suggestion is, I should be targeting a savings kitty, amount that's equal to about one times my salary, but you actually have bands around that one-time salary. Let's talk again about the things that would necessitate me going over that or shooting for a higher amount and things that where maybe I would be comfy having a lower amount.

Ward: Right. And again, it comes back to the household at retirement, what's the income level of the household, how much is Social Security going to make up of your retirement income? The things that these don't consider – any kind of pension income or defined benefit, where surprisingly to me, a number of retirees still have pension benefit.

Benz: Absolutely.

Ward: I think we'll see that shift as younger workers age and come into retirement. So, those are the things, the band – so, the higher the income, again, the less Social Security, you may need to target something a little higher. And this is all on the premise that you want to maintain your lifestyle in retirement.

Benz: Right. So, a lot of people, we have this bifurcated system in the U.S. where large employers usually field really great 401(k) plans with all the bells and whistles. Sometimes smaller employers have no plans whatsoever. So, how about people in that case, where there isn't a company retirement plan on offer? What are the options?

Ward: Well, let me just look at this from two perspectives.

Benz: Sure.

Ward: One is a person on their own, who does not have access to a workplace plan, or maybe their workplace plan, frankly, is not good. They have the option of IRAs. The issue with IRAs is that there's the contribution limits, $6,000. And you have catch-up if you know you're 50 or older. The problem with that, if that's your only retirement vehicle, $6,000 a year is not really going to help you get on track for a solid retirement. So, you'd have to look outside of and maybe start investing in some taxable, tax-efficient, taxable accounts, depending on your income level. Some people might need the tax efficiency, others may not and can really kind of go for total return. So, I think you have to look at that. Use a combination of IRAs with a taxable investment. That's a single person. Now, if you're married or partnered, as a household, one person might have to take on the role of saving for the household. So, maybe your spouse has access to a 401(k) plan, they might have to take the role of really saving for the household. And that might be an example of where you might want to save beyond the 15% or maximize that 401(k) plan, because you're really saving on behalf of two people, not just yourself.

Benz: Right. And I want to touch on that in the next section where we talk about when kids are in the mix, and sometimes you do have one of the spouses who is staying at home and being the primary caregiver, but it seems like we can cover it right now, that's when it's important to think about not just retirement planning for the person who's got an income coming in the door, but also thinking about retirement planning for the spouse who doesn't have an income.

Ward: Correct.

Benz: OK. So, I want to talk about asset allocation at this life stage. If you look at glide paths, and T. Rowe Price's target-date funds, for example, have historically been toward the more equity-heavy end of the target-date glide path. So, if I'm in my 20s, 30s even, I'd want to be staking a lot of my portfolio in stocks. The reason is, is that stocks have the best long-run return potential. So, what's a good rule of thumb for that? Is it 90% of my portfolio?

Ward: Yeah, I think, our rule of thumb is 90% to 100% of your portfolio in equity – your retirement-saving portfolio in equities in your 20s and 30s. Because, again, your greatest asset is time. And over time – I mean, you've got decades until you're going to retire. So, over time stocks do give you the best growth potential.

Benz: Benz: I had a conversation with Bill Bernstein, the asset-allocation guru, about this topic and his view is actually a little different in that he thinks newbie investors should start slightly equity light, like, I can't remember the specific recommendation but well under 90%, in part because they're kind of getting their training wheels on and they haven't necessarily lived through a big bear market. And that seems like it's maybe top of mind right now, given that we're 10 years into a very strong equity market rally. Does that make sense to you?

Ward: I would say, for a retirement portfolio, what we have found – because, as you know, T. Rowe Price has a recordkeeping business. So, we manage 401(k) plans. We have found that basically people in the 401(k) plans, they don't react to market movements, and especially the younger – if they're younger and they've been auto enrolled in a target-date fund, they just let it ride. So, I don't know that we've seen that behavior. I can completely understand where he's coming from, and that you don't want to scare someone to be totally out of the market when they're first starting to invest. I think maybe if it's outside of their retirement account, that's where they might want to be more cautious. We just haven't seen that kind of reaction. But you know, to the point, we've looked at past historical events, and I think it's less than 1% or 2% of the participant base actually takes action.

