Thousands of people retire every day, either stepping away from long-term careers or downshifting into either full retirement, a second act that pays less, perhaps a fledgling business idea, or a passion project that pays nothing at all.
Retirement is a glorious transition that should be celebrated, but too often this change of life creates stress. That’s because every single one of those new retirees faces a real question: Now that I’ve given up a steady income, will my savings last?
Of course, the financial industry is quick to provide a multitude of potential solutions to the problem of making retirement work. Let’s consider the pros and cons of a few.
Reducing your cost of living is the most common way to balance retirement income and spending needs over the long run. Many retirees move to low-tax states with warmer weather in a bid to lower overall costs.
While a popular means of stretching retirement dollars, selling a large family home is a one-off and the cost of housing across the country has risen dramatically.
Before you bank on retiring to paradise, consider how you will finance your new life and the costs of moving, not to mention the disruption of your social and family networks built over years.
You might want to road test a retirement move first. Take a couple of vacations in your target spot before committing.
Buying an annuity seems like a set it and forget it way to create guaranteed retirement income for the remainder of your life.
Annuity sellers often claim that the product is “free” to the buyer. And when you put in, say, $100,000 upfront, your account balance will read $100,000.
Nevertheless, the annuity seller will be paid, and that money does come from you, the buyer. It’s taken out in the form of ongoing mortality and expense (M&E) fees charged by the insurance company.
If the product were in fact free, those fees would be far lower.
There are a lot of other, built-in commission costs to consider. In addition, annuity providers charge investment management fees (on mutual funds within variable annuities, for instance) and there are rider charges if you buy optional features, such as inflation protection.
Because of how they are structured, annuities are incredibly complex. Have you ever sat down to read your homeowner’s insurance contract? It’s like that, but worse.
Timing your income
Broadly speaking, it’s best to delay claiming Social Security until age 70. If you claim the benefit before your official full retirement age (FRA), you will receive less than your full benefit — between 25% and 30% less.
Similarly, if you wait until past your official FRA you collect more, about 8% extra for each year you delay.
Of course, waiting on benefits means you could need a stopgap income between the moment you leave work and when you begin taking payments.
That might mean continuing to work part-time, or tapping into after-tax or tax-advantaged retirement accounts in a programmatic fashion.
Remember, though, that pension payouts can be taxable, and you will be required to make minimum distributions from 401(k) plans and traditional IRAs, also taxable, beginning at age 72.
Depending on your retirement income, you will pay federal taxes on 50% and up to 85% of your Social Security benefit. In addition, 12 states tax Social Security benefits.
The result can be a “stacking effect” of rising taxable income later in life, so planning is crucial.
A real financial roadmap
The commonsense answer is the following:
- work a little longer if possible
- save more using “catch-up” provisions in IRAs and 401(k)s
- judiciously trim expenses before entering retirement
- avoid complex financial products with high fees
- maximize monthly Social Security payments by taking benefits as late as you can
- plan ahead to manage your total effective tax rate
A qualified financial planner can show you how to set up your own retirement “paycheck”. It may take a touch of self-discipline, but more of your own money should end up in your pocket.
Another solid step forward, one that ensures that your interests are served, is to hire a Certified Financial Planner™ (“CFP®”).
All CFP® professionals are required by their designation to adhere to a strict fiduciary standard, or lose their designation. They must meet rigorous education, training and ethical standards and must remain committed to serving their clients’ interests first.
You can get by without a financial plan, but your money life will be far less stressful by having one. Achieving your personal goals in life, including building a retirement, implies major financial choices.
Creating a written financial plan helps you build on your success to achieve the stress-free retirement life you want.