10 moves to make sure you have enough money in retirement
As you approach retirement, it’s easy to become fixated on the magic number—a pot of money large enough to allow you to retire comfortably without outliving your savings. But figuring out whether you can afford to retire requires math, not magic, along with a thoughtful analysis of how you plan to spend your time and money.
Plenty of online calculators will help you figure out whether you can afford to retire based on the amount of money you’ll need to replace a specific percentage your current income. A popular rule of thumb suggests that you should plan on replacing 70% of what you currently make, or 80% if you want to live large.
But this guideline is deeply flawed, financial planners say. We’ll walk you through the steps to come up with a realistic estimate of how much money you’ll need to retire in style.
What’s wrong with the 70% rule?
During their early years in retirement,
many retirees end up spending as
much as or more than they did when
they were working, says Jennipher
Lommen, a certified financial planner
in Santa Cruz, Calif.
However, if you were to move to a
lower-cost area, say, or stop
supporting adult children, your
living expenses could drop in retirement. When you retire matters, too: If you retire before age 65, for example, you’ll need to figure out how to pay for health care before you’re eligible for Medicare.
To come up with your own magic number, you need to figure out how much you’ll actually spend in retirement, which means coming up with a comprehensive retirement budget. Only then can you determine whether your savings and other sources of income are sufficient to finance the lifestyle you’ve envisioned.
4% is also just a guideline
You’ll also need to estimate how long your money will need to last. You may have heard of the 4% rule, which is considered a safe withdrawal rate for a 30-year retirement that might include a bear market and periods of high inflation. Under this rule, you withdraw 4% from a diversified portfolio in the first year of retirement and adjust the amount
annually by the previous year’s rate of inflation. For example, with a $1 million portfolio, your first year’s withdrawal would be $40,000.
But this strategy won’t help you much if a 4% withdrawal rate won’t cover your living expenses. Once you’ve worked out your retirement budget, you can determine whether a 4% withdrawal rate—combined with other sources of income, such as Social Security and a pension, if you have one—will be sufficient to pay the bills. If not, you may need to save more, work a few more years, or both.
That’s a sobering thought, but this exercise can also be liberating. You may determine that a 4% withdrawal rate will provide more than enough money for a comfortable retirement, with some left over for your heirs. Several studies have shown that many retirees are so worried about running out of money that they’re unwilling to spend their savings, even if they’ve accumulated a substantial nest egg.
“When we all started talking about what people would do with their 401(k) balances, the initial thought was that they would take a trip around the world,” says Alicia Munnell, director of the Center for Retirement Research at Boston College. Instead, many are “paralyzed and don’t feel comfortable taking money out of their accounts,” she says.
Here’s how to break out of this inertia. You may find that you can afford to book that dream cruise after all.
INSIGHT
Figure Out How Much You’re Spending Now
Read More
Back Out Expenses That Will Decline or Disappear
DATA INSIGHT
Get a Handle on Health Care Expenses
DATA INSIGHT
Don’t Forget About Taxes
DATA INSIGHT
Figure Out the Cost of Your Retirement Lifestyle
Expect Changes in Expenses as You Age
Adjust for Inflation
Don’t Forget an Emergency Fund
INSIGHT
Create a Back-up Plan
INSIGHT
Once You’ve Retired, Review Your Expenses Once a Year
You may have a vague idea of how much you’re spending based on how much is left over from your paycheck every month. But do you really know how much of your paycheck goes toward groceries, gas, movies and all of life’s other necessities and non-necessities?
Now is the time to get a handle on the cost of your lifestyle. Comb through your credit card and bank statements and track all of your expenses for the past three to six months. Don’t overlook expenses that occur quarterly or biannually, such as
property taxes.
You can enlist tools such as Mint.com to get a breakdown of spending categories; some credit and debit card providers will also categorize your expenses for you. Review your pay stubs to plug in the amount you pay for health insurance premiums, retirement savings, and state and local taxes.
The more specific you can be, the better. Ian Rea, a certified financial planner in Medfield, Mass., asks clients who are preretirees to fill out a 50-line spreadsheet that covers everything from life insurance premiums to pet care.