Benz: Yeah, during a volatile market. OK. Let's talk about 401(k) loans, because that can sometimes be an attractive-looking option on the surface, especially if you're maybe someone with student loan debt or credit card debt. Are 401(k) loans ever a good idea? So, say, you've been amassing money in this 401(k) plan, you've now got a nice-looking balance, are they ever recommended?

Ward: I wouldn't say the word recommended. But I would say, sometimes it's not the worst thing in the world. And I'm probably going to get struck by lightning for saying this as a financial planner. I would caution -- there might be times where you do need access to that sum of money because of life circumstances. I would not want someone to be using their 401(k) plan as an ATM. Or if they're constantly…

Benz: To take a vacation.

Ward: Yeah, or perpetually taking a loan to make ends meet. That's an indication that there's some other issues and maybe look to your plan or your employer for some financial-wellness tools to help with that. But if once in a while something comes about and you need to take the loan, as long as you're continuing to contribute to the plan – I mean, if you were going to take that debt on somewhere, as long as you are continuing to contribute, and you do it in the loan terms or three years, maybe five years, it's not the worst thing in the world. If you're smart about it, and you know that you're going to repay it, plus continue to the contributions, it's not the worst thing. I would rather see someone do that than to liquidate an IRA, for example, because they've got some life circumstance that requires that money.

Again, I think where people tend to get in trouble with that is, they don't realize if they leave their job, they have to pay that back. Now, I think terms have gotten a little more lenient recently, that you still might be able to make periodic payments, and the time frame is longer. But they don't realize that they have to pay that money back or it's considered a distribution, subject to taxes and penalty. So, that's where I think some people need to think about, "OK, am I going to be in this job for another three to five years? Whether it's my choice or not?" I mean, you might want to move on to something else. So, you just have to know that you've got this outstanding loan. So, I would say, it's not probably the first place I would go to borrow money. But it's also not the worst thing in the world if you can continue to make contributions and you do it once in a while in like a three-year time period.

Benz: Yeah. I thought about Roth IRAs as potential savings vehicles in terms of you know you want to save additional assets for retirement, but you may need your money out prematurely. Roth IRAs actually look pretty good from that standpoint, right?

Ward: They do. Because you can take your contributions out. So, it is a way to save for retirement in a good retirement vehicle. But you still have access to some of that money should you need it. And I just think of – you know, we keep telling people save, save, save; use these retirement accounts. But then you don't want someone to become retirement poor, like someone might become house poor, where they've got all their money wrapped up, where it's hard to get to should something happen, because life happens. And sometimes we need access to that. So, I think being smart about how you access that if you have to, but a Roth IRA is a good idea for that, too.

Benz: OK. So, let's move along to the next life stage. Let's assume we've got people in their 30s and 40s, maybe kids have entered the picture, maybe earnings have picked up nicely from when they first started out. So, one thing that sometimes creeps up at this life stage is lifestyle creep, where suddenly you've got someone who cleans your house, and you've got a dog walker, and you're going out to dinner twice a week instead of the twice a month that you used to do. So, what are your tips for people combating that lifestyle creep? You talked about the importance of kind of setting the discipline of a budget early on, but what should people keep in mind as they do see their incomes pick up and they feel that they have more disposable income?

Ward: I would just – you know, go back to how are you tracking for retirement. We talked about these retirement benchmarks, and I think for age, like 50, 5 times salary…

Benz: So, at age 50, I'm trying to target 5 times my current salary.

Ward: Right.

Benz: OK.

Ward: So, make sure you're still tracking for retirement. Also, think about college costs for your kids. Are you going to start the 529 account? Have you already started college 529 savings? So, you want to try to get on track for those future savings goals. And we talk about saving money, it's actually you're saving money so you can spend it later. So, make sure you're on track for that. And then, if you can pay someone to clean the house because you just don't have the time because you're running around with your kids, work that into your budget. Are there other things you can – I hate to use the word "cut" -- but maybe adjust so that you can have these other things and maybe because you do have higher income or a dual-income-earning household, you can afford these kinds of things.

Benz: OK. So, you mentioned that fork in the road with college savings and retirement savings. We, I'm sure, both know many friends, family members firsthand where this is a struggle. I think people feel in their souls that they owe it to their kids to try to help them pay for college. So, how do they balance the two things? Retirement is expensive. College is expensive. How do you figure out how to allocate your capital across those two really important goals?

