Retiring is a huge milestone! You have worked for decades, and now it is finally time to consider your exit from the workforce. What will you do with this newfound time? Will you have enough money to live, let alone do what you want? Here are 7 questions to consider before you jump into your new identity as a retiree.
What you will learn:
- Do I have enough money to retire?
- What changes do I need to make to my investment accounts?
- When should I claim Social Security?
- How much will healthcare cost in retirement?
- What will my taxes look like in retirement?
- Where will I live in retirement?
- How will I spend my time?
DO I HAVE ENOUGH MONEY TO RETIRE?
The amount of money you need will depend on many factors, but they all relate to two things:
- How much much will my income be in retirement?
- What will my expenses be in retirement?
What will my income be in retirement?
The amount of income you will have might be the deciding factor on whether you choose to retire. After all, this is what you will use to live. Most people use a combination of financial instruments for income. The most common sources of income are social security (see below), pensions, and savings (IRA, 401(k), Roth IRA, 403(b), etc.)
It is important to analyze what your retirement income might be years before you retire and on an ongoing basis. If the result is less than you expect then you have time to start closing the gap through increased savings or lifestyle adjustments. Another option might be to retire later or have a part-time job in retirement.
People getting close to retirement often look at the large balances in their savings and investment accounts and wonder how the sums equate to a replacement income. This is when many decide to hire a financial planner to aid them for the rest of their life. Financial planners guide retirees in determining safe withdrawal rates of accounts, advising in pension and social security decisions, insurance, and investing retirement funds for both growth and safety. Some financial planners even offer tax planning and help in determining if things such as Roth conversions makes sense.
What will my expenses be in retirement?
Before retirement, many people estimate that their expenses will decrease by more than what comes to fruition. You may not have the costs related to your daily 9-5, such as lunches out, clothing, and a commute, but you may be trading those expenses in for new ones. We view retirement spending in three phases: the go-go years, slow-go years, and the no-go years.
The first part of retirement is the go-go years. This is the early part of retirement where you travel, participate in hobbies, and do the things you always wanted but never had the time for. If there is a reduction in spending during this phase of retirement it could be minimal.
The second phase of retirement is the slow-go years. During this time frame, retirees are reducing their activities and spending less due to a decline in health and or energy. This reduction can vary depending on your circumstances and whether it is early in the slow-go years versus later.
The third phase of retirement is the no-go years. This last part of retirement consists of drastically reduced discretionary spending. However, due to increased health care expenses this phase can be the most expensive of all. If you need skilled nursing care during these years, it is possible for your expenses to be much higher than what you ever spent while working.
WHAT CHANGES DO I NEED TO MAKE TO MY INVESTMENT ACCOUNTS?
Many Americans don’t know the details of their investment accounts. They don’t know how their accounts are invested, taxed, or whom the accounts would pass on to at their death. Therefore, most people find out that there is at least one change they need to make regarding their investment accounts.
An area where many people need to make changes in investment planning is beneficiary designations. If you have had your accounts for a while, you might have forgotten who you have designated to receive your account after you pass away. It is always good to regularly review your beneficiaries after significant life events such as births, deaths, divorces, and marriages. We recommend looking at it on an annual basis.
Investment accounts may also need their asset allocation adjusted. It is essential not to be too aggressive or too conservative so that your savings will last the rest of your life. Most retirees have portfolios consisting of 60-75% equity and 25-40% cash and bonds. We like to have 5-6 years of spending as a mixture of cash and bonds so that stocks don’t need to be sold in downturns to fund distributions. This portion of cash and bonds is what we often refer to as the “war-chest.” This is the part of the portfolio that you will take distributions from during turbulent times in the market.
Another example of a change that is frequently made is changing the individual investments themselves. We believe in building our clients’ portfolios with low-cost mutual funds. It is not uncommon for a prospective client to have mutual funds that charge fees more than 10 times higher than what we would use. Often the client had no clue what fee they were paying or that there are other options available.
WHEN SHOULD I CLAIM SOCIAL SECURITY?
The earliest a person can claim social security is age 62 but at a reduced benefit. This reduction can end up costing thousands over the long term if you live to an advanced age. A surviving spouse is locked into these lower benefits after your death as well. Some people have good reasons to start benefits early, such as they may need the income, don’t expect to live passed the break even point of where it makes sense to delay, or they expect their investments to grow faster than the increased benefit.
