The years leading up to retirement can be a time of both increased excitement and anxiety. For many, retirement offers the possibility of pursuing new opportunities and experiences. However, with this new sense of freedom comes a heightened level of concern about whether your money will last. To create a successful retirement, there is no substitute for thorough planning and informed decision-making.
Start by gathering information on all the different elements that make up retirement – from how you hope you'll spend your time to your expenses and your resources. All this information will go into your plan. Make sure you've done everything on this checklist before you actually retire.
1. Define What You Want to Do
After working most of your life, retirement is the time to figure out if there are things you want to do that you'd missed out on earlier in your life. Some people take up new hobbies such as golf or tennis. Many use this time to travel and see the world. Others get deeply involved in volunteer work or take up a new career. If you live up north, you may decide to spend the winter in a warmer climate, either by renting or purchasing a vacation home. Some retirees decide to relocate to another country, at least for the early years of their retirement (see Retirement: U.S. vs. Abroad).
“I recommend to everyone I deal with to write down what retirement looks like – beyond where, to what you would like to do for 16 hours out of the day. This will keep you engaged in life and make sure you have a long and enjoyable retirement,” says Mark Minder, RFC®, Minder Planning Group, LLC, Grand Blanc, Mich.
Once you figure out what you want to do during retirement, you need to define, prioritize and quantify your key choices in terms of money. Start by prioritizing your goals from most desirable to least desirable. This should help you determine which goals are more important for you to achieve. Then cost out each goal and see how well it matches your situation. If you want to spend $50,000 a year on travel, for example, but you only have $600,000 in total assets, you need to rethink your plans. Once you define and quantify what you want to do in retirement, this is a sign you are mentally ready to retire. It should also help you determine how much extra money beyond monthly living expenses you need to allocate.
“Before retiring, we recommend having a plan. While a comprehensive plan is best, a focused plan designed to assess your financial readiness for retirement is an essential step to take before starting this next phase,” says Charlotte A. Dougherty, CFP®, Dougherty & Associates, Cincinnati, Ohio.
2. Budget for Your Living Expenses
One of the most common mistakes retirees make is understating the income they'll need during retirement. The rule used to be that 60% to 80% of your current working income was the amount you should expect to need. But this is not the best way to estimate your retirement expenses, and the number-one reason retirees run out of money is poor budgeting skills.
Here’s the better approach: Add up your current expenditures, using your online banking or checkbook records and any other regular payments. Determine your monthly expenses and figure out if they are going to increase, decrease or stay the same during retirement. Many retirees make the mistake of assuming expenses will go down. However, if you decide, for example, to buy a vacation home, this could add an additional monthly mortgage payment – and you'll definitely owe taxes, utilities and general maintenance, plus possible association fees. Extensive, expensive travel could have a similar effect on your finances. Our tutorial Budgeting Basics can help you get started.
Once you establish a retirement budget, factor in that what you will need will grow at an inflationary rate of 3-4% per year. Even though this may seem high, it is much better to be conservative over the long run. Overestimating inflation only leads to having more assets left for your heirs instead of risking that you run out of money.
Inflation is one of the biggest risks retirees face during the latter half of their lives, so it is extremely important to plan for it ahead of time. To illustrate the effects of inflation, consider that a $50,000 retirement income stream would need to be worth $67,195 in 10 years. Getting the purchasing power of $50,000 after 20 years would require having $90,305.
Once you've drawn up a budget, it's time to compare it with what you think you'll have for retirement and determine how well the two figures match. But first, don't forget to factor in how paying for medical and dental care changes once you retire.
3. Add in Your Healthcare Options and Costs
“The biggest unforeseen expense that can ruin retirement is healthcare, whether a medical procedure or long-term care, such as home healthcare, assisted living and nursing-home care,” says Carlos Dias Jr., a wealth manager and founder of Excel Tax & Wealth Group in the Orlando, Fla., area. Most people assume that when they retire, healthcare is taken care of. After all, once people turn 65, they automatically qualify for Medicare coverage, don't they?
The answer: Not necessarily. You qualify for premium-free Part A coverage if you have worked at least 40 quarters of coverage and have paid the appropriate Medicare payroll tax. You may also qualify if your spouse has worked 40 quarters of coverage. If you do not qualify, the 2017 premium rate for Part A could be as much as $413 a month. This could be an unforeseen expense that cuts into your retirement nest egg.