Ward: Yeah, and I actually just did an article about how to limit debt. And a lot of it is planning ahead for one and talking to the kids about, you know, what do you expect from them, do you want them to go to college, are they expecting to go to college? I mean, we think now that the college degree is the new high school degree. And so, a lot of parents do expect their kids to go to college. How much are you going to be able to help them? And then, think about how are you going to pay for that in the future. There's a lot of sources that could be your incomes, you or your child, if they're working as well. You could pay college costs through income, through savings. So, you want to plan ahead, because you've only got like an 18-year time horizon to save. And we think that it might be prudent to think savings could pay for maybe a third to a half. I think it's very difficult for families to save enough to cover total college costs. So, if you can target a third to a half through savings, that might be more reasonable. There's also grants and scholarships. A lot of that comes from the institution. And then, there's loans, basically. And what I kind of say is, you save now, or you borrow later. The other thing to do is think about, do you have to put parameters around that college-buying decision. And explain this to your child. Like, this is why we're doing this.

Benz: At what point do you start that conversation about…?

Ward: Before they are in high school.

Benz: Yeah.

Ward: I mean, I would try to sprinkle that throughout just so it just comes up naturally. If you have a 529 account for your kids, maybe if you're comfortable sharing that and saying, look, we're saving for your college, it's not going to cover everything. So, we need to talk about expectations. Is it just you want to be in state schools? It's hard. I know we want to do the best for our children, but whatever college at whatever costs could really set the whole household back. And a lot of times the child might go to school and transfer after a year. So, it's just – look at it as a buying decision and really be thoughtful about what your family can afford.

Benz: Yeah, yeah. I had friends who I feel like they've gone to visit schools with kids. And it's been sort of like, well, let's not think about money right now. And then the acceptance letters start to roll in, and it's like, oh, guess what, we really can't afford $80,000 a year to send you there, even though you had your heart set on it. This seems like a little late to be having that discussion.

Ward: Right. Yeah. And I don't think your kids want to be a burden to you. So, I think they're more than willing to compromise if they have that whole picture. But what you just said, you go everywhere, and then they're very disappointed, because they thought this was the plan and you say, no. It can be disappointing. I think eventually they will get over it. But just being upfront and having those conversations along the way, I think can just set it up for a better situation.

Benz: OK. So, you said you had just completed an article about loans and kind of rightsizing student debt. Let's talk about that. That's an important question. How much debt is advisable to let your kids bite off for college?

Ward: Yeah. Well, interestingly, we had a survey -- our parents, kids and money survey -- where like a third of parents were willing to take on $50,000 and more in debt for the benefit of their child, and they were willing to also let their child take on that amount of debt. My view, if you can, limit the debt to the federal student loan amounts. I think that's a good benchmark to use. And you can use that as you're planning your college.

Benz: And what are those approximately?

Ward: So, for a dependent undergraduate student for four years, it's $27,000. I think if you go a little longer, it could go up to like $31,000. So, that's one benchmark to think about, if you can limit it to that. Another rule of thumb that I've heard is to not borrow more than what you expect the first-year salary to be once you graduate. Now, that's a little more difficult, unless you absolutely know, but you can do some research to look at what are some starting salaries in different fields, in different industries, and get an idea of that. I do this fun little exercise where I talk about my daughter who went to school and, I said, "Is this good debt versus bad debt?" And everyone agreed, "Oh, you know, student college funding is good debt." And I'm like, "OK, well, what if she decided to go to this school and it was a very expensive out of state school?" They're like, "Well, yeah, I think it's a still good debt." And I'm like, "Well, what if I told you, she's going to be a kindergarten teacher, and this is what they make in their first year?" They're like, "Oh, gosh, I don't know." And I'm like, "Yeah, that's why we looked at in-state schools." And she is a teacher as a matter of fact, not kindergarten. But yeah, we limited the search, because she knew what she wanted to do. There were some good local schools. So, we limited the search. And she's done great since then.

Benz: OK. So, moving along a little bit, thinking about people who are maybe well into their 50s and they're kind of thinking of turbocharging their retirement savings. Let's talk about some benchmarks for them. So, say, people between 55 and 65, sort of, retirement looming within maybe the next 10 years or five years even. Kids maybe are out of the house. So, the college-funding thing is in the rearview mirror. Let's talk about some things to think about to try to really step it up on the retirement front.

