If you have begun considering retirement, "Do I have enough to retire?" is probably the first question that pops up. You probably already know the answer depends on many factors, and planning is the key to sorting them out.
Your Retirement Date Will Probably Pick You
The first question you’ll want to answer is "When do I want to retire?". You may have an ideal age in mind, but how much control do you really have over when you retire? Research increasingly shows that many of us retire earlier than we expected. In fact, it shows people retire about five years earlier than expected and that 48% of people retire earlier than they planned. So, when might you retire?
It turns out the answer is 61. Sixty-one is the "golden age" of retirement, and people that plan to retire earlier than age 61, on average, work longer than they planned. Conversely, people that plan to retire after the age of 61 tend to retire earlier than they planned.
The chart below, showing poll data from Gallup, compares when people expect to retire (the blue line) with when they actually retire (the redline line). Note a couple of trends shown in the chart. First, the ages are drifting up so in the future, the golden age of retirement may be 62, or 63. Second, the dangerous gap between when people expect to retire and when they actually retire is getting wider.
Chart 1
The Hidden Danger
There's a hidden danger in the gap between when you plan to retire and when you actually retire - running out of money. When you plan to work longer, and defer your retirement date, you run the risk of not saving enough. This is because you expect earned income for a longer period of time (and spending in retirement for a shorter period). Since people tend to retire five years earlier than they planned, they may not have enough money for that earlier retirement.
So, if you're saving and investing at a lower rate because you plan to work longer, you may be forced to retire before you've banked enough to fund your lifestyle and retirement. This means it's probably not a good idea to defer savings or invest less than you need to just because you plan on working longer.
Moreover, you may not want to retire completely and instead retire to a lower level of working activity. There are benefits to retiring to something, including the ability to retire earlier with partial employment, the psychological benefits of having co-workers and structured time in your semi-retirement.
Pre-Retirement Timeline
Once you have an idea of when you would like to retire, you're ready to create a retirement timeline with all of your critical dates and deadlines. If you're still employed, use your HR department to your fullest advantage. The HR department is a repeat player in the employee retirement game, and they are there to help employees in your situation. Often, they've developed retirement materials tailored to your company’s retirement benefits.
Start by collecting all available employer materials and resources available to you as an employee. Use the materials to populate your retirement timeline with the critical dates and deadlines. Make special note of your retirement health insurance benefits, any pensions, and retirement plan dates. This is to avoid having to scramble at the last minute to make critical retirement benefit decisions, such as pension elections under pressure.
Once you have your timeline, talk with an employer retirement counselor or someone in the HR department familiar with all of the retirement resources. If you can, pick someone that has worked with other employees preparing for retirement. Be aware that referrals to outside counselors might be 3rd party financial advisors in disguise. Your employer's interest in pairing you with a financial advisor is not always in line with your best interest. If you have been referred outside your employer to a financial advisor, make sure they're fee-only and fiduciary so they put your interests first. Try to find an advisor that specializes in working with people preparing for and entering retirement.
Retirement Healthcare
You’ve probably guessed that healthcare will be one of your largest retirement expenses and will continue to grow as you age. According to Fidelity, it is estimated that the average couple will need $295,000 in today's dollars for medical expenses in retirement, excluding long-term care.
Your two options for healthcare coverage in retirement are Medicare and private insurance. Since it's usually much cheaper, most retirees opt for Medicare. Remember, if you miss the enrollment deadline for Medicare, you’re subject to annual premium penalties - for life!
You'll Probably Be Retired Longer Than You Think
It's impossible to know how long you'll be retired. If you're married, and in good health, a twist of statistical math makes your "joint life expectancy," higher than you think. Since you both have a chance to live to a particular age, those chances are combined using statistics to estimate the likelihood that one of you will live to that particular age. You may even live beyond 100! The good news is we're living longer, higher-quality lives than we used to. The bad news is you may be underestimating the risk of running out of money in retirement.
Your savings may have to last 40 years in retirement.
Below is a life-expectancy chart created using life insurance actuarial data for a "preferred" rated non-smoking couple at age 70. The probability of the husband life-expectancy is shown by the blue bars on the horizontal, the wife's is shown by the orange bars, and the probability that either one of them will live to a particular age is shown by the green bar.
Chart 2.
