What is high net worth?
There are a variety of definitions of high net worth. One common criterion is having $1 million or more in investable assets, above and beyond the equity in your home. Other definitions include possessing total assets of at least $5 million or at least $10 million. Ultra-high net worth individuals are typically classified as those who have over $50 million, or $100 million by some definitions, in assets.
While the exact definition may vary, a common assumption is that high net worth individuals generally have substantial assets available to help fund their retirement. While this may be true, it does not mean that retirement planning is a piece of cake for those with high net worth. Nor does it mean that individuals who fall into this category don’t have legitimate concerns about funding their retirement.
In fact, whether you have $5 million or $50 million in assets, the complex financial situations that are common with many high net worth individuals often mean that it can actually be more difficult to draw up a retirement plan. In addition, this complexity can lead to concern caused by uncertainty as to whether you will be able to preserve your standard of living in retirement.
If your goal is to gain the financial freedom to live the lifestyle of your choice in your golden years, and that lifestyle is dependent upon your current salary, even a large fund of retirement savings can be quickly depleted if there aren’t sufficient sources of income to replace your salary. This doesn’t even take into account the deleterious effect inflation can have on your savings over time if your investments don’t achieve a positive real rate of return.
As a high net worth individual, how can you avoid having to downgrade your standard of living in retirement?
The answer is that proactive retirement planning can substantially improve your ability to maintain your lifestyle in retirement. Whether you perform the planning yourself or work with a financial advisor, it is essential to take action now to put yourself in a position to fully enjoy your retirement.
At its core, high net worth retirement planning is about making your money last. As lifespans have lengthened in recent decades, longevity risk, the risk of outliving your income, has increased.
For instance, a monthly cash outflow of $20,000 may seem easy to handle if you are bringing in $30,000 a month in salary. However, if your expenses stay the same when your salary ends in retirement, that level of monthly outlays can quickly deplete even a sizable amount of savings.
Another factor that poses a serious challenge to high net worth investors is inflation. A decline in the purchasing power of your savings can have a disproportionately negative effect if you have a high net worth, making protecting your purchasing power an important factor to consider in drawing up your plans for retirement.
To overcome these and other retirement challenges, careful planning is needed. The following action items can help you identify steps you can take to make your money last in retirement:
- Decide what you want to do in retirement: Studies have demonstrated that staying active is conducive to a successful retirement, whether traveling, hobbies, regular exercise, or some other form of activity. Being involved with friends, family and your community are also important. Whatever you decide to do with your time when you retire, planning for it in advance is crucial to performing step #2.
- Determine how much income you will need to support your spending in retirement: Coming up with this number requires taking into account a number of factors, including where you intend to live, what you intend to do with your time, what the cost of living where you live is likely to be, etc. Once you have an estimate of your probable retirement expenses you can move on to step #3.
- Identify your sources of retirement income: These may be from sources such as annuities, Social Security, retirement plans such as pensions, 401ks and IRAs, and other investment accounts. Once you have calculated this total you can determine whether your income sources as currently calculated can cover your expenses.
- Create a savings plan if necessary: If your projected income doesn’t cover your expected expenses in retirement, you will need to draw up a plan to create enough in additional retirement savings to cover the gap.
- Stress-test your retirement plans: Also known as a Monte Carlo analysis, a retirement savings plan stress test analyzes the results of hundreds, and even thousands, of tests based on historical records to determine whether you are likely to reach your savings objectives given your current plans. If these stress tests succeed from 75% to 90% of the time, they are said to fall within the Comfort Zone.
This refers to a level of performance that provides you with the comfort of knowing that, given the past performance of portfolios similar to yours over a wide variety of time periods and economic conditions, your investment strategy has a high likelihood of allowing you to reach your retirement savings goal.
If your results are above 90%, it may indicate that you are saving more than you need to in order to reach your retirement investment goals. If your results are below 75%, it suggests that you need to do more, whether by investing more aggressively or setting aside more in retirement savings, to reach your retirement savings Comfort Zone.
Beyond stress testing your retirement savings plan, it is vital to analyze your finances in order to ensure that you are taking all the steps necessary today to maximize the amount of money available to you in retirement. Doing so requires taking a hard look at your budgeting to make sure you are striking the right balance between current spending and saving for the future.
Additionally, those with a high net worth typically pay more in taxes – meaning that the income you earn from your assets can be significantly reduced by taxation unless you take action to minimize the tax hit you face on your income from employment and investments.
