In the final years of your career, you will have a second job – planning for retirement.
It’s not a full-time gig, but it’s time-consuming and vitally important to the outcome of the next phase of your life.
One of your key tasks will be to craft a retirement budget, not for just one year, but for the next many. The assumptions and decisions you make in crafting this spending plan will give you clarity into how your retirement will look, and perhaps force you to make some choices. It’s important to get this right. Here are some things to consider as you begin the process.
Be realistic. Ideally, you shaped a vision for your retirement many years ago and have saved enough to fund that dream of travel, building a mountain cabin, et cetera. If not, with retirement approaching, now is the time to take a steely-eyed look at how you can live in retirement with the income available to you from social security, retirement savings, pensions, rental income and/or a part-time job.
There are any number of free retirement expense calculators available on the internet that can help you figure out your monthly nut based on your dreams and visions.
This will prompt your first hard call. If you can’t reconcile your post-career income with a tolerable retirement lifestyle, you need to think about other options. Should you work longer? Move to a lower-cost-of-living state (or country) in retirement? Or simply revamp your vision of retirement?
Don’t underestimate your life span. We are living longer, healthier lives. Statistically, you will likely live into your mid-80’s. Consider this as your budget. Will you be OK if you live 20 years in retirement? 25? What happens if you live to be 95?
Your financial needs will change as you move through retirement. Typically, retirees are very active until about age 75 – traveling, taking on new hobbies, keeping the grandkids for a week. At that point, we tend to slow down a bit. By 90, most folks are sticking pretty close to home and living a quiet life.
Think about when you will take Social Security. The longer you wait, the bigger benefit you receive. For most folks, retiring at 62 and taking social security will pin you at just 75% of your full monthly benefits. At 66 or a slightly older (FRA, “full retirement age” which depends on your birthday), you’ll receive 100%. Wait until you are 70 and you’ll get up to 132% of your full FRA benefit. In most cases, I recommend taking Social Security once you’ve at least reached what the SSA deems as your FRA (typically 66+). If you are under 66 and strapped for retirement income, consider taking a part-time job or starting a side business to cover the gap until it makes sense to start Social Security.
Know how much you can take from savings. It’s time to start using that nest egg you built over years of work and sacrifice. But it needs to last for several years, so how should you parcel it out? One of my rules of thumb is the “$1,000-Bucks-A-Month” rule.
This rule essentially says that for every $240,000 you have invested; you should be able to withdraw approximately $1,000 bucks per month in retirement.
Before we delve into the details of the $1,000-Bucks-A-Month Rule, it’s imperative to understand that this rule is a rule of thumb. The rule does not work linearly in any given year, and it doesn’t work the same at every age. Before you put the rule to work, be sure that you understand the following:
Based on my $1,000-Bucks-A-Month Rule, someone at “normal” retirement age is in their mid-60s. This group can plan on an approximate 5 annual percent withdrawal rate from their investments (without adjusting for inflation) – over time. However, younger retirees in their 50s should plan on withdrawing a lower number than 5 percent per year, typically 4 percent or less. The reason for this is because if you retire in your 50s, there is simply too long a time horizon to start withdrawing 5%- it’s just too early.
In years that the market and interest rates are in a normal historical range, the 5% withdrawal rate works well (again, if you are at a normal retirement age or an older retiree). But you must be willing to adjust your withdrawal rate in any given year if market forces work against you. You may need to take less in those years and be flexible enough to adapt to what’s happening in our economic environment.
This might mean that you can take a little extra in the good years, but it’s critical to understand that you might need to take less in the years that aren’t as profitable. This rule is predicated on two factors: income investing and the 5 percent rate with zero interest.
Income investing is a way to generate consistent cash flow from your liquid investments via stock dividends, bond interest and distributions from various areas like publicly traded REITs. It allows your money a fighting chance of lasting a retirement lifetime rather than running out in 20 years. The 5 percent rate to zero essentially says that if your retirement reservoir was sitting in cash and yielded zero, you’d be able to withdraw 5 percent every year and your nest egg would last for 20 years.
Lay down the burdens. As you twist the budget Rubik’s Cube, remember that many of your current expenses will go away or be reduced in retirement. Perhaps the largest single drop will be in taxes. In many states, retirees pay reduced income and property taxes. Plus, you won’t be paying Social Security tax on your income like you did when you were receiving wage-related paychecks.
You also won’t have the cost of commuting, or maintaining a professional wardrobe or buying your lunch every day. It’s likely you will drive less, thus reducing your gas and repair bills. Now that you have more free time, maybe you can let the lawn service go and cut it yourself.
If you have a big life insurance policy that was designed to replace your working income for 20 years, you could consider dropping it and pocket that premium.
Clear the decks. You can reduce your retirement spending needs by paying for some big-ticket items before you get the gold watch. Consider paying off your mortgage. Make major repairs that are looming, such as replacing the roof. If you need a new car, buy it while you’re still getting a paycheck.
This is a lot to think about, but don’t let it overwhelm you. Take it step-by-step, always remembering that you are on the verge of an incredibly exciting time in life. Prepare well, and make the most of it!