If you're a married couple in decent health and nonsmokers, you can see that there is a 50% chance of one of you living to age 97. There's a 20% chance of one of you living to the age of 103! Plus, every decade that passes sees even longer life expectancies due to improved quality of living and advancements in medical care.
Matching Retirement Income & Savings with Spending
It may seem obvious, but planning for spending in retirement is the key to not running out of money. Spending a couple hundred dollars a month over what you can afford can dramatically reduce how long your savings will last.
The first step is taking stock of your after-tax retirement income and savings. First, you'll need a Social Security claiming strategy that maximizes your after-tax benefits based on your spending needs. Usually, claiming later is better, but not always and everyone's situation is different. Up to 85% of Social Security benefits are taxed as ordinary income depending on your annual taxable income. Always check with a trusted financial advisor to see what strategy is right for you.
Next, tally up taxable pensions and annuity distributions, along with any taxable investment income. Your Social Security and taxable income will give you an idea of your near-term retirement tax rate. Of course, IRA distributions, eventual IRA Required Minimum Distibutions (RMDs), and other pre-tax savings distributions will be added in, but you do have some control over these amounts.
Summing all of these up will give you an idea of your after-tax retirement income. Any additional distributions from your tax deferred savings, such as IRAs, will have to be discounted by your expected tax rate. The rule of thumb for sustainable annual distributions from your savings is 4%, but a safer estimate is 3% if you can achieve it. This means $30,000 of income for each $1,000,000 of retirement savings.
Combining all these sources of income will give you a good idea of how much you can sustainably spend in retirement. Hopefully, the number isn't too far off what you're currently spending each year.
The Hidden Risks of Retirement Spending
Did you know that many more people die climbing down Mount Everest than climbing up? Retirement savings is similar – it's more dangerous spending down your retirement savings (distribution) than saving them up (accumulation). If your retirement savings are to survive your retirement, you must manage the risk.
Some of the risks to watch out for are:
Market Risk – The average retiree will likely have to face three to five downturn, or bear, markets in retirement.
Sequence of Return Risk – Taking distributions from your retirement savings can dramatically shorten how long your savings last.
Interest Rate Risk – Low interest rates put additional pressure on retirees to create the income they need for their lifestyle.
Investment Behavior Risk – Retiree's emotions are a powerful force that can drive them to buy high and sell low in a volatile market
Inflation Risk – Like interest rate risk, inflation puts pressure on retirees to take more in distributions from their savings than they had planned because of a rising cost of living.
Withdrawal Rate Risk – The rate, or percentage, of your savings that you spend down every year is another risk, which leads us to the 80% spending rule.
The 80% Spending Rule
It turns out, you end up spending about as much in retirement as you did before retirement. It makes sense when you think about it – it's challenging to reduce your standard of living once you're used to it. Research has shown that retirees spend about 80% of what they spent while they were working, although it's sometimes more.
A conservative approach is to estimate you'll spend 80% of your pre-retirement income, adjusted for savings and taxes. So, your take-home pay minus your savings is a good starting estimate for how much you may be spending in retirement (plus inflation, of course).
The Double Benefit of Pre-Retirement Downsizing
Downsizing now helps you cut your retirement spending AND increases your pre-retirement savings. Moving to a less expensive home, area, and lifestyle are common themes, but don't forget the silent cost of depreciation. That new $75,000 luxury automobile will probably lose about 40% ($30,000), of its value after five years - not including the extra taxes, insurance, and maintenance costs.
Pre-Retirement Tax Planning
Once you've established your after-tax retirement income, savings, and spending needs, tax planning can make your income and savings go even further in retirement. You can consider moving to a tax friendly state – seven states have no state income taxes: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
When it comes to investments, you'll want to hold your tax efficient assets in your after-tax accounts. Practice annual tax-loss harvesting on your after-tax accounts. Forecast your RMDs throughout retirement so you don't get hit with big tax bills, and consider a Roth IRA conversion review the end of every year.
Complimentary Retirement Strategy Session
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Chart 1. "Snapshot: Average American Predicts Retirement Age of 66." Newport, Frank. Gallup, 2018. https://news.gallup.com/poll/234302/snapshot-americans-project-average-retirement-age.aspx. Source material provided upon request.
Chart 2. Life Expectancy Calculations. WealthPoint, 2019. Source material provided upon request.