Figure out how much
you’re spending now
Once you retire, you’ll no longer contribute to a 401(k) or other workplace retirement plan, so that expense will go away. If you contribute to a health savings account through your job, that expense will go away, too—once you sign up for Medicare, you can no longer contribute to an HSA (but you can use the money in your account to pay for unreimbursed health care costs).
If you plan to pay off your mortgage, that’s a large line item you can remove from your budget (although you’ll still need to plan for property taxes, homeowners insurance and maintenance). You can remove health insurance premiums deducted from your paycheck, but be prepared to add back costs for health care, even if you’re eligible
for Medicare.
Some preretirees still have adult children “on the payroll”—that is, they’re providing financial support, either directly or indirectly (the kids still live at home, for example). That can complicate your estimates of how much you’ll spend in retirement, especially if you plan to cut them loose after you stop working, says Sean Curley, a CFP in Greenwood Village, Colo. Likewise, if you gave a child money for a down payment on a home, that’s an expense you can remove from your spending checklist.
Back out expenses that
will decline or disappear
Give some serious thought to how you’ll spend your time—and money—once you stop working. The first few years of retirement—65 through 70, for example—are often referred to as the “go-go years,” a term popularized by Michael Stein, a CFP and author of The Prosperous Retirement. It’s the period when many retirees are still in good health and eager to do all of the things they didn’t have time to do when they were working.
Retirees “always spend more on travel and entertainment than they thought they would,” says Jorie Johnson, a CFP in Brielle, N.J. Instead of one big annual vacation, they’ll go on two or three trips a year, she says. Even if your dream retirement involves staying close to home and working in the garden, your heating (or air conditioning) bill will probably go up because you’ll be home all day.
You may also decide that it’s high time to renovate your kitchen—which you’ll be using more because you’ll have more time to cook.
Figure out the cost of
your retirement lifestyle
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The average Medicare beneficiary spent more than $5,400 in out-of-pocket costs for health care in 2016, according to the Kaiser Family Foundation. The total includes spending on premiums for Medicare Part B, prescription drugs, supplemental insurance and other costs.
To estimate your individual costs, you’ll need to decide whether you want to sign up for Medicare Part B plus Part D and a medigap plan—a supplemental policy that covers costs traditional Medicare doesn’t cover—or Medicare Advantage. Medicare Advantage plans provide medical and drug coverage from a private insurer that has its own network of doctors. To figure out how much you’ll need to budget for the plan you choose, go to Medicare’s Plan Finder at Medicare.gov. You can also click on a link that will provide information about the costs of various medigap policies.
Dental care isn’t covered by traditional Medicare (although some Medicare Advantage plans cover it) and can be a huge expense in retirement, says Diane Pearson, a CFP in Pittsburgh. She has had clients who paid $30,000 to have their teeth removed and replaced with implants. She’s also seen clients spend more than $3,000 on hearing aids, which aren’t covered by Medicare, either. Fidelity Investments estimates that 15% of your retirement income will go toward health care, and if you have a chronic illness or disability, the percentage could be much higher.
If you retire before age 65, the costs for health insurance premiums, along with deductibles, can be steep. You can stay on your employer’s health insurance plan for up to 18 months under the federal law known as COBRA, but you’ll have to pick up the entire premium, not just the percentage you paid as an employee. On the plus side, you’ll be able to stay in the same provider network you had while you were working. Your human resources department can tell you how much you’ll pay under COBRA; don’t forget to factor in deductibles and other out-of-pocket costs.
Another option is to buy a policy through your state’s health insurance exchange (search for your own state’s options at HealthCare.gov). These policies can be pricey, but the insurer can’t turn you down because of preexisting conditions, and many retirees qualify for income-based tax credits.
Get a handle on health
care expenses
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The tax code offers some perks for seniors. If you’re 65 or older, for example, you can claim an additional $1,300 for your standard deduction in 2020 ($2,600 if you and your spouse are both 65 or older and file jointly) or an additional $1,650 if you’re unmarried and not a surviving spouse.
But if you factor in a precipitous drop in your tax bill, your budget could fall short. All of the pretax money you’ve dutifully socked away in traditional IRAs and 401(k) plans will be taxed at your ordinary income tax rate when you take it out. Most pensions are also funded with pretax income, so you’ll pay taxes on that money at ordinary income tax rates, too, when you get your payments. Depending on your other income, a portion of your Social Security benefits may be taxed as well. And don’t forget about state taxes. Some states exclude some or all of your retirement income from taxes (or have no income tax), but others tax everything, including Social Security benefits.
