The decision to retire can cause a great deal of anxiety, especially if you aren’t sure if you’re ready. Some people use milestones like career achievement, age, or even savings to assess their readiness for retirement, but there are other factors you should consider as well.
Ideally, you should create a comprehensive plan for your financial well-being in retirement. Such a plan makes it easier to deal with financial setbacks and other bumps along the road. Furthermore, the plan should help protect against as many contingencies as possible, to minimize the odds of being caught off guard. To ensure you’re prepared for retirement, it can be helpful to create a readiness checklist. While this list will look different for everyone, some of the key items to include are:
It’s probably not possible to say exactly how much you’ll spend in retirement, but estimates can help you get a general sense. A detailed budget will give you a better idea of how much you’ll need, both monthly and annually. This estimate should include all expenses: basic costs such as housing, utilities, food, transportation, and healthcare, as well as irregular expenses like travel and vacation. Your expenses may change in retirement, but it’s still a good idea to figure out how much you’re spending now, to create a baseline estimate. Remember that the more detailed your budget is, the better—don’t leave any expenses out.
During retirement, you may receive income from a wide number of sources, including investments, Social Security payments, and more. You may also have an annuity or pension income. Adding up your expected monthly income from these different sources can give you a better sense of what you’ll need to save to close the gap and ensure you can cover your bills. In addition, this tally will help you determine if you’ll need to reduce your spending or increase your income through options like downsizing to a smaller home or getting a part-time job.
The question of how much you need to save for retirement is a complicated one. Ultimately, you should base this number on the retirement budget you created for yourself, and then add plenty of room for cushion. To get a very broad estimate, multiply your estimated annual spending by 25. If you expect to have other sources of income in your retirement besides savings, subtract them from your annual spending, then multiply that number by 25. If your actual savings are less than the calculated estimate, it is time to revisit your budget and see what adjustments you can make.
Prior to retiring, you’ll need to plan how you will draw from your retirement accounts. It’s important to be strategic about how you draw down, especially if you have a variety of different accounts. Typically, tax-advantaged accounts should go untouched for as long as possible. Of course, traditional 401(k) and IRA plans have minimum required distributions once you reach 70.5 years of age, but Roth accounts do not have the same requirements. Roth accounts can continue to grow well into retirement, so try to keep as much money as possible in these accounts, for as long as you can.
Carefully consider your anticipated healthcare costs in retirement and figure out what insurance you’ll need. For most people, healthcare is the most significant cost in retirement. Medicare is a given, but many people find that they need supplemental insurance. You should also have an emergency fund for expenses not covered by insurance plans. Keep in mind that the cost of long-term care can quickly lead to bankruptcy, because traditional insurance does not cover it. If you know you won’t be able to shoulder the cost of long-term care, it’s vital to research insurance for this level of care. Long-term care policies become more expensive as you age and your health declines, so you may want to purchase a policy sooner rather than later.
While you might wait until you’ve actually retired to begin legacy planning, start thinking about what you want to leave behind before leaving the workforce. Your legacy could influence your retirement savings target, the timing of your retirement, and your estimated retirement budget. You should also draw up an estate plan. Be sure to revisit it regularly (at least every five years) to ensure everything remains up to date. During retirement, it’s important to have regular conversations with your spouse and heirs, so that everyone knows what to expect and any transition of assets proceeds smoothly.
No one wants to think about the possibility of losing their spouse. However, if you are married, it’s important to consider how your death or the death of your spouse will affect the survivor’s finances. Failing to plan for this could put one of you in a terrible financial situation during one of the most emotional times in life. Talk to your partner about what the surviving person should do; consider things like whether you should stay in the same home or whether you’d need additional sources of income. Some sources of retirement income are tied to one partner, so their death could mean the loss of a specific income stream. Identifying these potential gaps early will help you and your spouse protect each other and your family.
One of the biggest risks that people face in retirement is the cost of healthcare. People frequently underestimate the cost of healthcare and often do not get adequate insurance to protect themselves.
That said, sometimes it’s impossible to correctly anticipate the coverage you’ll need in retirement. While some people know the health issues they will face in the future, most people must guess. Either way, underestimating healthcare needs can put a significant strain on your finances and make it difficult to make ends meet. Many people believe that Medicare will cover them completely. While Medicare Part A covers some levels of hospitalization, you’ll have to pay premiums for Medicare Part B, and you may need supplemental insurance. Even with this, you’ll still have out-of-pocket expenses.