For those depending on income from investments to make up a large portion of their retirement income, selecting the optimal investment strategy for their retirement savings is especially important to help overcome both longevity risk and inflation risk. However, many investors invest for retirement without taking the time to evaluate how likely their investment approach is to realize their retirement savings goal.
This is where the stress test described above comes in. Whether you perform such an evaluation yourself or with a financial advisor, this type of analysis is critical to helping you select the strategy most likely to enable you to achieve your investment objectives.
Because those with a high net worth often have complicated financial situations, making plans in isolation, whether for retirement, purchasing a home, paying for a child’s education, or any other purpose, can be dangerous to your ability to achieve your financial goals. The reason for this is simple: progress towards any one goal can be thwarted by financial issues caused by other aspects of your finances.
For instance, if you have allocated funds to your investment portfolio to buy a house but instead must use them to make tax payments, this represents a planning failure due to not taking into account your overall financial situation. Another example could consist of being forced to raid your retirement savings to pay current expenses because you haven’t built up an adequate cash reserve fund, endangering your ability to live the retirement lifestyle of your choice.
The way to avoid these types of dilemmas is to construct a comprehensive financial plan. This type of planning stresses the importance of considering all elements of your finances when making financial plans. The overall view of your financial situation provided by this approach enables you to more effectively plan to achieve multiple financial objectives. One of the questions to ask your financial advisor when discussing your financial plan is whether they can help you in the following areas typically covered by a comprehensive financial plan:
- Financial plan creation
- Tax analysis
- Retirement planning
- Portfolio review
- Investment management
- Insurance analysis
- Trust and Estate planning
- College funding for children and grandchildren
- Executive compensation – stock options, deferred compensation, etc.
By drawing up a comprehensive financial checklist enabling you and your planner to take into consideration all relevant aspects of your financial situation, you can significantly reduce the likelihood that an unforeseen event will devastate your financial plans. This is a major benefit of comprehensive financial planning, especially for high net worth individuals planning for multiple, often interrelated, financial objectives.
Also consider: What Does it Mean to be Wealthy?
Whether you are working with a financial planner to draw up your retirement plans or doing it yourself, it is vital to understand your unique needs. There is no one-size-fits-all retirement plan. For instance, one person’s goal might be to maintain their current lifestyle in retirement, while another’s might be to travel around the world.
One extended vacation would not necessarily throw off your retirement planning, but if your plan was to travel extensively after retiring, funding such a lifestyle would likely require greater savings than doing things closer to home.
On the other hand, if you plan to downsize your living quarters in retirement this could free up a substantial sum from which to generate retirement income. Moving to an area with a lower cost of living could have a similar impact.
Whatever lifestyle you plan to lead in retirement, taking the time to evaluate the expenses you are likely to incur in doing so is a vital part of the process of understanding what type of plans you need to make to achieve your retirement goals.
If it turns out that you need to devote a considerable amount of your income to saving for retirement, this reduces the amount of funds available to fund your current lifestyle. If this is the case, you must make hard decisions about whether or not to cut back on current spending in order to increase the amount you can contribute to your retirement savings.
The key is to analyze your future goals through the prism of your current requirements – to do this as efficiently as possible requires asking yourself what you value the most and what tradeoffs you are willing to make between your current and desired future lifestyle.
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The modern tax code takes a significant chunk out of the income of high earners. This applies both to income from employment and short-term investment income from capital gains or dividends. As a result, tax planning for high net worth individuals is essential to maximize the amount of income they keep after taxes.
There are a number of strategies you can use to legally reduce your tax burden. Some of the most popular approaches include:
- Aiming for long-term capital gains
- Forming a business to write-off business-related expenses
- Contributing to a Health Savings Account (HSA)
- Investing in tax-free municipal bonds
- Investing in annuities or cash value life insurance
- Maxing out retirement account contributions
- Income smoothing over multiple years
- Deduction clustering in alternating years
The complexity of tax planning in this day and age, especially for high net worth individuals, means that consulting with a tax expert is highly recommended to ensure that you are doing everything possible to minimize your tax burden. If your financial advisor is not a tax expert, they should be able to refer you to a specialist who can evaluate your financial circumstances and devise an action plan to optimize your finances from a taxation standpoint.
