Retirement Strategies Of The Rich

Rich people have a variety of options when it comes to investing for retirement. Many millionaires keep a significant portion of their wealth in cash or highly liquid cash equivalents, such as money market mutual funds, certificates of deposit, and Treasury bills. They also tend to invest in stocks, stock funds, and retirement accounts, such as 401(k) plans, which offer tax advantages and allow for larger contributions. Real estate is another common investment, with many millionaires building large portfolios of residential and commercial properties. Other investments include private equity and hedge funds, as well as alternative investments like fine art, expensive musical instruments, and intellectual property rights.

Tax-advantaged retirement accounts

There are two broad categories of tax-advantaged retirement accounts: "tax deferred" and "tax-free". Tax-deferred accounts allow you to make tax-deductible contributions and defer taxes on those contributions and any investment gains until you make withdrawals, at which point withdrawals are taxed as ordinary income. Tax-free accounts are funded with after-tax dollars, and earnings and withdrawals in the future are tax-free.

Traditional IRA

Earnings in a traditional IRA are tax-deferred until the owner withdraws funds after retiring. If the account owner has no employer-sponsored retirement plan, they can deduct their traditional IRA contributions on their federal income tax return up to certain statutory limits. For 2023, the maximum traditional IRA contribution is $6,500 for those under 50, and $7,500 for those 50 and up.

Roth IRA

A Roth IRA offers long-term tax benefits. You are not required to make withdrawals at a certain age, and withdrawals are tax-free because contributions are made with after-tax dollars. However, there are income limits for eligibility. For 2023, only single filers with a modified adjusted gross income (MAGI) of up to $138,000 and married couples filing jointly with a MAGI of up to $218,000 can contribute the full amount. Annual contribution amounts are the same as for a traditional IRA.

401(k)

The 401(k) is a common plan offered by employers, with tax-deferred contributions and potential employer matching. For 2023, the 401(k) contribution limit is $22,500 for employees and $66,000 for combined employee and employer contributions. Those age 50 and up can contribute an additional $7,500 in catch-up contributions, for a total of $30,000 in employee contributions, and up to a total of $73,500 for combined employee and employer contributions.

Solo 401(k)

The solo 401(k) is ideal for self-employed workers who want to maximise tax-advantaged savings. It allows deferral of up to $18,000 pre-tax (those 50 and older can defer an additional $6,000). The account also permits pretax profit-sharing contributions from their business entity, up to 25% of compensation. Combined total contributions must not exceed $54,000 (or $60,000 for individuals over 50).

Self-directed IRA

A self-directed IRA allows you to invest in assets outside of stocks and bonds, such as real estate, precious metals, private lending, limited liability companies and private equity investments. These accounts are for more sophisticated investors looking to utilise their expertise to outperform traditional IRA investment options.

Health Savings Account (HSA)

An HSA is a common way to pay for medical expenses tax-free, but it can also be used as a retirement savings vehicle. Savings into the account are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are tax-free.

Simplified Employee Pension (SEP-IRA)

A SEP-IRA is commonly used by self-employed, single-person businesses. For 2023, the maximum contribution is 25% of each employee's pay, contributed by the employer, up to a limit of $66,000.

Savings Incentives Match Plan for Employees (SIMPLE) IRA

A SIMPLE IRA can be implemented by employers with 100 employees or less. It has a lower employee contribution limit than a 401(k).

Asset allocation

A simple asset allocation model can be based on just two or three funds, making it easier to invest and save for retirement. One fund can target growth, such as an S&P 500 index fund or an international stock index fund, while the second fund can generate stable income, such as a total bond market fund. A third fund can be added for further diversification, such as a broad-market ETF or index fund.

The percentage of the portfolio balance invested in these funds depends on the investor's age and risk tolerance. For example, T. Rowe Price suggests the following allocation based on age:

• 20s and 30s: 90% to 100% stocks, 0% to 10% bonds
• 40s: 80% to 100% stocks, 0% to 20% bonds
• 50s: 65% to 85% stocks, 15% to 35% bonds
• 60s: 45% to 65% stocks, 30% to 50% bonds, 0% to 10% cash/cash equivalents
• 70+: 30% to 50% stocks, 40% to 60% bonds, 0% to 20% cash/cash equivalents

As investors age, they may need to rebalance their portfolios to maintain their desired risk tolerance. The asset allocation can become more conservative as retirement approaches, with a greater focus on fixed-income and bond investments.