Some of the Issues with Health Insurance Coverage in Retirement
During your working years, your employer will often pick up the majority of healthcare insurance premiums, so it’s understandable that many retirees are caught off guard with the amount they suddenly have to pay. At the very least, you will need to pay Medicare Part B premiums. These premiums depend on income; costs are higher for people who make more money. While the premiums are low, starting around $140 per month, Medicare Part B does not cover all health expenses, which leaves many people needing a Medicare Advantage Plan or a Medigap policy to fill in the cracks. Even still, Medigap policies may not provide dental or vision coverage, both of which could also leave you with costly bills. Medicare Advantage covers dental and vision needs, but it offers fewer hospitalization benefits, so a serious illness could come at a very high expense.
The other issue you’ll need to consider as you approach retirement is long-term care coverage. Long-term care is one of the most expensive healthcare needs for older adults, and Medicare does not cover the majority of the cost. Luckily, long-term care insurance is available, but it’s not always cheap, especially if you wait until retirement to purchase it.
As a general rule, purchasing insurance earlier in life makes the premiums much more affordable. The downside is that you’ll be making monthly payments during a time when you’re less likely to actually need long-term care. At the same time, long-term care can quickly bankrupt you in retirement, so this type of insurance shouldn’t be dismissed lightly. This is especially true if you have a family history of a serious geriatric disease, or if you have a serious chronic health condition.
The Average Healthcare Costs Faced by Today’s Retirees
As you approach retirement, it can be helpful to use an online calculator to help estimate the costs of care you’ll face in the years to come. For the average, 65-year-old male, the typical cost for premiums and out-of-pocket healthcare expenses is about $4,500 per year, which translates to $375 per month. You should try to factor at least this amount into your monthly expenses.
Keep in mind that the cost of healthcare is rising at a rate double that of inflation. In other words, your out-of-pocket healthcare expenses could easily be closer to $675 in another decade. If you have a chronic condition, you may have to pay even more, and couples will need to double that figure. In addition, this amount does not account for long-term care. In other words, the cost of healthcare in retirement can be extraordinarily high.
The Key Strategies for Reducing Healthcare Costs in Retirement
Luckily, retirees aren’t completely helpless when it comes to the extremely high costs of healthcare. One of the most important things that you can do to control your costs is to stay healthy by receiving proper preventative care. Healthcare plans prior to and during retirement will cover preventative visits and services. While routine check-ups and such may seem unnecessary and come across as a hassle, they are all aimed at keeping you healthy and helping you avoid costly treatments and procedures. Skipping out on these visits can cause a small health problem to become more serious and therefore more difficult and expensive to treat. In addition, some cancers are curable only when detected and treated early.
The other side of the strategy for keeping your healthcare costs low involves managing distributions in a strategic way. As mentioned above, the cost for Medicare increases as your income rises, but you can manage your distributions in such a way that your premiums are kept in check.
For example, income from HSA accounts, Roth IRA accounts, and cash value life insurance policies do not factor into the formula that determines monthly Medicare Part B premiums. Income from a reverse mortgage is also not included in this calculation. If you have significant amounts of money in a traditional IRA, you may want to consider transferring some to a Roth account before turning 65 to avoid being forced to take large minimum withdrawals down the line. These minimum withdrawals do not apply to Roth accounts. You can also use deductible healthcare expenses to offset the money withdrawn from a traditional retirement account.
Figuring out the best way to save for retirement can be tricky—everyone’s financial situation is different, which can make it hard to find the right balance between saving for retirement, putting money aside for other goals, and maintaining a comfortable lifestyle.
There is a lot of retirement advice out there, but not all advice is created equal. In fact, most of the advice commonly shared about retirement savings should be altogether ignored. To help you determine which savings plan is right for you, first you have to learn what not to do. Here are five of the most frequently shared—but ultimately ill-advised—retirement advice tips.
Monthly expenses go down in retirement.
If you assume your monthly expenses will go down once you retire, you may end up not saving enough. Many people think that they will save on commuting expenses or they will no longer have a mortgage, but the reality is that the majority of retirees replace their old expanses with new ones. While you may no longer drive to work every day, you will likely still drive to volunteer or recreational activities, not to mention incur the increased costs of travel that often occur during retirement.
Also, when homeowners pay off their mortgage, they may funnel that money into new hobbies or making lifelong dreams come true. Though research has shown that about 20 percent of retirees have lower monthly expenses, another 20 percent spend more. The remaining 60 percent tend to have about equivalent monthly expenses.
People need X amount of money to retire.
Many people will offer an exact figure for how much money you need to save to be able to retire. Unfortunately, these numbers rarely reflect the truth for everyone—though you will need a significant chunk of money to retire, choosing an arbitrary number is not helpful. If you choose an amount that’s too high, you may become discouraged because you feel like you will never hit that amount. Or you may become so focused on saving enough that you forego important opportunities in the present.