Full retirement is when you get your full social security benefit. Your full retirement age is 65-67, depending on when you were born.
The opposite end of the spectrum from taking early benefits is delaying benefits. For each month after full retirement age that you delay taking benefits, your monthly amount of social security will increase.
The easiest way to find out your estimated benefits for various ages is by going to www.ssa.gov and requesting your personalized retirement benefit estimate.
Timing social security is a decision that is very specific to an individual and their unique financial situation. What is right for one person may not be suitable for the next. Social Security is an area where talking to a financial professional can help you understand the effects of different decisions.
HOW MUCH WILL HEALTHCARE COST IN RETIREMENT?
Healthcare costs are always a consideration when determining the timing of a person’s retirement. If you retire before 65 years old, you will have to find insurance coverage until you are eligible for Medicare at age 65. Even after you begin Medicare, there are still expenses you must pay.
When you retire, there is a great chance you will no longer be part of your employer’s health insurance program. Some methods of bridging the gap between employer-provided insurance and Medicare include COBRA, a spouse’s health plan, private insurance, and the public marketplace. The cost of these insurance options can often be relatively high. It is always a good idea to research your options before you officially retire so that you have an idea of what you may be spending.
There will still be healthcare expenses incurred after you begin Medicare. You will not be getting 100% free healthcare as a person utilizing Medicare. According to a study done by KFF (The Kaiser Family Foundation), the average out-of-pocket spending for traditional Medicare beneficiaries (parts A&B) was $5,806 in 2016. Examples of out-of-pocket health expenses a person on Medicare might experience are premiums, deductibles, dental care, prescription drugs, and long-term care.
WHAT WILL MY TAXES LOOK LIKE IN RETIREMENT?
Taxes do not go away after retirement. If Social Security is your only source of income, then you will probably not pay any income taxes. If you have other income sources, up to 85% of your Social Security benefits may be taxable as income on your tax return. Other sources of taxable income can include IRA and 401(k) withdrawals, pension income, some annuity income, and income from work.
Some retirees are surprised to see that they pay more in taxes in retirement than while working. Taxable income such as pensions and withdrawals from 401(k)s and IRAs can cause a portion of Social Security income to be taxable. Retirees may also have capital gains taxes levied if they sell assets from a brokerage account. One of the best ways to plan for taxes during retirement is to have your assets spread across multiple types of accounts. It is good to have money in bank savings accounts, tax-free accounts, taxable accounts, and tax-deferred accounts.
Another tax people should budget for is property tax. Many areas of the country continue to see rising property tax rates. For people with limited income, this bill can be a significant piece of their yearly budget.
Tax planning is an area that is not always offered by investment advisors and financial planners. It is a good idea to ask any potential advisor or money manager if they offer this service and for how much. It is definitely a worthwhile service to obtain, especially if you have a high net-worth.
WHERE WILL I LIVE IN RETIREMENT?
One important decision in retirement is where to live. Now that you are no longer tied to a job, you can decide to move wherever you want. Perhaps you may decide to move to another state or closer to family? Maybe retiring abroad is more your style?
Another consideration regarding where to live might be the affordability of your home. Depending on your retirement income, you might not be able to afford as large of a home as you did in your working years. Downsizing could make your new retirement income a lot more manageable.
Finally, many retirees realize that their existing home is not friendly to the aging process. To make it more manageable, they may need to remodel or move to a new home altogether.
“Age-friendly” homes or apartments have features that make life easier for people in wheelchairs, limited mobility, or who have other impairments. Some examples of features people find helpful are:
- No-step entrances
- Low maintenance yard
- No-slip flooring
- Grab-bars in the bathroom
- Wide doorways
- Single floor living
HOW WILL I SPEND MY TIME?
You are likely to have excess time once you retire. What will you do to fill it? Many people choose to brainstorm what they want their retirement to look like before taking the plunge. They consider trips they want to take, hobbies they would like to pursue, new social clubs to join, and a host of other adventures. Some people even dream up a side hustle that they can enjoy and make money at, such as crafting, photography, or woodworking.
Retirement is a big decision and life change. A large portion of your identity ends, and you have more free time. Your day-to-day life suddenly looks very different.
Maybe this year is your year for retirement? Regardless of what you ultimately decide, it is wise to begin considering all the aspects of this major life change.
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