Retirement often means big changes in your financial life. Financial priorities will change as you move from saving for retirement to generating reliable income from your retirement savings. Sources of your income will shift, as well as your expenses.
As you plan for retirement, you need to project your life ahead for 20 to 30 years as best as you can. Financial stability is important at any age, and typically it begins with smart money management.
Here are the 7 steps for managing your money in retirement.
Step 1. Determine your budget.
It is important to know how much you will spend in retirement. You will not have the safety of every month’s paycheck to support your expenses. The amount that you spend is extremely critical to how long your money will last in retirement.
You have to be careful and not spend a lot of money early in retirement because it could deplete your resources early. If you deplete your retirement funds early, you may need to cut back later. Or it may mean going back to work when you are older.
A retirement budget is critical because it shows what your income is, what your expenses are, and what amount of money you need to have a comfortable retirement.
You can determine your budget around your needs and wants:
- Do you still have a mortgage on your home?
- Are you planning to downsize or retire in place?
- Are you planning to stay put or relocate in retirement?
- Can you move to a more affordable place and save?
- Do you plan to reduce your expenses?
- Do you plan to travel in retirement?
Your budget should show your retirement income sources such as Social Security, pension, part-time job, and withdrawals from retirement and investment accounts. Most importantly, it shows if you have enough retirement income to pay for rent/ mortgage, utility bills, groceries, transportation, taxes, healthcare, and other costs of living.
Also, you need to be as honest as possible and even add to your budget some extra unforeseen expenses and emergencies like home repairs, car troubles, and unexpected medical procedures.
It is a good idea to start more conservatively with your estimates. It is better to assume that you will spend more than you actually do when you retire, so you will have more flexibility later.
Step 2. Create reliable retirement income.
When you finally retire, you need to figure out how to turn your retirement savings into a consistent retirement income. In fact, studies show that retirees who have guaranteed retirement income are less stressed than retirees who make random withdrawals from their retirement accounts.
What are the guaranteed sources of retirement income?
Social Security and/or pensions are considered the source of a guaranteed retirement income.
An annuity is another source of guaranteed retirement income you have to create yourself. When you buy an annuity, you will turn your retirement savings into a predictable retirement income.
One of the most popular methods of creating a retirement income is to create different money buckets or accounts for different spending needs.
Near-term income. The first bucket is called a cash bucket and has 2 or 5 years of income in cash reserves. This bucket contains your cash and short-term fixed-income investments that can be easily converted to cash. These are your safe assets that can generate income. High-yield savings accounts can be a good place to keep your money.
As you use money from your first bucket with cash reserves, you will need to replenish it with cash from other buckets.
Mid-term income. The second bucket contains investments that you will need for about 3 to 7 years. The second bucket should have a mixed investment in things like bonds, CDs, and mutual funds. These types of assets will provide income and growth.
Long-term income. The third bucket contains assets that you don’t need to tap for 7 to 10 years. This bucket can provide growth and can be invested in stocks and mutual funds. You have to plan not to touch this bucket for at least 10 years. The goal here is to have a strong ability of solid long-term gains and more time for investments to recover from the ups and downs of the market.
As you manage your money, it is important to keep safety in mind. While you may feel safe keeping all your assets in short-term income investments, you will lose out to inflation over time. Your portfolio needs to have growth. On the other hand, you cannot have all your assets in stocks because of the stock market volatility.
Step 3. Cut back on your expenses.
Once you are retired, there are not so many options to make money. You need to live with what you have. In retirement, every expense needs to be accounted for.
Generally, you cannot avoid expenses like utilities, food, transportation, taxes, healthcare, and rent. But you can manage your discretionary expenses like entertainment, travel, hobbies, and activities with caution. This doesn’t mean you shouldn’t enjoy your retirement years.
But with smart money management, you should pay for them out of retirement savings that are specifically allocated for longer-term goals. Otherwise, you can drain your retirement funds fast and have to go back to work.
When planning for smart money management in retirement, be prepared for spending shifts.
When we first retire, we should expect to spend more because we are still active and like to do lots of things. After that, we enter a period of slowing down and staying closer to home. We should expect to spend less on entertainment, eating out, and traveling.