In reality, future retirees need to think about how much they will likely spend each month in retirement and use that number to come up with a figure that more accurately reflects their personal goals and lifestyle preferences. Financial advisors and other professionals can help you set more realistic goals.
Social Security will run out in the next few years.
Over the years, many people have talked about how Social Security is going broke. While Social Security has been more robust in the past, it is not in imminent danger of going bankrupt. Most often, retirement professionals hear people bring this fact up when they want to draw on Social Security early (even though this involves a penalty). These people tend to want to get in on the money while they can. However, Social Security is funded through a payroll tax, so as long as people are paying their taxes, there will be benefits for retirees. Taking a permanent reduction in monthly income can cause a lot of issues down the line. While you may be tempted to hedge your bets and plan for retirement without factoring in Social Security, the truth is that this money is not running out anytime soon.
There is always time to catch up with savings.
If you have not been able to save for some reason, do not despair—there are things you can do over time to help you boost savings. However, thinking that there is always time to catch up and using that as an excuse to delay savings is unwise. When you start saving early, you maximize the benefit of compounding returns and also give yourself some leeway when it comes to investing decisions.
Individuals who start down the road put themselves at a serious disadvantage since their money will never grow at the same rate it could have if they had started earlier. Sometimes, extenuating circumstances get in the way, but you should be diligent about saving as much as possible—now.
Only one savings tool is necessary.
One of the biggest traps that people fall into is putting all of their savings into a single type of account. There are many different types of savings accounts, and they all have their unique benefits and drawbacks. You can look into other options, like an IRA, to supplement the money you put into your work-related savings accounts, such as a 401(k).
The problem with having one savings tool is that you may start to feel like you have maxed out your savings. For example, when you have gotten as much matched from your employer as possible, you may stop saving. At this point, you need to look at other options and figure out what will benefit you the most once you have achieved the maximum for an employee-sponsored account. Often, it makes sense to have at least one traditional and one Roth account, giving you options for lowering your taxes in retirement.
Nowadays, the majority of workers do not have a traditional pension that they can depend on for income once they retire. As a result, saving through a 401(k) has become more important than ever. However, maximizing your savings through this vehicle is not always as simple as it seems. You will need to pay close attention to the rules governing deposits into your account, as well as current tax policy. Otherwise, you may end up costing yourself money down the line.
Importantly, rules and policies change every year, so it is imperative that you pay close attention as you continue to save for retirement. However, there are some general tips that you should follow to maximize your savings:
1. Avoid fees
When choosing your 401(k) provider through your work, you should opt for one with the lowest or fewest amount of fees. While fees may not sound like much, they can add up quickly and significantly cut into the account value down the line, especially when accounting for compounding over time. Of course, the plan should also have the right risk tolerance. You should never feel like you have been cornered into a particular plan because of fees. If that happens, it is time to talk to human resources and consider an alternate savings plan, such as an IRA. Taking advantage of employee matches may still make sense, but once that is maxed out, another product may prove to be the best choice.
2. Diversify savings
When it comes to investing for the future, diversification is important—but many people do not understand how to do so. Diversification reduces your portfolio’s risk by making it more stable during market volatility or downturns. Financial planners recommend choosing both stocks and bonds to provide some degree of balance, as well as periodically rebalancing the portfolio to target allocations.
For example, individuals may rebalance their portfolio to reduce their investment risk as they get closer to retirement to protect the stability of their overall investment. One piece of advice that all financial planners agree with is that investors should never make impulsive changes to their risk profiles without consultation and great need.
Diversification may also mean investing in more than one 401(k) product. A Roth account can offer several benefits to people who max out their contributions to a traditional account.
3. Get matched
Perhaps the most important aspect of maximizing 401(k) savings is taking advantage of employer matching programs. Most often, employers offer 50 cents on every dollar from the employee, up to 6 percent of total pay (although the policies differ between companies). You should know exactly what your company will match and plan to take full advantage of the program. After all, matching is basically free money in your account. This matching program is an easy way to significantly boost your account and provide a larger base for further compounding in the future.
4. Get vested
Importantly, companies also have different policies on getting vested, which means that employees who leave the company too early may not get their 401(k) contributions matched. At some companies, getting vested takes as long as five or six years of service. While some will not pay out at all until an employee becomes vested, other companies will allow employees to keep a portion of their matched contributions when they leave early.
Often, becoming vested means thousands of dollars directly to the retirement fund, so it makes sense to stay as long as possible. However, you should never let the promise of getting vested drive you to stay in a bad job.
5. Rollover balances
When people do switch jobs, they have the opportunity to cash out their 401(k) plan—this is rarely a good idea. Before the age of 59 1/2, you will face a 10 percent early withdrawal penalty and you will be required to pay income tax on the balance. This can be problematic even if you want to reinvest your money in a different account rather than spend it.