Ward: Yeah, it's interesting. So, I think there's been some studies that said, you know, once the kids graduate college and move out of the house, do parents kind of, again, turbocharge their retirement savings. And I think some of the research says, "No, they don't." And I have to admit, we didn't do that, because we remodeled our kitchen. Like, we did all these things around the house that we had neglected to do for many years. So, there might be some short-term things that people will do. But I would say, again, make sure how are you tracking for retirement. I think our guideline for someone aged 60 is 9 times; 55, 7 times salary. So, you want to start looking at how you are tracking for retirement. You can start to contribute more to your plans. You might want to start building up money outside of your qualified plans…

Benz: So, you mentioned that a couple of times as an option and a way to enhance what you call tax diversification.

Ward: Right.

Benz: So, there, I'm just using some kind of a taxable brokerage account or something like that, using mutual funds probably. And you mentioned the importance of being tax-efficient there, so like index funds might be a good option.

Ward: Yeah, and this is kind of beyond your emergency reserve, where you want to have that in something more accessible and more stable, but also building that up, because that can also be a tax-efficient way to build savings, but also possibly pass along to heirs. So, if you have the ability to do that, that more affluent where you are maybe maxing out these other vehicles, it's not a bad thing to have some additional money on the side.

Benz: So, the virtue of that if it gets passed on to heirs is that the investment gains that you've enjoyed during your lifetime or that the account has experienced during your lifetime, the gains, the taxable capital gains kind of go away for the people who inherit the account, right?

Ward: Right. And so, one of the differences with a taxable account is that you might benefit from capital gain rates. Now, the difference is, you might have to pay taxes along the way, like, every year or every transaction versus the qualified retirement account. But the tax rates for capital gains are more favorable than the ordinary income tax rate. So, you might be paying lower tax rates. And then, when your heirs, they get that step-up in basis, so it's a good vehicle to possibly pass on to heirs.

Benz: OK. So, I'm considering the taxable account, assuming that I'm funding my other accounts, my IRAs and 401(k)s and so forth. How about health savings accounts? We haven't talked about these, but it seems like every financial planner loves them. Do you love HSAs as much as everybody else seems to?

Ward: Well, they are the trifecta, right? You get the tax benefit up front, you get the tax deferral while money grows, and it's tax-free if used for qualified medical expenses. So, it is the trifecta it would seem. I always go back to – this is a healthcare-coverage decision first and foremost. Now, your company, you may not have a choice, you may only have a high-deductible health plan option. But in order to have access to an HSA, you have to have the high-deductible healthcare option. So, that's number one. You have to make sure if you have a choice, that that's the right health coverage for your family.

Benz: So, you might have a PPO or the high-deductible plan.

Ward: Right.

Benz: Address that fork in the road first to see which is the right thing for you.

Ward: Exactly.

Benz: OK.

Ward: I mean, if there's people in your household that have some chronic medical conditions, you might want the best health coverage you can afford. And it may not be the high-deductible plan. So, that's the first decision that you have to make.

Benz: And look at how your employer might be subsidizing the various types of plans.

Ward: Exactly. Right. Now, if the high deductible plan you think you know will work for your family, if you have that choice, then the health savings account, like we said, it is a trifecta. Most people are using them to cover current medical expenses. If you are able to use it as more of a pseudo-retirement account where you can put money in and invest it for the long term, it could be a really nice way to supplement your retirement savings. And it's a way to then cover healthcare costs in retirement, that is another source of tax-free money.

Benz: OK. Let's talk about people who are planning to work longer, but are prematurely forced out of the workplace, which unfortunately happens with people in their 50s or 60s where maybe their anticipated retirement date was 67 or 70, but they are out earlier. So, if I'm looking at my various accounts, trying to figure out, well, where I need some income, where do I go, where would you advise people to look?

Ward: Well, that's one of the places where this brokerage account, taxable account might help. And if you are over age 59.5, you can start looking at your qualified plans. In your workplace plan, if you're 55 and separated from service, you have options there to take money out penalty-free. So, you do have the options. The hard part is, is that you are tapping that money sooner than you thought that you would. Now, if you have a spouse – again, we're kind of looking at things from an individual perspective, but you have to consider the household, too. So, if you have a spouse that you're able to stay on their plan, a health plan, so healthcare-cost coverage is a huge consideration if you're under age 65. That's a huge consideration and challenge for some people. But you know, if you have the spouse that is still working, and you can be on their plan, it might not be as difficult. If you don't, then it can be really challenging, especially if you're leaving the workforce early because of a health concern.