Estate planning for high net worth individuals is often part of the overall financial planning process. It is designed to ensure that funds not spent during a person’s lifetime are passed on to their selected beneficiaries as efficiently as possible. When drawing up an estate plan, a trust is frequently used to provide more control over the process of distributing trust assets. If structured properly, a trust can also help reduce the total taxable estate for large inheritances. Additionally, trusts help preserve privacy by avoiding the probate process when trust assets are distributed.
In some cases, a life insurance trust is used to provide funds to pay any estate taxes. Charitable remainder trusts also often play a prominent part in estate planning for many large estates as a way to support causes a decedent believes in while also providing beneficial tax impacts.
Any wealth management plan worth its salt will take into account the risk involved in your investment plans. While stock market, or equity, investments have typically outperformed other asset classes over long periods of time, they tend to be more volatile in the short run than more conservative investments such as bonds or CDs. As a result, be careful to consider your investment time horizon as well as your risk tolerance when making retirement investment plans.
If you have many years to go before retirement, investing heavily in equities may often be the best strategy from the standpoint of growth potential. On the other hand, taking an aggressive approach, one that is equity top-heavy, when you are close to or in retirement can be a risky proposition. This is because you have less time to let your portfolio recover its value later in life, meaning that if the market crashes or enters a downturn you may be forced to lower your retirement lifestyle expectations.
For this reason, many financial advisors suggest gradually adjusting your retirement portfolio investment allocation to include more fixed income or other less volatile assets as you get closer to retirement. In addition, because your financial circumstances can change due to a variety of reasons, an advisor can help you evaluate how any such changes impact your portfolio in terms of risk management.
Many advisors and some packaged financial products offer risk management support in the form of portfolio rebalancing to ensure that your portfolio’s allocation remains within acceptable parameters in accordance with your risk tolerance. This can reflect changes in portfolio allocation due to market trends that increase or decrease the value of certain holdings within your portfolio or the introduction of new assets to your portfolio in the form of stock grants, IRA rollovers, inheritance, etc.
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High net worth individuals should make sure to do thorough due diligence when selecting a financial advisor. Given the many complex financial issues typically involved in HNW wealth management, finding the right advisor is of utmost importance. To accomplish this, make sure to look for an advisor with the experience and expertise to help you with the specific challenges facing high net worth investors.
Look for a financial advisor who serves as a fiduciary, which requires them to put their clients’ best interests first when offering financial advice. They should also have the broad expertise necessary to offer you advice related to tax planning and estate planning in addition to traditional retirement planning. The advisor should also have access to a team of experts in these areas for those extremely complex situations where a specialist’s advice is needed.
Another factor to consider is how the advisor charges fees. Hiring a fee-only financial advisor avoids the potential conflict of interest associated with working with an advisor who charges commissions on a transaction basis. Charging commissions in this manner allows a broker or advisor to earn compensation by making trades, presenting the potential of account churning, which occurs when a broker makes trades to increase compensation rather than to benefit the client.
At Financial Freedom Fee-only wealth management our passion lies in helping our clients achieve their financial goals. We do not charge commissions and we do not charge a percentage of our clients AUM. We use a retainer fee structure. This retainer fee is based on the services we will be providing and will be mutually agreed upon before services commence.
Additionally, the advisor should be able to demonstrate experience in developing complex plans and analyzing a variety of financial strategies. Ask an advisor if they can provide you with a Comfort Zone evaluation of your retirement strategy that can provide you with the peace of mind of knowing that you are well-positioned to reach your retirement investment objectives – or serve as an impetus to make changes to improve your chances if your current plans don’t land in the Comfort Zone.
Read our blog article: Financial Planning Services for High Net Worth Individuals
Retirement planning for high net worth individuals and families can be an extremely complex undertaking. As a result, it can be helpful to use portfolio performance stress tests to determine whether your retirement savings efforts are likely to place you within the Comfort Zone. Doing so is an effective method for cutting through the complexity of the planning process and generating the confidence that comes from knowing you are on track to achieving real financial freedom in your retirement years.
In addition to running portfolio stress tests, if you choose to work with a financial advisor it’s essential to find one who has the credentials and the experience to guide you through the totality of the planning process, including tax and estate planning and investment risk management.
Finding your retirement investment Comfort Zone as a high net worth individual can help put you on the path to living your golden years in style. By following the steps outlined above, you can improve the odds of reaching your retirement savings goals and living the retirement lifestyle of your choice.