When you retire and start living off the fixed income, your lifestyle will be affected dramatically if there is not enough money to cover your expenses. In retirement you can control your expenses by sticking to your spending plan, but it will be harder to control your income.
What factors will affect your retirement income and how to plan for that?
How inflation will affect your retirement income?
In simple words Inflation is when the prices of goods and services go up over time.
There is so much talk about the inflation in the media. Why we need to remember about it?
Why, because the inflation erodes our savings and reduce our purchasing power.
We all noticed that the price of gas, groceries, clothes, construction materials and even doctor’s office going up with every year. But the longer we live, the more we’ll feel the impact of inflation on our retirement money.
Inflation has averaged about 3 ½ percent per years since the 1920s. At that rate, what costs one dollar today will cost a lot more in the future. If you need $1,000 per month today to pay for food and utility bills, you might need $2,000 in 20 years to pay for the same items.
If you expect to spend 30 years in retirement, you need to have a retirement income that keep up with an inflation more than someone who will live only 15 or 20 years in retirement.
If your assets don’t grow much faster than the inflation rate, your investments won’t buy more in retirement than they do today.
There are several ways to protect your retirement income from inflation:
- Get the most from your Social Security paycheck.
Many of us will rely on Social Security check to provide a portion of our retirement income. Social Security has automatic annual cost of living increase. So, if you are getting closer to retirement, you might want to delay collecting Social Security until age 70, even if you stop working before then. The longer you wait, the higher your paycheck will be for the rest of your life. Delaying Social Security will give you an increase of 8 percent for each year between your full retirement age and 70.
- Annuity is a pension you buy for yourself.
If you decide to buy an annuity as a source of retirement income, you might want to buy an inflation-adjusted annuity. This type of annuity promises to pay you monthly check that will rise with the cost of living every year until you die.
Annuities don’t come cheap, you need to pay extra if you want to add a feature to your policy. Experts recommend buying this type of annuity only if you expect to live long.
- Choose investments that rise with inflation.
Historically, stocks and real estate did much better job of outpacing an inflation. So, one of the best ways to protect against the inflation is to keep a portion of your retirement portfolio in these assets. On the other hand, you will be losing money if you decide to keep most of your retirement assets in cash.
2. Life expectancy
How longevity will affect your retirement income?
How long will you live?
On average you can expect to live to your mid 80’s. But, no one is an average. Many people die before or right after retirement, and other live to 90s and beyond.
Do you know your family history? Or your spouse history? Did they have a history of living into their 90s, or did they tend to die in their 50s?
Knowing how long you might live, can help you to plan for the years you will spend in retirement. The longer you need your retirement money, the more careful you need to be with your expenses.
How to estimate your life expectancy?
There are life expectancy calculators to help you with this task. If you want to estimate your own and a spouse’s life expectancy, go to living to 100. You will need to answer the questions about your diet, exercise habits, social life and your family history. You may even learn how to improve your health and make changes to your lifestyle.
After you get the idea for how long you might live, you need to put together an estimate of your retirement income and expenses and for how long it will last when you stop working.
How debt will affect your retirement income?
Being in debt is hard at any age but being in debt when you’re near retirement is one of the worst case scenarios. The older we are, the more difficult to pay down our debts. Why? There are many reasons behind this simple question:
- If you lose your job it might be difficult to find another one.
- If you have health issues, you might be forced into early retirement.
- You might be going through a divorce or your spouse died.
- Your peak earning days are behind you.
If you don’t pay off your debt it will put a big hole in your retirement income and a lifestyle.
The sooner you clear your debt the better. Don’t wait until it’s too late. You don’t want to run out of money in your late years and then regret buying things that weren’t really important.
How do you sort all this out?
First, set up the step-by step plan of how you want to pay off all your debts.
Second, avoid a future debt and make sure that you have three to six months of living expenses in your emergency fund.
4. Medical expenses, long-term care costs
How medical expenses will affect your retirement income?
I admit it is very difficult to predict your medical costs in retirement. The health care cost seems to go up with every year. Many experts saying that most of retirees underestimating future health care expenses.
Health care in retirement is not free.
Medicare will cover some of your medical expenses – but not all of it. On average, we could expect Medicare to cover about 50 percent of our health-related expenses. In addition, we’ll have to pay for premiums and out-of-pocket cost. And these expenses will cost us more in the future.
According to the latest data report from HVS Financial, a 65-year-old couple will pay $363,946 for total lifetime healthcare costs.
It’s a big risk not to have planned for medical and long-term care expenses. You don’t want these expenses to wipe out your retirement savings.
How emergencies will affect your retirement income?
There are times when we need to make a fast decision. Life happens and emergency situation comes our way. Emotional stress comes with the financial stress if we don’t have enough money to cover these emergencies. That’s why we need to have an emergency fund.
There are a lot of opinions out there how much money you should put into your emergency fund. If you have saved and put at least $1,000 into your fund, it’s better than nothing. But let’s be honest it’s not enough for people who are close to retirement. For us it’s better to have saved from three to six months of living expenses in emergency fund.
If you don’t have an emergency fund, it’s time to start one today. It’s going to take time to build up your emergency fund.
Calculate your basic living expenses, like mortgage or rent, utilities, food, gas. Then ask yourself how much money you would need to have stashed away to feel secure. At a minimum you should have three months of living expenses. So, if you need $3,500 a month to cover your basic living expenses, then you need to put $10,500 in your emergency fund.
An emergency fund brings stability and peace to your financial life in any phase of your life, but it’s especially true for retirees. Instead of panicking at every unexpected emergency expense, you’ll have a small pot of money at hand and ready for use.
6. Market risks
How market risks and volatility will affect your retirement income?
If the market goes down when you’re retired or five years or less prior to retirement, it’s easy to freak out. Why? Because stock market crash might significantly reduce the value of your retirement savings. What happened in 2008-2009 financial crisis when retirement portfolios lost more than 40% of their values, might happen any time in the future.
You don’t want to see your 401(k), IRA and Roth IRA investments go down. You don’t have another 10 to 20 years to see them recovered from market downturn. You might not have enough time to make up those losses. You will need these money to generate your retirement income.
If you want to protect your retirement savings from economic recession and market downturns, you need to spread the risk. You need to diversify your portfolios. The idea is that not everything in your investment portfolio goes up and down by the same amount at the same time. Don’t put all your eggs in one basket.
You might already know that investment portfolios are traditionally organized by age, your goals & risk tolerance. The sooner you think you’ll need the money, the less risk you should take. Why? You have no time to recover the setbacks. Simply put, If you portfolio suffered 50 percent loss, you will need to recover 100 percent to make it even. It will be hard to bounce back from significant financial losses.
When your retirement within the reach, the experts recommend diversifying your portfolios with 60/40 asset allocation. It means 60 percent invested in stocks and 40 percent in bonds.
Putting it all together
According to the experts when it comes to retirement, one of the worst mistakes people make is neglecting to plan ahead. Instead, they just “wing it” and draw down their retirement savings fast. They take out what they need for living expenses and hope their money will last.
Well, hope might not be a good strategy!
Instead, you’ve got to have a plan. You’ve got to carefully consider what your retirement needs, how much is your retirement income and how it will be affected in the long run. All this planning is to make sure you don’t run out of money in your late years.
Do you know how much is your retirement income? Are you prepared for the long run?