A common mistake when planning for retirement is to focus solely on increasing one's net worth without giving sufficient consideration to future cashflow. If at retirement you have a mountain of assets counting toward your net worth on paper, but this "mountain of assets" yields nothing in the way of cashflow, you would have a very strong personal balance sheet chalked full of assets but would also be incurring significant losses on your personal income statement. At retirement your employment income ceases, but living expenses do not, especially if a large amount of expense is incurred annually to maintain the "mountain of assets". The correct way to think about funding your retirement is to build future cashflow with as many income streams as possible for you to enjoy during your Golden Years. If at retirement a significant amount of your net worth is derived from real and other tangible assets, and if the assets generate very little in the way of cashflow, these assets are not benefiting you in retirement. It's very common for retirees to find themselves in their own personal "liquidity crisis", so to speak, especially in scenarios where a retiring individual's net worth is comprised mostly of tangible assets held but not readily converted to cash. In these scenarios, when a new retiree is faced with this reality and discovers that they were unprepared, they often find themselves having to sell such assets at fairly steep discounts to meet short-term liability and expense obligations. If the market for such asset classes are not overly active and/or are dependent on the state of the macroeconomic environment (e.g., prevailing interest rates), this can create a real challenge for retirees. When such assets are held but the market for the respective asset classes are not overly active, newly retired individuals can find themselves selling these assets at 20% - 30% (or more) below what they'd otherwise receive if not forced to sell on short notice. For transactions to be completed at the actual market-clearing price in a market with limited activity, an extended period of time is needed for a seller to locate a buyer willing to purchase the asset(s) at a reasonable price indicative of an arm's-length transaction where neither the buyer nor seller are pressured to accept unfavorable terms.

If you don't believe this applies to you, we urge you to consider a little further. Common asset classes where this occurs include large real estate, especially when prevailing interest rates are high and the demand for real estate is reduced. Collectables such as classic cars, motorcycles, artwork, firearms, and other such items would also fall under this category, especially in recessionary periods where discretionary spending among market participants is impaired. You will need the assistance of Bradley Ray CPA to think through these matters and devise a plan that maximizes cashflow at retirement.

Effective planning includes understanding the value of pensions, benefits, and other financial contracts. A great way this can be demonstrated is with the military pension earned by those that retire after twenty years of service. When Soldiers, Sailors, Marines, and Airmen are young and early in their careers, they don't fully understand the value of the benefits they can earn. Instead, they're of the belief that military pay is low, and that they're somehow sacrificing the possibility of ever becoming wealthy by serving our great nation. This is a flawed way of thinking when one does not understand how to value financial contracts and benefits. For example, let's assume a young man or woman enlisted into the military at age 18, served twenty years, and retired at the age of 38 at the paygrade of E-7. Let's also assume that the basic pay for which their retirement is based at that rank was $5,800 per month, which results in a monthly retirement pay of $2,900. The question that should be asked is "how much would I need to contribute to a portfolio of assets to earn a yield of the same $2,900 per month that I would receive from a military pension?". If we were to assume that the $2,900 was based off an asset portfolio yielding 5%, the total value of the portfolio would have to be $696,000 to result in the same amount of cashflow. Additionally, military pensions receive "COLA", which is an annual cost of living adjustment that requires no further contribution from the benefactor and will always increase in an attempt to curb the impact of inflation. Add in the fact that retirees receive mostly free healthcare for the rest of their lives through TRICARE, will have access to duty-free (tax free) shopping at the BX/PX and commissaries, will receive significant educational benefits through the GI Bill that can also be passed to children, and the multitude of other benefits such as the VA Home Loan Guarantee, the complete portfolio of pension and benefits would exceed $1 million in value. In the example above, if properly valuing these financial assets and contracts, the 38-year-old retiree would likely be a millionaire when including those assets on their personal balance sheets and have another twenty-five to thirty-years to continue accumulating wealth and building cashflow.

Critical to planning for retirement is understanding that the value of a dollar tomorrow will be worth less than the value of a dollar today. The more dollars in existence and circulating throughout the economy, the less valuable each individual dollar becomes. As such, as more dollars are printed, it takes more of those dollars to buy the same goods and services. For retirees on an income that remains fixed at a given dollar amount, the everyday purchases of housing, food, utilities, medication, and transportation consumes a larger portion of the retiree's fixed income as more dollars are printed. For example, let's assume that at retirement in the year 20X1 Mrs. Smith's fixed income is $4,000 per month. Her expenses consist of rent at $1,200 per month, food $600 per month, utilities $100 per month, medication $75 per month, and transportation $400 per month, which consumes 30%, 15%, 3%, 2%, and 10% of Mrs. Smith's income (respectively), leaving 41% available to visit grandkids. Now let's assume Mrs. Smith has been retired for a while and it's now the year 20X8 and Mrs. Smith is still on her $4,000 fixed income. Let's also assume that during this period the Consumer Price Index (CPI) increased 3% each year between 20X1 and 20X8, but her income remained the same at $4,000 per month. Mrs. Smith's monthly rent would have increased to $1,476, food to $738, utilities to $123, medication to $92, and transportation to $492, which is a 23% increase in each cost category over this period, and results in the total amount of income remaining to visit grandkids reduced to $1,079, which is 34% less than was available during her first year of retirement in 20X1. Additionally, travel costs to see her grandkids will have also increased 23%, making it even more difficult with the reduced amount of money left over to purchase plane tickets, hotels, rideshares, etc. The longer Mrs. Smith lives and is forced to survive on the $4,000 fixed income, the more difficult it becomes. In this example, with the rate of cots steadily increasing at 3% per year and her income fixed at $4,000 per month, she will no longer have any money left over after expense at year 18 of retirement and will no longer be able afford her bills in years 19 and beyond. This example demonstrates why understanding the impact of inflation on fixed incomes is critical and preparing for this reality is an essential part of retirement planning. Bradley Ray CPA will help to ensure you have a plan in place to address this challenge.

Once you retire and are no longer earning employment income, your tax liability will likely change considerably. Once you retire you will no longer be earning income from wages, will begin liquidating 401K and Individual Retirement Accounts, will begin collecting social security, etc, which will have a substantial impact on your tax liability, as your total effective tax rate will likely be reduced. However, though your liability will likely be reduced, it will not be eliminated, and oftentimes your return will be more complex than a typical Form 1040 electing the standard deduction with W-2 income. Depending on the amount of retirement income from other sources, taxes may be levied on none, some, or most of your social security receipts. Additionally, depending on the type of IRA being liquidated (e.g., Roth vs Traditional), taxes may need to be paid on those distributions. With that being said, using a CPA for financial planning is a must, because while investment salespeople claim to be "Financial Advisors" that help prepare you for retirement, they lack the competency to consider the entire financial picture of an individual, which includes the tax implications of retirement. Bradley Ray CPA will ensure all aspects of retirement planning are considered, not just filling out forms to open an IRA and selling you investments to earn commission. Bradley Ray CPA is FEE ONLY and will simply bill you by the hour to help provide a comprehensive financial plan based on your facts and circumstances.