As we grow older, we need to be prepared for medical spending because our medical expenses will grow every year.
Step 4. Make withdrawals from the right accounts.
When managing money in retirement, every penny counts. That is true when it comes to tax savings.
You must make the most out of your tax-deferred retirement accounts, such as 401(k) and IRA. The longer you give them compound without having to pay tax on the capital gains, the better off you will be.
That is why financial advisors recommend that the order of withdrawal from your accounts should be the following:
- Taxable (investment) accounts
- Tax-deferred accounts – 401(k), IRA
- Tax-free accounts – Roth IRA, Roth 401(k)
Step 5. Be smart with your withdrawals.
A simple way to stretch your retirement funds further is to manage your withdrawals smartly.
To achieve this, you need to calculate how much money you need each year to live on. Then you need to figure out how much you can safely withdraw each year to meet your needs and wants. And do not forget to account for the income tax impacts of those withdrawals.
The most recommended 4 % rule is a good starting point. You should be able to withdraw 4% annually without running out of money for 30 years if you have saved a sufficient nest egg.
If you did not save enough money to have a comfortable life in retirement, many experts recommend taking only 3% from their accounts. It is better to play things extra carefully. A small misstep early in your retirement could drastically affect your retirement years.
By leaving money in the account, your investments have a chance to grow in future years. Thus, going with a lower withdrawal rate will be more a conservative and smart way to manage your retirement funds.
Step 6. Look at your home equity.
Home equity is going to help out many of us who are lucky enough to own a home.
Your home is not only a shelter with a roof and walls but also your biggest financial asset that has increased in value over the years. For most households, home equity represents the biggest source of wealth.
There are many ways we can use that wealth to pay for our retirement.
Downsizing is one of the best ways to access the money you have in your home. It is a great option if you live in an expensive area, or your home is too large for your needs in retirement.
This may not matter to you if you have saved a sufficient nest egg for retirement. But most people have a limited amount of retirement savings. Downsizing and moving to a more affordable place to live could make all the difference in allowing your savings to last longer.
Keep in mind that housing is your biggest budget item. Even in retirement housing costs as a percentage of spending will remain around 35% on average.
Reducing your housing costs now will give you more cash to put toward your other retirement goals. Once you are retired, the fact that you have lower housing costs means you will need less income in retirement for this essential expense.
A reverse mortgage is often the best choice if you like your home, do not plan to move anywhere, and own your home mortgage-free. A reverse mortgage allows you to borrow some of your home equity while retaining ownership of your home.
There are many benefits of getting a reverse mortgage. It provides you with regular income and does not require monthly payments. You still have to pay taxes and home insurance, and you will be responsible for maintenance.
But the best part is that you will receive a portion of your home equity in cash without requiring you to move out. However, the loan has to be repaid when the owner leaves the house.
Step7. Rebalance your portfolio for income and growth.
When you retire, your biggest challenge will be balancing the need for income today with the need for growth in future years.
When you are planning for 20 to 30 years in retirement, you need to rebalance your portfolio. But you need to play carefully with your portfolio to make sure you have enough money for today and tomorrow. Hence, if you can generate enough income from only a portion of your portfolio and let the rest grow, you are going to be in good shape for the long run.
You need to decide how much to allocate to stocks and how much to bonds.
Some financial advisors recommend a mix of 60% stocks, 35% fixed income, and 5% cash when you are in your 60s. As you age, your portfolio should become more conservative. This means having a smaller allocation in stocks and a higher allocation in bonds and fixed-income investments to preserve your capital.
Managing and rebalancing a portfolio requires a lot of work. If you don’t want to do it yourself, you have the option of working with a financial advisor who can do that heavy lifting for you.
Related posts you might want to read:
- 7 Simple Ways to Pay Yourself in Retirement
- Is Relocating in Retirement a Good Idea?
- 8 Budget Categories You’ll Spend More in Retirement
- Should I Pay Off a Mortgage Before Retirement?
- How Much Is a Nest Egg Enough to Retire Comfortably?
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