Additionally, investors can consider having a short-term reserve in their investment portfolio, equivalent to two to four years' worth of living expenses, invested in high-quality, short-term bonds or other fixed-income investments. This reserve can help weather prolonged market downturns and avoid tapping into more volatile stock investments.

The specific allocation will depend on individual circumstances, such as income, financial goals, and comfort with risk. It is essential to regularly review and adjust the asset allocation to align with changing needs and market conditions.

Rental property

Rental properties can be a great way to generate a steady income during retirement. While it may not be a passive investment, it can be a lucrative option for those who are willing to put in the time and effort.

One of the biggest advantages of investing in rental properties is the potential for high returns. Unlike traditional passive investments, rental properties can produce significantly more income if you purchase the right property at the right price and on the right terms. The key to success is finding a good location, as this is more important than simply finding the cheapest property. It's also crucial to ensure that you can earn about 8% per year on your investment after costs to make it worthwhile.

Another benefit of rental properties is that they offer a more predictable income stream than other investments, such as stocks or mutual funds. With rental properties, you can more easily predict your returns based on factors like purchase price, market rent, and expenses. Additionally, you have more control over your returns and can take steps to mitigate risks, such as screening rental applications and buying rent default insurance.

Leverage is another powerful tool in real estate investing. By taking out a mortgage, you can increase your cash flow over time and don't need to commit as much of your own cash upfront. This also allows for easier diversification, as you can invest in multiple properties instead of putting all your eggs in one basket.

There are also tax advantages to consider. Rental property owners can claim various deductions, such as depreciation, property taxes, mortgage interest, operating expenses, and repair costs. These deductions can result in paper losses, even when there is a positive cash flow.

However, investing in rental properties does come with some downsides. There is a substantial barrier to entry in the form of knowledge and skill. It takes time and effort to learn how to calculate rental cash flow, find good deals, finance properties, and manage tenants. It is also a high minimum cash investment, requiring thousands of dollars upfront, even with a mortgage.

Additionally, real estate is infamously illiquid, meaning it can take months to buy or sell a property. There are also various costs associated with buying and selling, such as closing costs, which can add up to thousands of dollars.

Despite these challenges, rental properties can be a great addition to a retirement portfolio, providing a steady income stream and the potential for long-term growth. However, it's important to remember that it requires a hands-on approach and should not be your only source of retirement income.

Dividend-paying stocks

However, it is important to note that dividends are not guaranteed, and companies may choose not to declare them. Dividends are also taxed at a higher rate than capital gains, which can impact overall returns. Therefore, it is generally not recommended to devote an entire retirement portfolio to dividend stocks. Instead, they should be part of a diversified portfolio that includes other investment options.

When considering dividend-paying stocks, retirees should look for companies with a reliable history of consistent or steadily increasing dividend payouts. Additionally, it is important to assess the overall financial health of the company, as missing dividend payments can be a sign of financial distress.

In summary, dividend-paying stocks can be a valuable component of a retiree's investment portfolio, providing a regular income stream and mitigating risks associated with volatility and inflation. However, they should be carefully selected and combined with other investment strategies to ensure a well-diversified and tax-efficient retirement portfolio.

Annuities

There are several common types of annuities. Fixed annuities offer guaranteed repayments of the purchase price plus a modest return and generally have lower fees. Variable annuities, on the other hand, offer no guaranteed payments and may result in losses if the underlying investments perform poorly. There are also index annuities, also known as fixed index annuities, which are a hybrid of fixed and variable annuities. They offer reduced investment growth compared to variable annuities but provide some protection against market downturns.

When considering an annuity, it is important to be aware of the fees involved. Annuities can have complicated phrasing and hidden or difficult-to-understand fees. Additionally, annuities may have surrender fees, which are incurred if you withdraw your money within the first few years of the contract. It is also important to note that annuities are taxed as ordinary income upon withdrawal, which could result in a higher tax rate compared to other investments.

Despite the potential drawbacks, annuities can be a good option for those seeking a guaranteed income stream in retirement. They can complement other retirement plans and provide benefits such as tax-deferred growth, guaranteed yield, and flexible withdrawals. When deciding whether to invest in an annuity, it is essential to consider your financial goals, risk tolerance, and the fees involved.

Frequently asked questions