So, this is where you want to scrub your spending. How are you spending your money? Is there anything that you can do there? Is there any way to pick up additional income? I've seen the research that said it's difficult for people that are in their 50s or even 60s to get rehired. The gig economy maybe is helping there. I don't know how many Uber drivers I've met who are retired. So, that might be a way to look for additional income. Also, look at your spending, and then maybe adjustments to lifestyle.

Benz: OK. So, how about people who are retiring for the opposite reason where they feel like, "Oh, gosh, I have more than enough." People are looking at enlarged balances today and saying, "I'm 55, I think that I have enough." What should they think through beforehand? Healthcare coverages should be top of mind. What else? I mean, because you're potentially going to be retired for like 40 years. So, the 4% guideline maybe not serve you well.

Ward: Yeah. Some of the research that we've seen is that the 55-year-olds who tend to retire have a defined benefit. That's some of the research we see. So, if you have that defined benefit, or that pension income, that absolutely will help your situation.

Benz: And that's not portfolio dependent. So, that's good.

Ward: Right. But yeah, you have to think about the longevity aspect. Could you live into your 80s, 90s, or your spouse?

Benz: So, data absolutely suggests yes, right?

Ward: Yes. Right. So, that's the big consideration for a lot of these retirement decisions is that longevity. How long are you going to have to fund your retirement? And if you don't have a defined benefit, and you're relying on Social Security, you're not going to be able to start until you're age 62, unless you're disabled…

Benz: And even then, you probably shouldn't at age 62 in most situations.

Ward: Exactly. Right. So, what are your sources of income? And is your portfolio going to be able to withstand how you're going to be spending your money throughout retirement? So, we like the idea of, if you can stick it out for a few more years even till your full retirement age, I think that's a good place to start. If you can work longer or want to work longer, that's great, too, but at least try to your full retirement age or if you go sooner than that, I think the big consideration is your health coverage, because you're not eligible for Medicare until your age 65. So, what are you going to do to bridge that gap?

Benz: Right. I loved that research that Christine Fahlund at T. Rowe Price did about – I think she called it pretirement or practice retirement. Let's talk about that. The basic idea was, I stop contributing to my 401(k) plan or my IRA, because those additional contributions later in life, while it would be great to continue to make them, they don't add that much. Whereas if I can keep working, and maybe have some disposable income, that's the real beneficial thing to my total plan, if I can stick it out, but make working more fun, maybe take some of those big trips while I'm still young. Let's talk about that.

Ward: Yeah, and maybe pay off some debt. So, the idea there is, trying to get people to stay in the workforce a little longer so that they don't have to start drawing on their saving sooner, they can put off Social Security. And when I say a little longer, I mean, like into your mid-60s. If you can wait till 70, that's great. I don't know a lot of people that want to do that. But we were seeing the data that were suggesting a lot of people were retiring in their early 60s, age 62, when they could get Social Security. So, the idea is, if you can stick it out for a few more years, that's a huge benefit for your retirement. But also, to what you just said, maybe cut back on your contributions. Like, if you're contributing the max in your catch-up to your workplace plan, maybe cut back, so you're still getting a match. But then use that money to try something different, maybe explore where you might want to live in retirement by taking vacations there, or check out hobbies, maybe it's the time to pay down your debt so that you're in a better position when you do retire. So, maybe try to have some fun with this extra income for a few years, so that you can at least stay in the workforce and still have that wage and that health insurance coverage for a few more years.

Benz: Let's talk about asset allocation at this life stage, because it seems here is where you would want to start thinking seriously about taking some risk out of the portfolio. How should people approach that question?

Ward: Yeah, we think that leading up to in retirement, you probably now want to have more of a balanced approach. You still want to have stock exposure. I think like at retirement, our target-date funds are maybe around 55% equity. So, it's a true balanced approach. As a rule of thumb, I say 40% to 60%. So, you still want to have equity exposure, because you don't spend all your money the day you retire, right? You still need money to last maybe another 20 to 30 years. But you want to start softening that so that the downsides that you experience in the portfolio are not as sharp and it's something that you could withstand for maybe a couple years versus a five-year recovery, maybe you could handle a two-year recovery with that kind portfolio.