And Part A is only the beginning (see Medicare 101: Do You Need All 4 Parts?). It is still important to know how Medicare works with your existing physicians and treatments. Many doctors may not take Medicare as a form of payment – so you may need to change physicians or pay much more than you did before. Part B, which helps pay for doctors’ services, outpatient hospital care and medical equipment, is usually recommended for most retirees. To enroll, the average retiree pays Medicare Part B premiums of $134 a month as of 2017 (those with incomes above $85,000 – $170,000 if married and filing a joint tax return – pay more). At the top, singles with incomes above $214,000 ($428,000 if married and filing jointly) pay $428.60 per month.
Medicare also offers Plan C (also known as Medicare Advantage ) and Plan D (drug coverage) as additional purchase options to help reduce overall health costs. Another option, with Parts A, B and D is a Medigap plan from a private insurer to fill in payments missing from regular Medicare (see Medigap vs. Medicare Advantage: Which Is Better?). Prior to enrolling in Medicare, understand what each part costs and which services it covers.
If you decide to retire prior to age 65, healthcare is a very critical issue. Unless your previous employer structured a retirement-benefits package, you will have to seek a third-party healthcare service. This plan needs to “fill the gap” between the present time and when you turn 65. Reading 5 Things You Should Know About the Health Insurance Marketplace will get you up to speed for now, but new legislation may soon change the healthcare landscape.
4. Be Sure You Have Enough Money
When most people begin planning for retirement, the income-planning segment is a common place to start. However, it makes more sense to perform this task after you have quantified exactly how much is needed on an expense basis.
The first step in this part of the process is to determine how much your stable income streams are going to pay. These include any pensions, Social Security and annuities.
Most retirees make the mistake of taking Social Security too early without doing proper research first. Any withdrawals taken prior to your full retirement age cause a permanent reduction in your benefit. If you decide to continue working past your full retirement age, taking Social Security in addition to your employment income might make it taxable. Plus, delaying Social Security causes your benefit to grow at a guaranteed rate.
Then you need to look at your assets. One key item is "evaluating your investment allocations, whether in a 401(k) or IRA, and making sure you’re not taking excessive risk or jeopardizing your retirement due to a market downturn such as 2008,” says Dias.
Once both the amounts and the timing of these income streams are determined, you can decide how much to withdraw from savings. As a rule, most retirees should take a maximum of 3% to 4% from a portfolio. Anything above this rate significantly increases the risk of depleting funds early. For example, for a nest egg totaling $1 million, the total withdrawal rate should not exceed $40,000. If the money remains in a noninterest-bearing account and the withdrawal rate increases by 3% inflation each year, the $1 million would last just over 19 years. Increasing the withdrawal rate by 1% reduces that same timeline by three years and the $1 million will last only 16 years. This also demonstrates the importance of investing, as inflation erodes the longevity of your retirement portfolio (see What Does an Ideal Retirement Portfolio Look Like?).
When entering retirement, you should have a healthy blend of income-producing and growth investments. Although it may seem logical at first to generate the 3% to 4% from fixed income, inflation eventually affects the total performance. With luck, and thanks to advances in healthcare, the average person could spend 25 to 30 years in retirement or even more. This makes the retirement years a long-term investment horizon that warrants putting some of your money in growth investments. (See What's the Best Retirement Drawdown Strategy for You?)
5. Develop and Monitor Your Retirement Plan
If you have completed all four tasks above, you have taken important steps in securing a successful and secure retirement. You will have plans, an expense budget that includes healthcare and an assessment of how much income you can expect.The last stage is to assemble all the pieces and draw your conclusions. How much can you afford to spend given the income you have coming in, plus the money you can draw down from your savings? How does this compare with your plans for retirement? Refigure your monthly and yearly budgets to determine what you can spend and what changes you might need to make in your life.
Realize that even this is just your starting point. Both life and retirement constantly change. Markets move up and down. Unforeseen events occur for which you cannot plan. Retirement itself has stages, and you need to plan for those as well. Use The 4 Phases of Retirement and How to Budget for Them to help you think through that process.
“If you monitor your plan effectively, you will be more efficient at planning other aspects such as taxes, healthcare expenses and inflation. One should never use the ‘set-it-and-forget-it’ mindset as it will lead to many unplanned surprises,” says Dias.
This is why it is important to do ongoing monitoring and adjust your retirement plan as needed. These adjustments could require changing your withdrawal rate, reevaluating your investment risk tolerance or even having to give up on a retirement goal. To help with the monitoring process, see 5 Apps & Calculators for Retirement Planning.
The Bottom Line
You are ready to retire if you have defined what you want to do, established a budget, decided on your healthcare, determined you have enough money and developed a retirement plan. Missing any one of these crucial steps could negatively affect your ability to stay retired. There are many resources available regarding retirement planning, but it is always recommended to meet with a financial advisor or certified financial planner to confirm you are taking the correct path for the rest of your life.