We all have our dreams of retirement. But whether you plan to travel the world or just enjoy the freedom of doing nothing, we all have one thing in common – figuring out how to pay for our life in retirement.
Perhaps the biggest challenge of transitioning from work to retirement is learning to live without a regular paycheck.
Instead of receiving a steady income from the employer you suddenly find yourself dependent on Social Security, a pension (if you are lucky), your investments and savings. But as Social Security dwindles and pensions become a rare commodity, it is more challenging to build a dependable and consistent retirement income that meets all your needs.
After decades of earning income and saving for retirement, you finally need to shift gears and learn how to spend what you have saved.
In this post, we look at Suze Orman, America’s most recognized financial guru, recommendations on how to pay yourself in retirement and not run out of money.
1. Know your living expenses.
This sounds so basic, but most people do not know what they really spend each month.
You might have a good idea of how much you spend on mortgage/ rent, utilities, cars, and groceries. But you forget to add occasional trips, gifts, gym membership, eating out, etc. All these expenses can drain your money fast.
In her book, The Ultimate Retirement Guide for 50+ Suze Orman recommends calculating everything from major costs such as mortgage payments, utilities, transportation and groceries to smaller purchases like clothes, accessories, and entertainment.
The best way to do it is to create a list of your living cost categories and calculate your monthly spending.
If you want to automate calculations and track your expenses use the technology. A good quality budgeting app will track your expenses for you and save you time.
2. Calculate your reliable retirement income.
This one is a very important calculation and is not always easy to figure out.
But you need to calculate all sources of your retirement income to get a clear picture of how much money you will have coming in.
There are three building blocks to your retirement income:
- Social Security benefits
- Pension income (if you are eligible)
- Income from your investments
Social Security benefits and pensions are considered guaranteed income and it’s easy to calculate.
Go to the Social Security Estimator to find out your calculated benefits depending on the age you start collecting.
But to secure a dependable income from your investments can be tricky because you will be at the mercy of market fluctuations.
You can still create a retirement paycheck from bond and dividend payments investments. However, there are several drawbacks to interest and dividend investing. First, many retirees cannot live on interests and dividends alone. Second, dividends are never guaranteed. During difficult economic times, some companies choose to cut or eliminate their dividends.
3. Pay your fixed living expenses from guaranteed income.
Your retirement income plan should be built on the common sense of stability.
The stability you want should allow you to pay all your essential living costs no matter what. If the markets are going down, you want to know that you have enough income to cover your basic living expenses.
There are three types of retirement guaranteed income:
- Social Security
- A pension
- An income annuity you purchase yourself.
Guaranteed income means that these income sources are set and will not go up or down with financial market changes.
Your goal should be to cover all your essential living expenses from these guaranteed income sources.
Here is a list of essential living expenses:
- Mortgage/ rent
- Medical insurance
An income annuity (fixed income annuity) is a personal pension you create for yourself.
You can purchase an annuity from the insurance company in exchange for an agreement to send you a locked-in payment every month once your annuity starts.
Keep in mind that any type of annuity is an expensive insurance product. And if you buy an income annuity, the money you pay the insurer is no longer yours.
Here is the list of income annuities to consider:
- Immediate income annuities. You pay your one-time premium to the insurance company, and payments start immediately.
- Deferred income annuities. You buy the annuity today, but do not start the payouts until a set period of time, such as 5 years or 10 years.
But if you place a high value on having a guaranteed income, you should consider adding an income annuity to your other sources of guaranteed income such as Social Security and/or pension.
4. Keep at least two years of living expenses in cash.
Every household needs an emergency fund that can cover up to 6 months of their living expenses or even longer.
According to Suze Orman’s advice you need to have a separate bear-market emergency fund in retirement.
This fund should have at least 2 years of living expenses in it. If you expect that you will not cover all your living expenses from guaranteed income, then she recommends keeping 3 years of expenses in safe accounts. And this fund is in addition to your typical 6 to 8 months emergency fund.
Emergency cash fund gives the flexibility you need to handle financial markets downturn. This fund is also where you get the money to pay for out-of-pocket medical expenses if it is unexpected.
In her book, she recommends creating this bucket of cash from your bond portfolio.
For example, if you have $500,000 in investments, it should be split into $250,000 in stocks and $250,000 in bonds. Let’s assume your annual living costs are $35,000. You should move at least $70,000 (two years of living expenses) of your bond portfolio into savings accounts, CDs, or short-term bonds.
This fund is a helpful alternative to instead of selling stocks for a loss or taking a high-interest personal loan for an emergency.
5. Hatch an RMD plan.
RMD stands for required minimum distributions – the minimum amount of money retirees must withdraw from their retirement accounts when they reach a certain age.
If you have savings in tax-deferred retirement accounts such as 401 (k) and IRA, the federal government is going to force you to start taking money out each year.
Even though you do not need the financial needs to touch these accounts, you still must start making annual withdrawals. Neglecting to withdraw money on time can cost you thousands of dollars in penalty fees.
Just because you must take withdrawals from your retirement accounts, that does not mean you should spend all of it. After you pay the IRS their tax, do with your distribution what you want even consider reinvesting some of your RMDs in a regular taxable account.
And do not worry you do not need to do the RMD calculation yourself. The company where you have your IRAs and 401(k)s invested will calculate your RMD for you.
6. Plan to spend no more than 3% of your portfolio in your first year of retirement.
Most of us closer to retirement are familiar with a popular 4% rule for retirement spending.
The 4% rule says that you should be able to comfortably live off 4% of your retirement savings. For example, if you have $1 million you would withdraw no more than $40,000 in your first year of retirement based on the 4% rule.
Keep in mind that you should adjust that amount each year by the rate of inflation.
However, Suze Orman recommends spending no more than 3% of your portfolio in your first year of retirement.
For example, if you have $1 million you would withdraw no more than $30,000 in your first year of retirement. Even though your RMD will be higher than 3%, she recommends spending just 3%.
The most important factor to consider is whether you retire in a bull market or a bear market.
If you have the misfortune of retiring in a bear market, you should be spending as little as possible of your portfolio. Taking money out in a bear market leaves your accounts depleted. By scaling back your withdrawals you will give your money time to recover.
7. Stay Flexible.
The most important part of your retirement income plan is to stay flexible as your life situation changes and modify your plan with time.
You can still retire at 65 but you can delay retirement to increase your Social Security benefits. Also, think about picking up a side hustle or a light part-time job to supplement your guaranteed income and maintain your retirement lifestyle. Consider these options when working on your retirement income plan.
Also, you can always plan on spending less to make retirement more affordable.
Maybe you should postpone a luxury cruise vacation or trim your monthly dining-out habits. Maybe you should reduce cash gifts to your kids and grandkids or consider downsizing your home to save thousands of dollars on housing costs.
But whatever you do, keep your retirement plans realistic.
The final words of advice – it is never too late to start finalizing your retirement plans and calculations. The earlier you start, the better prepared you will be.
Here are a few related posts you might want to read:
- How Much of a Nest Egg is Enough to Retire Comfortably?
- Should I Pay Off a Mortgage Before Retirement?
- 5 Best Ways to Withdraw Money from Retirement Savings
- How Do I Decide When Best to Retire?
- Understanding Different Types of Retirement Accounts
- How to Prepare Retirement Budget in 5 Simple Steps
- The 3 Buckets Strategy for Retirement Income
- 3 Best Ways to Generate Retirement Income
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