Benz: OK. So, let's talk about retiring into a volatile market, because I think that it's a legitimate concern for this cohort of new retirees. They've had a really strong equity market. Realistically, they may encounter some turbulence in the years ahead. So, can you go through kind of some best practices to bear in mind if my retirement happens to coincide with a lousy market environment, maybe let's first talk about why that can be so bad. And then get into some coping techniques in terms of my portfolio, maybe my spending?

Ward: Sure. So, it can be bad if you retire, and then the market goes down and you just overnight, basically, or in a short time period have lost maybe 20% of your savings, and you're using that money to draw from, you know, you're spending money from a portfolio that's down. So, you know, you're not going to recoup what you have spent; your portfolio may recoup, but you've already taken money out, especially early in retirement, because you really needed that portfolio to last. So, some things to think about is, we talk about withdrawal rates. And I know we talk a lot about the 4% rule. And that really is a conservative starting point.

Benz: So, 4% doesn't mean I'm taking 4% out of whatever my balance is every year, let's talk about it's 4% in year one of retirement, and then that dollar amount gets inflation-adjusted thereafter.

Ward: Right. Yeah. And that's how we use it to run analysis. So, I kind of look at it maybe a little differently.

Benz: OK.

Ward: I look at it as a starting point, but not a spending plan. Because retired, they just don't spend their money that way. They're not that rigid about it. And that's the other thing with retiring and volatile market, or even just withstanding a volatile market, retirees are willing to adjust and adjust their spending. And there's a lot of research that shows that. And so, that's another thing. As you're entering into these years up to retirement, you really want to get a good handle on what your expenses in retirement are going to be. What are going to be the essentials, what's discretionary. If you do want to tighten the belt, you know where you're going to start. And essential and discretionary might look different for some people. So, something essential might be the trip across country to see my grandkids. That might be a central spend, because you do not want to give that up. So, it could look different for retirees. But I think it's – that's where you want to really look at, what are your spending your money on? Where can you cut, if you feel like you need to tighten the belt?

The other thing is to maybe have what we talked about this contingency outside of – like a cash contingency. And I call it sleep-at-night money, where maybe you have one to two years of what you think you're going to spend in a safer vehicle, whether it's money market, or short-term bond or something that you can draw from that if your portfolio is down across the board, and to get you through. And we think up to two years might be a good number, because we've seen in the past, like the Great Recession, a 60%-40% portfolio rebounded in two years, versus an all-stock portfolio where it took, I think, almost five years to rebound. So, to get through those couple of years and then allow your portfolio to then get on the upswing. And then, of course, your asset allocation. That's an important decision. So, I think there are some things that you can do if you're heading into or it happens at retirement or even throughout retirement to prepare.

Benz: One piece of research that you all did at T. Rowe Price a few years ago, I guess in the wake of the financial crisis was looking at simply foregoing that inflation-adjustment piece of right 4% guidelines. So, in the years that the market is down, your portfolio is down, don't give yourself that raise. That makes sense. And that actually improved outcomes quite a bit.

Ward: Yes, it does. And I would kind of look at it as instead of don't take the inflation because like, who even knows what that means when you're in retirement. It's more like, try to keep your spending flat. It's more about you have the basket of goods and services that you want to consume as a retiree, and those costs are going to go up. So, maybe it's looking at, OK, out of this basket, if I need to keep my spending flat for a of couple years to get through this market volatility, again, what am I going to forego or what am I going to adjust? But yeah, it's basically, if you can keep your spending flat for a couple years, you're going to come out probably in a good spot.

Benz: Last question – well, I have a couple of more questions – but I want to talk about required minimum distributions, because our readers love to hate their RMDs.

Ward: Yes, absolutely.

Benz: And so, I hear a couple of issues about RMDs. One is, A: If I take this money out, it's going to take me over my planned withdrawal rate. So, that's one question I get. I'm hoping you can address that. And the second question is, if my RMDs are in excess of what I actually need to spend, what do I do with that money? How can I get it reinvested? So let's talk about those two questions.

