You are getting close to your retirement age. But do you know if you are financially prepared to retire?
Retirement is a big step and it will be hard to reverse a decision. Not everybody wants to retire. Many people who are old enough are not ready to retire. But according to the surveys, there are a significant number of people who feel they retired too early and were not fully prepared for that step.
Most people dream of having a great time when they stop working. They dream about having a nice place to live, exciting travels, and leisure time spent with a family. But it all costs money. Not to mention ordinary bills for food, transportation, utilities, medical insurance, and taxes that must be paid every month. It is hard to do things or even live comfortably if you do not have enough money saved for retirement.
Following this checklist should help you being financially prepared for retirement:
Get a clear picture of your retirement lifestyle.
What do you want to do when you retire?
It is important to have a clear picture of how you want to spend your time in retirement. Ask yourself:
Do I like to travel? If you are like me and dream about traveling in retirement, you need to know where and how much it will cost.
Do I have a list of activities or hobbies I want to start? Does it require you to buy new equipment or to have an additional space? Will I need internet and cable in my day-to-day life?
How are you planning to fill in your days?
There are a few questions to ask yourself:
Do I want to spend more time with my grandchildren?
Do I want to volunteer for a local organization or take a part-time job?
Do I want to join a club or start attending classes at a local college?
What is my passion? Cooking? Gardening? Maybe I will cook homemade meals and invite friends instead of eating out.
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Where do you want to live when you retire?
Are you planning to retire in place or relocate? If you want to relocate have you made a list of your priorities:
- Retirement community?
- Proximity to the beach? Or near the mountains?
- A small town? Or a big city?
- Close to children and grandchildren?
- Medical facilities?
Have you researched places you want to relocate? Or have you visited these places? Do you know how much will it cost to relocate? Housing will be the most expensive category of your retirement budget.
If you want to retire in place, ask yourself:
- Will my home be paid off? Or will I have a mortgage to carry into retirement?
- Do I want to have a few small projects upgrading my home? Or one big home renovation?
- Is downsizing an option? Is it time to consider something smaller and easier to maintain?
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Calculate financial needs to support your retirement lifestyle.
The first step to being financially prepared for retirement is to determine how much money you need to afford your dream lifestyle. Once you have a picture of your retirement lifestyle you can get a sense of how much money you need each month to pay for this life. The number should include your daily living expenses and the money you want to spend on hobbies and activities.
You should have enough saved to live on 80 percent of your annual pre-retirement income. This number is a good rule of thumb if you do not plan on making any major budget changes when retire. However, not all retirees spend less in retirement.
The best advice is to create an estimated retirement budget based on your current and future expenses. You might have a general idea of what you spend now. But you will be better prepared financially for retirement if you have a clear picture of your expenses now and how that might change in the future.
When you retire you do not need a lot of things that you did when you were working. The costs of commute, take-out lunches, and business clothes will go down. But you will start spending more money on travel, hobbies, and activities. And maybe your medical expenses will increase with time.
It is important to include big-ticket expenses into retirement budget as well. Sending a grandchild to a college or paying for a wedding. Buying a new car or a lake house with a boat will require a significant amount of money withdrawn from your retirement funds.
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Get a clear picture of your retirement income.
When you are working you probably have a single employer and a single source of income – your salary. In retirement, everyone has different sources of income.
As a retiree, you receive income from multiple sources:
There are several sources of guaranteed income:
- Social Security
- Annuity – a guaranteed income you must purchase yourself
Other sources of income:
- Part-time job
- Rental income
Sources of income from your investments and savings (your nest egg):
- Tax-deferred accounts – 401(k), IRA
- Tax-free – Roth IRA, Roth 401(k)
- Taxable investment accounts
- Taxable bank checking and savings accounts
While working, you receive a paycheck regularly – probably every two weeks. When you retire, you might receive income monthly, quarterly, annually, and even irregularly. Getting a clear picture of your retirement income should help to make sure that you have enough money to cover all your living expenses.
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Develop your withdrawal strategy.
Do you know how much income you can pull from your nest egg?
If you want to be financially ready for retirement you need to have an income plan or your withdrawal strategy. An income plan is a strategy for withdrawing money from your retirement accounts.
