Are you one of the 82% of households (per a Fidelity study) that doesn't have a written financial plan? Maybe you
think that you don't need one. Maybe you have a DIY spreadsheet/back-of-the-napkin plan that you think is sufficient.
Or, maybe you trust generic advice and benchmarks to guide you. If that's the case, with respect, I propose that you are doing yourself a disservice.
Regardless of your net worth or stage of life, having a comprehensive financial plan is a crucial step in assessing your current and future financial health and it provides a roadmap to becoming financially secure. It helps you to establish realistic goals, understand the direct impact that current decisions have on long-term results, and to track your progress. It also eliminates the need for guessing, hoping, and relying on any advice that presents broad generalizations as specific goals. Seeing your financial future in black and white is eye-opening, and it will give you the confidence to make the best possible financial decisions for your future. If your current retirement planning methodology doesn't accurately account for the following 10 factors (at a minimum), you will benefit from creating a written, comprehensive financial plan:
• Only ~80% - 85% (in some cases, even less) of your tax-deferred savings will be spendable in retirement. The other 15%-20% will likely go to the I.R.S.. Prepare to make do with significantly less than your balance shows.
• Did you plan on expenses being perfectly consistent for every year of retirement? They won't be. Some will end, some will change, and some will start. Yes, that matters. Multiplying a fixed amount by 25 (years) and thinking that amount is what you need to save is lazy math and terribly misguided. Varying expenses usually translates to varying withdrawal amounts from retirement savings, directly affecting your potential earnings. Itemizing expenses and how they will change during future time frames (as best you can) is necessary.
• Did you include mortgage and car payments in your expenses that will be affected by inflation? Those amounts (and possibly others) are fixed and should not be inflation adjusted. This reduces expenses over time.
• Did you use an average investment return rate for all years? Big mistake. Are you familiar with the term, "sequence of returns risk"? Your investment returns will vary by year, and may average out to 7%/year (for example), but it is the specific order of those returns that matters, not the average of all years. Assume you have $1M, and take a $50k withdrawal each year. For the first 4 years your return rate is +25%, +8%, +10%, -15%. At the end of 4 years your balance would be $1,072,510. Now reverse the order of returns to be -15%, +10%, +8%, and +25%. At the end of 4 years your balance would be $1,008,000. The overall rate of return is the same in both examples (7%), but the difference in the ending balances is $64,510 less in only 4 years! While you can't accurately predict annual returns, using varying rates of return will be more accurate than using an average rate for every year. The markets don't return an average amount each year so you shouldn't plan that way either. Especially for the first few years of retirement, plan a slightly pessimistic return rate (include at least one mildly negative year) rather than an optimistic one. It's one way to protect yourself from unexpected outcomes at inopportune times. The bottom line - life isn't static, don't plan it that way.
This is also a good way to stress test your results.
• Did you plan on health care costs rising at a rate of ~6% each year (~ 2 1/2 times the rate of historical core inflation)? That's what The U.S. Dept. of the Actuary is predicting for at least the next decade and it will eat into your budget at a surprising rate.
• Did you factor in that tax-deferred withdrawals count as ordinary income, and they can cause a significant increase in your Medicare premiums? If you aren't familiar with IRMAA (Medicare's Income Related Monthly Adjustment Amount), you may be in for a big surprise. Income above $91k ($182k, if married) will trigger Medicare premium increases which could amount to hundreds of dollars per month, per spouse. Also, it is your income from 2 years ago that is reviewed each year. Did you make a lot of money, or retire, in the 2 years before you started Medicare? Will you need to take a large withdrawal in a particular year (a new roof?), or is your total income over the threshold? Uh-oh.
• Income levels (which include Traditional 401k/IRA withdrawals) over $34k ($44k, if married) may also cause up to 85% of your Social Security income to be taxed. That's another reduction you need to factor in.
• Planning on using the "4% rule" as a withdrawal rate? It's over-hyped misinformation. Do you know that it assumes a 60/40 stock/bond allocation for every year of retirement (with bonds returning far more than they do now), uses historical market returns as a basis (overly optimistic, especially with a lower risk tolerance as you age), and assumes perfect consistency in both spending and return rates for every year (which won't happen)? Also, it's pretty much useless if the amount of your withdrawals won't be sufficient to help you pay your expenses. Your withdrawal rate should be based on actual need, and does not need to stay at or below 4% every year in order for your money to last through retirement. Use the specifics of your unique situation to generate a reliable financial forecast, not outdated assumptions or rules of thumb.
• How did you choose when to claim Social Security? Desire? A random age? Claim as early/late as possible? Did you factor in the long term affect on your total plan of claiming at different ages, your family history of longevity, which spouse should claim first to maximize benefits, or the possible death of a spouse at an earlier than expected age? Did you know that it may be more beneficial to delay claiming and use other funds to pay expenses for a few years rather than claiming early just so that you don't need to dip into savings? Always model all of your options to find the best solution before making a decision - it will make a big difference in the long run.
• Did you factor in the benefit, or non-benefit, of doing a Roth conversion? If done at the right time, this is an option that can significantly reduce taxes and save money in the long run. But it's not always a slam dunk. Understanding the timing involved, and your tax status for before and after retirement, is key to modeling the potential benefit. Or, the non-benefit.
This list could be much longer, but the point is that your finances, needs, and goals are unique and require individualized attention. That's what a comprehensive financial plan provides, with detailed year by year results. You can create your own plan (high degree of difficulty to account for decades of variables year by year), use a detailed financial planning tool (easy with minimal cost), or hire an adviser (easy but expensive, but can also include investment advice), but please don't take financial planning casually, or delay it. Your comfort in later years depends on what you do right now, and on your ability to make informed decisions. Do your due diligence, have confidence in where you stand and where you are headed, and understand the steps that you can take to positively affect the outcome.