Have you done everything you can to make a secure retirement? For years you’ve been working and saving diligently for that one day, just over the horizon, when you can finally hang it up. Nevertheless, the fact is that you can’t know exactly how much your investments will earn in retirement, or even how long your retirement will last.
So it’s crucial that you stress-test your nest egg to make sure that it’ll hold up regardless of how circumstances unfold. Here are three things you’ll want to do before scheduling your last day on the job. (For more, see Build Your Own Retirement Plan.)
Craft a Budget That Will Get You Through
Trying to pin down your cost of living in retirement can seem like a fool’s errand, but the more accurate you can make your estimate, the more useful your financial model will be. Sure, there are certain rules of thumb out there. You may have heard, for example, that you’ll need to bring in 70% to 80% of your current living expenses to get by in your later years. That’s because certain costs, such as commuting to work, go by the wayside.
The fact is, though, that the actual cost depends on a number of factors that will vary from one individual – or one couple – to the next. For example, you may need more if you’re still paying off a mortgage or, for that matter, if you plan to take up an expensive hobby, such as traveling or joining a golf club. That’s why it’s better to customize your budget as much as possible, rather than sticking to a one-size-fits-all number.
When you’re calculating your expenses, keep in mind that they’ll change over time. Some retirees might be able to cut costs for the first several years after they quit the workforce. However, if they experience a health problem or need extra help with housekeeping or meal preparation down the line, those costs can skyrocket in a hurry. Your stress test will be a lot more realistic if you escalate the costs when you run your numbers.
Test Your Retirement Income vs. That Budget
When you’re in retirement and stocks tumble, you don’t have the luxury of waiting for the market to bounce back. That’s why experts suggest gradually adjusting your asset allocation over time in favor of fixed-income vehicles. For a fairly typical example of this, take a look at the Retirement 2020 Fund from T. Rowe Price. At the retirement date it gives investors a mix of 55% stocks and 45% bonds. However, 10 years on that stock-bond split becomes 40/60.
Given that steady shift toward asset protection, how much can you realistically pull out of your portfolio each year? One axiom suggests that you withdraw no more than 4% in your first year of retirement and adjust that amount each subsequent year for inflation. In theory the strategy is supposed to leave enough money in place to fund a 30-year retirement.
But this longstanding rule now has some critics. Among them is R. Evan Inglis, an executive with Nuveen Asset Management. Because fixed-income investments are paying out such low interest rates these days, he’s telling people to start with a 3% withdrawal and make cost-of-living adjustments from there.
To calculate your total retirement income, you’ll also want to factor in other sources, such as Social Security payments and pension checks. To receive an estimate of what the former will provide you, a quick visit to the Social Security Administration’s "my Social Security" website is worth the effort.
If you’re not able to bring in enough to cover the expenses you calculated in the first step, you may need a Plan B. That could entail working a little longer than you expected or taking a part-time job in retirement to help bridge the gap. (For more, see Will Your Retirement Income Be Enough?)
Plan for Longevity Risk
A market downturn isn’t the only contingency you should be thinking about before retirement. Healthier retirees should also be aware of the potential that they’ll outlive their savings. Living a long, healthy life is the best possible outcome, but only if your income will see you through.
Fixed annuities, which provide income for life, are one of the primary ways to eliminate longevity risk. Unless your assets dwarf your long-term needs, they might be worth a look. (For more, see How to Plan for the Longevity Risk in Retirement.)
How can you tell if an annuity is right for you? One approach financial advisors use is to tally up your income sources that provide a lifetime stream of income. For most folks that means Social Security and any pensions you receive from an employer. If those sources alone aren’t enough to cover your monthly expenses, you might want to take some of the money you’ve invested in bonds and use it to purchase an annuity. But the key is to buy only as much as you realistically need to make up the difference.
For one, fixed annuities offer a relatively small rate of interest compared to other instruments. What’s more, any extra funds ordinarily won’t be passed along to your heirs, unlike funds in an investment account. Many seniors opt for immediate annuities that start generating income once you purchase the contract. However, deferred-income annuities, also called “longevity annuities,” have their merits as well. They don’t start disbursing funds until a later date, but when they do, the payouts are bigger than for immediate annuities. You can set up your annuity payments to adjust for inflation, but there’s a catch: You’ll either have to shell out more money upfront or live with small payouts during the first few years of the contract.
All these decisions can be incredibly complicated. That’s why, though it’s helpful to get an overall picture of your finances on your own, it’s probably worth testing them out with a trusted financial advisor at some point prior to retirement.
The Bottom Line
Once you set a retirement date, changing course can be difficult. Still, if you really want your later years to be happy and secure, it’s a good idea to stress-test your finances and adjust your plans if necessary.