If, like most preretirees, you have a combination of taxable and tax-deferred accounts, it’s worth sitting down with a financial planner or tax professional to discuss the most tax-efficient way to withdraw money from your various accounts. A tax pro can also help you come up with a realistic estimate of your federal, state and local tax bill.
Don’t forget about taxes
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Many people have grown accustomed to low inflation over the past decade, but that could change. And even if the overall inflation rate remains low, health care expenses have historically risen much faster than the rate of inflation.
When calculating cost of living, Pearson uses a 2% inflation rate for ordinary expenses but bumps it up to 10%—or even higher—for health care costs. Similarly, if you’ve purchased long-term-care insurance, you can expect your premiums to rise at a rate faster than inflation; some insurers have hiked premiums on policies purchased before 2005 by 50% or more.
Insurers have done a better job of pricing more recent policies, but it’s prudent to plan for an increase of about 20% every 10 years.
Adjust for inflation
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Numerous studies have shown that Americans fall short when it comes to putting aside money for emergencies. But keeping a well-funded rainy-day account is even more important once you retire, because you usually can’t put in overtime (or ask the boss for a raise) to pay for major car repairs or a new roof.
Bobbie Munroe, a CFP in Havana, Fla., advises her clients to put aside $200 to $300 a month, ideally in a separate account, for big-ticket items. “Even new tires can bust a budget,” she says.
Don’t forget an emergency fund
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During their go-go years, many retirees spend as much as they did before they retired, if not more. But once they reach their mid seventies (this will vary, of course, depending on health), many hit what Michael Stein refers to as the “slo-go” years—they’re less active, which means they spend less, and may downsize to a condo or smaller home.
Retirees spend less on food as they grow older, too, according to the Employee Benefit Research Institute. EBRI found that average annual spending on food for people age 65 to 74 was $4,400 to $4,900. Once they reached age 75, it fell to $3,700 to $4,000.
Unfortunately, that decline in spending doesn’t last, because during your last years in retirement—what Stein sadly refers to as the “no-go” years—your expenses will likely rise to cover health care costs. If you need long-term care, those costs could rise precipitously.
Expect changes in
expenses as you age
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One way to assuage your fears that you’ll run out of money is to buy an immediate annuity. With an immediate annuity, you give an insurance company a lump sum of money in exchange for a paycheck for the rest of your life, or for a specific period. Here’s where your expense worksheet really comes in handy, because you can use it to estimate your regular monthly expenses (such as utilities, groceries and a mortgage, if you still have one) and buy an annuity to cover those costs. With those costs covered, you may feel more comfortable withdrawing money from your savings for travel and other non-discretionary items.
Unfortunately, this is not an optimal time to buy an immediate annuity. Payouts are tied to interest rates for 10-year Treasuries, which are historically low. You may want to wait until interest rates are higher to purchase an immediate annuity, or use a laddering strategy, which involves making smaller annuity purchases periodically—say, every three to five years. If interest rates rise, you’ll capture them. Plus, the annuities you purchase in your later years will pay more no matter what happens because payouts are higher for older investors. To get an idea of how much you’ll need to invest to get a specific monthly payment, go to immediateannuities.com.
Paying off your mortgage before you retire will also provide an extra layer of security. You won’t have to worry about selling stocks or mutual funds during a downturn to make your monthly mortgage payment.
And don’t forget about Social Security, which will provide you with a monthly check for the rest of your life, adjusted every year for inflation. You can claim benefits as early as 62, but that will reduce your payout by up to 30% compared with waiting until full retirement age (66 and 8 months for those turning 62 this year). For every year past your full retirement age that you delay claiming, your benefit grows by 8%. You can get an estimate of your benefits from the Social Security Retirement Estimator. But whether you claim Social Security benefits now or later, you don’t want them to be your only source of income.
Create a back-up plan
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That way you can determine whether you’re spending more or less than you expected and adjust withdrawals from your savings accordingly. You can also adjust your projections to account for changes in your circumstances—a paid-off mortgage, for example, or a child who has moved out.
If you spent less than you estimated, congratulate yourself and make a gift to charity, or start planning that cruise.
Once you’ve retired, review
your expenses once a year
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