Ward: Sure. And I think for people that have probably been doing everything right, where they've been saving throughout their career in pretax, and maybe they have some pension income, they've got Social Security income, they live a frugal lifestyle, and now they're hit with these taxable events, when they've done everything we've told them to do. And they don't necessarily need to take these distributions. So, they're creating this taxable event that they don't need. And the money is taxed at ordinary income, which is the highest rate. So, there's a few different things people can consider. Some is maybe converting money to Roth in low-income years, maybe at retirement, if they don't think they're going to spend all their money in retirement. Another thing is, maybe start spending from those accounts before you have to.

Benz: So, ideally, you would do this stuff before RMDs commence, correct?

Ward: Absolutely. Absolutely. I think you asked about withdrawal rates. So, if you just use your RMDs, that's actually a pretty good withdrawal structure, that's going to help your money last, if that's how you're using it. The RMDs, if I remember the research that we did correctly, I think the RMD rate, overtakes, if you're looking at a pure 4% role, where you start out 4%, and then you increase with inflation, I think the RMD rate overtakes that spending in maybe your mid-to-late 80s. So, that's where you're, kind of, taking out more than what you would if you had followed that 4% guideline. But it's just, you know, the government wants their money. And one of the things I really like now that we talked to people a lot about is if they're charitably inclined the idea of the QCD, so the qualified charitable distribution, so what you can do is, you can take your RMD. Now, you have to be 70.5 to use the QCD. It's a little different than the RMD rule. But basically, you can take the money out of your IRA. This doesn't apply to a workplace plan, but out of your IRA, and designate up to $100,000 to a charity, and it has to go directly to that charity, and that can count toward your RMD. It also reduces your taxable income because it's a charitable deduction. And you can use it whether you itemize or not. Because I know a lot of people because of the tax changes are now using the standard deduction. And so, they lost some of these charitable deduction opportunities. This is a way to still reduce your taxable income and give to charity if you're charitably inclined and it still counts toward an RMD. So, I think they're a great thing for people to look at that don't need their RMDs.

Benz: Right. But you have to be subject to RMDs, to take…

Ward: You have to be subject to RMDs. Yes, it has to go directly to the qualified charity. The other thing is reinvesting the RMDs. So, maybe you don't need that money now, but you might need it in the future. So, you don't necessarily want to give it away to charity. So, you can always reinvest those RMDs into a taxable account.

Benz: OK. Now, truly, my last question is – let's talk about one or two aspects of retirement planning, financial or otherwise, that you think are kind of underrated, underdiscussed?

Ward: So, I would say, going back to the younger cohort, or even, I guess, saving for retirement in general, I just think the aspect of just the sheer saving, like the amount that you save for retirement, the amount you're saving for retirement is going to have a much greater impact on your retirement success than your investments. And I know that -- again, I'm going to get struck by lightning more than once today. But if you're in a diversified portfolio, that's going to help I think, at the margins. But really, the greatest impact you can have is deferring 10% to 15% of your salary versus 3% or 4%. That's the greatest impact you're going to have on your success. The second thing I would say, is this is nonfinancial, but thinking about how you're going to spend your time in retirement. How do you want to spend your time as a couple? Are you going to spend time together? Are you going to do it separately? What is that vision you have for retirement? And really concentrate on your health. I just took my mother-in-law to her doctor, and she has health issues. And he said, we need to be stimulated, we need to be physically active, socially active, and mentally active. And that is what is going to help us get through and have a fulfilling retirement. So, I think it's important for people to keep that in mind and really work towards that.

Benz: Great advice, Judy. Thank you so much for being here. It's been really illuminating. I've enjoyed talking to you. You've taken us through many different aspects of financial planning and retirement planning. It's been a great pleasure to have you here.

Ward: Thanks.

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decisions.)

About the Podcast: The Long View is a podcast from Morningstar. Each week, hosts Christine Benz and Jeff Ptak conduct an in-depth discussion with a thought leader from the world of investing or personal finance. The podcast is produced by George Castady and Scott Halver.

About the Hosts: Christine Benz and Jeff Ptak have been analysts and commentators on investments and the investment industry for many years. Christine is Morningstar's director of personal finance and senior columnist for Morningstar.com. Jeff is head of global manager research for Morningstar Research Services, overseeing Morningstar's team of 120 manager research analysts in the U.S. and overseas.

To Share Feedback or a Guest Idea: Write us at TheLongView@morningstar.com

Judith Ward: Planning Well at Every Life Stage

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