Luckily, there are other options. You can choose to keep the money in the 401(k) and let it grow over the years, but it can be difficult to keep track of your different accounts from each company you have worked at. Another option is asking your former employer to transfer the balance to a new account, which helps to avoid any fees or penalties and keeps all of your retirement money in a more centralized location.
6. Take distributions
Just because you’ve finished adding to the principal of your 401(k) account does not mean that you’re finished managing your account. These accounts have required minimum distributions starting at the age of 70 1/2. At this point, you must make minimum withdrawals on an annual basis or face a hefty penalty: 50 percent of the amount that should have been withdrawn. Since you may draw on multiple accounts during retirement or you may not be retired come this age milestone, making the withdrawal can sometimes fall through the cracks and result in a significant loss. Notably, this rule only applies to a traditional 401(k) account. With a Roth 401(k), there are no mandatory annual distributions.
When people feel like they may not have enough money saved for retirement, they may think about selling their homes to reduce their monthly costs. Even those who have saved may consider downsizing their homes as a way of making the most out of the money they have in retirement. After all, retired couples often do not need the same amount of space that they once did after their children moved out and started their own families. Certainly, downsizing your home or moving to a less expensive area can save you money, but it does not always make sense to take this step during retirement. Ultimately, individuals need to think about the total costs involved with this decision and whether or not they will actually save money as a result.
The Numerous and Sometimes Intangible Costs of Selling a Home
Selling a home is a considerable investment. Often, individuals need to pay for some updates or a facelift to maximize the price that they get. In addition, sellers frequently need to pay Realtors a commission, which can total 6 percent or even more of the total sale price. Another consideration is capital gains taxes, which can take a large chunk out of earnings if individuals make a lot of money during the sale. Beyond these costs, retirees could also potentially face expenses involved in moving to a new space, which could range from purchasing or renting a new home to paying for the cost of movers. Closing costs can consume even more money. Furthermore, people often find themselves needing new, smaller furniture for a smaller living space. Other incidental costs may also arise. Another issue is the fact that people often think that their homes are worth more than they actually are.
Selling a home may also involve some intangible costs. These costs also deserve some consideration before a decision is made. Particularly when people move to a new area, they will have to say good-bye to friends, family members, doctors, community members, and others. These relationships are not easy to rebuild in a new place, which can make individuals feel somewhat lonely once they move and result in some regrets about their decision. Plus, our homes have a lot of sentimental value. People should avoid treating this decision too lightly and find themselves wishing that they had followed a different path. For many people, staying put is worth the extra expense in retirement.
When Moving to a New Home in Retirement Can Make Sense
Some people may put themselves in a better position by moving. Perhaps moving will bring them closer to family members or make it easier for them to run their weekly errands. Another important consideration relates to health. As people grow older, they may begin to experience mobility problems, which could make it appealing to move into a home with greater accessibility, such as one without stairs. Of course, individuals can often make their current homes more accessible, but the costs involved can be high, making it more appealing to find a new one. As health concerns become more serious, individuals may end up needing some assistance, which could also influence their decision to move.
Another point to keep in mind is that many retirees successfully boost their monthly retirement income by opting to downsize. According to a study published by the Boston College Center for Retirement Research, individuals who move from a $250,000 home to one that costs $150,000 can net $6,250 annually from the decision. This gain translates to an additional $520 per month, which is a lot of money for the average retiree. Of course, this number is only theoretical. Before making the decision, retirees should create a budget that takes into account utility costs, commuting expenses, insurance needs, and other monthly expenses related to both homes to figure out how much they could potentially save with the move. This figure will often make it much more clear whether or not the decision is the right one.
Choosing a Middle Path When It Comes to Relocating in Retirement
Retirees may want to consider a third option other than relocating to a new home or keeping their current one. This third option involves renting out their current home and then moving to a smaller one. The rental proceeds can help to put a lot of money in the bank without involving many of the expenses mentioned above. Of course, renting a home can also involve a number of costs, such as hiring a management company to dealing with losses if your home goes unrented for a month. However, these costs are generally much less than those involved with an outright sale, especially if the value of your home is expected to increase in the years to come.
People may choose this third option for a number of different reasons. Some may simply want to test out a smaller place while having the option to move back to their home in case they decide that they made a bad decision. Others may want to keep the home in the family so that they can will it to their heirs. Retirees may also simply not want to go through the hassle of a sale, or they may want to have the freedom to relocate easily with the security of knowing that they already own their home should something happen. As with the decision to sell, it is important to think about the expenses involved and the rent that you can potentially secure to ensure that the deal is worth the hassle.