Monday, November 29, 2021

Why Retiring Now Is a Bad Idea

Clients planning to downsize or move abroad may be unaware of the true cost of such moves.

Luis Strohmeier
Luis Strohmeier

After decades of working, and the stress of a global pandemic, many clients may be considering if it’s time to finally retire. Or maybe they had planned to retire this year, but are now wondering if it’s really the right time. Retiring is one of the biggest financial decisions of someone’s life because starting to use your portfolio as income and making that switch from saving to withdrawing can be a complicated process.

Most advisors would agree that you don’t want to base an investment approach on trying to time the market. But in terms of retiring, proper timing can be very influential in how successful the retirement is. If clients are able to wait even a year or two before retiring, they may be much better off in the long run.

Uncertainty Surrounding the New Tax Plan

The ramifications of President Biden’s tax plan are uncertain right now. It’s unclear what Congress will ultimately agree to, and this bill will have to be bipartisan in nature. There’s a lot riding on the plan that will impact both individual and corporate taxes.

Higher earners who make over $400,000 a year in income will likely be impacted most by upcoming tax changes. If a client is in that category and plans to retire soon, it may make sense to wait and design a retirement strategy with more capital assets than income assets to adjust. Delaying retirement for even one year will make a difference if it provides greater clarity around the future tax situation. But once a plan is set in motion through actually retiring, it can be much more difficult to adjust on the fly.

We’re at the Top of a Market Cycle

Thinking about the economic cycle is also helpful when determining an appropriate time to retire. Right now, valuations are becoming stretched, and we are potentially arriving at the height of the market.

If a client retires and is using their portfolio as income, the long-term effects of a 20% to 30% pullback in the first year of retirement would be much harder to handle than if the same pullback occurs five or 10 years into the investment time horizon. Let’s say a client has $2 million saved for retirement and is planning to use it to generate $60,000 of income per year. If they face a 10% decline in year five of retirement, they would still be able to receive $60,000 for each of the first five years while the money is growing in the market.

But if they face a 10% decline in the first year of retirement, it will substantially impact future income opportunities. So they will theoretically receive only $54,000 of income each year for the rest of their retirement because markets typically don’t rebound in a matter of months, and they’ll still need to pull money from the portfolio that’s down 10% overall.

Accordingly, at this late stage of the market cycle, it could be beneficial to wait and see what happens regarding a potential decline while continuing to work, maintaining your income and putting additional funds toward retirement savings.

Are You Really Downsizing?

From a housing standpoint, downsizing is common in retirement. But just because you’re moving to a smaller home doesn’t mean you’ll pay less. Housing prices have soared over the last 18 months, so where clients decide to downsize will have an impact.

Moving within the same general community may allow clients to profit from the sale of their house as they downsize to a smaller home. But if someone is planning to move to a more expensive real estate market, it may make sense to wait until prices stabilize. For example, a move from Columbus, Ohio, to Miami or Phoenix could result in little profit even when downsizing, due to the higher prices in those markets.

Another aspect to consider is how homes are priced based on square footage. While real estate agents will discuss the average price per square foot, homes are actually priced per increment of square footage. This means there’s a specific price for the first 1,000 square feet, and then the price decreases comparatively for each additional increment of 1,000 square feet.

So, if you’re moving from a 3,000-square-foot home to a 1,500-square-foot home, the comparison for price per square foot isn’t congruent. This distinction isn’t often discussed, but understanding what goes into the price of your home can impact your decision to downsize.

Moving Abroad with a Weak Dollar

If a client is thinking about moving abroad in retirement, it’s critical to talk to them about currency. The value of the dollar is weak right now compared to other currencies. It has lost 5% to 6% of its purchasing power over the past year, so anything you buy abroad is going to be more expensive.

Additional Reading: Planning for an International Move in Retirement

It’s likely the dollar will remain weak over the next several years, potentially resulting in an even greater loss of purchasing power. The U.S. currently has an incredible amount of debt, and may raise that debt ceiling even more. The more debt we take on, the weaker the dollar becomes, and the less the currency is worth. It’s doubtful the dollar will gain strength over the next three or four years unless an economic boom occurs unlike any we’ve seen since the early 1900s. Such a boom would allow the government to significantly curtail its spending.

Diversifying a portfolio by adding currencies like the euro, yuan, yen or Swiss franc can help hedge against a weaker dollar if a client is living abroad. It could also help mitigate some of the risks stemming from any further potential deterioration of the dollar.

Patience May Pay Off

Because of so much uncertainty right now, it would be a good idea for clients to wait a year or two before retiring so they can see where the chips fall, especially if they’re on the cusp of a comfortable retirement. The combination of the new tax plan, late market cycle stage, expensive real estate market and weak dollar create an environment where if clients can continue working, receiving an income and saving toward retirement, we can help them better plan for their future.

Luis Strohmeier is a partner and wealth advisor at Octavia Wealth Advisors

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