A good starting point for many retirees will be a well-known rule of thumb – the “4% rule”. The 4% retirement rule refers to your withdrawal rate. If you have a well-balanced retirement portfolio (60% stocks and 40% bonds), you can withdraw 4% of your account balance.
For example, if you have $500,000 saved in retirement funds you can withdraw 4% of that amount – $20,000 in the first year of your retirement. You can adjust that number every year for inflation but following this rule should help not to run out of money for at least 30 years.
Though, you have to be aware that this rule of thumb is not perfect. When I have researched the “4% rule” it has shown all kinds of pros and cons.
There are a few problems associated with following this rule:
- Return risk – the risk of earning lower returns than it was in the past.
- Longevity risk – the risk of living a long time and running out of money at the end of your life.
- Series of return risks – the risk of a market downturn during your early withdrawal phase.
Even it is not perfect, the 4% rule is a good starting point you can adjust with time.
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Pay off debt.
Paying off debt, no matter how much you owe, is a key to a stress-free retirement. Getting into retirement with any kind of debt will put a burden on your lifestyle. I am sure you will be irritated knowing that you need to make a credit card payment every month with your retirement savings. The best advice is to pay off all your debts before you retire including a mortgage.
Your mortgage payment will be the largest and most consistent expense in retirement. When you live on a fixed income you need to have a plan on how to handle these payments.
Check how many more years of payments you have on your loan and try to pay it off before you stop working. Maybe you can use some savings to pay off the home loan. However, if you cannot pay it off in full, consider downsizing and selling your home.
Some retirees have enough money saved to afford mortgage payments and to enjoy their life in full. But if you have limited retirement funds you will be better off without a burden of a home loan.
While paying off debt including a home loan might not be realistic for everyone, the less debt you have the better you prepared financially for retirement.
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Determine how to cover medical expenses.
You will become eligible for Medicare at the age of 65. If you plan to retire before age 65 you will need to find a separate plan to cover your medical expenses.
When you stop working, your health insurance provided by your employer ends. Even if your current employer promise to cover your health insurance in retirement does not mean they will not change their mind in the future or reduce coverage significantly.
Thus, you will need to find and buy your health insurance coverage. Individual health insurance is expensive and could cost more than $1,000 a month. Make sure to shop around for the best prices.
Even being eligible for Medicare brings its own set of challenges because it does not cover all medical expenses. Medicare does not cover premiums, deductibles, co-pays for doctor visits, dental and vision care, long term care, personal care, and other expenses. This means you need to include healthcare costs in your retirement budget.
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Remember about tax strategies.
In retirement, we still need to pay taxes, but not all sources of income are taxed the same. Withdrawals from tax-deferred accounts such as 401(k) plans and traditional IRAs will be taxed as an ordinary income.
Withdrawals from Roth IRAs and Roth 401(k) plans will be tax-free. If you want to withdraw money from taxable investment accounts, you will have to pay capital gains taxes.
In addition to taxes, you need to remember about required minimum distributions (RMD). You will face this requirement when you reach the age of 72. By the US tax law, you are required to start taking withdrawals from your retirement accounts such as 401(k) and IRA (excluding Roth IRAs). The amount you must withdraw will be determined by the IRS. If you have more than one retirement account, you can withdraw money from each account or total RMD from just one account.
For example, you have several IRA accounts. First, you need to calculate the RMD for each IRA separately each year. Next, you can sum up your RMD amounts for all your IRAs and then withdraw the total from one IRA. You do not have to take a separate RMD from each IRA account.
It is important to remember that your RMD withdrawals might push you into a higher tax bracket.
Think about what tax strategies will work for you the best. If it makes more sense you can roll your assets into Roth IRA before you reach RMD age. Another option is to start taking withdrawals from your retirement accounts before RMD kicks in so you would not face the sudden jump in taxes.
Putting It All Together
Getting closer to retirement can be both exciting and stressful. But if you want to have a happy and comfortable retirement you need to take time to understand your retirement picture.
You do not want to be one of those people who want to retire, but when that day finally arrives, they just let it happen. You want to be smart and invest time in planning and preparing for a big day. Before you take the plunge make sure that you are financially ready!
If you do it right it might be the best time of your life!
Are you financially ready to retire? Please share your thoughts in the comments below.
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Disclosure: This information is only educational. The intent if this post is to provide a simple guideline for an extremely complicated matter. I am not providing any specific financial advice or recommendations to any of my readers.