You’ve spent your whole life saving so that during retirement, you can lounge on a beach, play golf or travel to faraway lands. Figuring out how to spend your retirement nest egg can be stressful for most people though. Having to make do with less is an adjustment financially and emotionally, but planning is the best way to calm uneasy nerves.
“The reality is the Baby Boomer today entering retirement has a high probability that retirement lasts north of 20 or 30 years,” says Pat O'Connell, executive vice president at Ameriprise Financial. When you’re looking at spending down your wealth in retirement, a good plan will help you make sure you don’t run out of money before you run out of life.
“It’s hard to quit working and then figure out how to make the money do what you need it to do,” says Scott Halliwell, certified financial planner at USAA. “If you have a plan for how you’re going to turn your lump sum into an income stream, it takes away a lot of concern and anxiety for what you’re supposed to do.”
Expenses during your retirement will vary throughout the years. “For most people, retirement tends to be very active at the beginning,” says chartered financial analyst Robert Stammers, director of Investor Education for the CFA Institute, “and as people get older, retirement becomes much more static and things like health care costs become more important.” Likely, you’ll have to make adjustments along the way.
As you prepare for your retirement years, here are questions that can help you devise a plan for spending your nest egg.
When should you retire?
Whether you’ve saved enough cash is key. “You can’t start thinking about how much you’ve saved when you’re 60,” says Ted Sarenski, certified public accountant financial planner and CEO of Blue Ocean Strategic Capital. “If you haven’t saved throughout your work years, maybe retirement’s not in the cards for you and you may have to delay retirement, if you can retire at all.”
Consider how much Social Security you’ll receive. “People should continue working until at least age 66, when they can get their full benefit,” he adds.
If you delay Social Security until age 70, you’ll receive 132% of the monthly benefit, according to the Social Security Administration. When you delay Social Security, you may have to dip into your savings to bridge any budget gaps. “By doing that, you may not be leaving an inheritance to the next generation,” says Sarenski. “You need to be selfish and focus on yourself by making sure you have enough money to make it through the rest of your life.”
What are your expenses?
You may not have budgeted when you were working since your job provided a steady stream of income. During retirement, though, not only does your income change, but so do your expenses depending on your lifestyle — traveling or pursuing a hobby may very well increase these, as does where you plan to live and whether you downsize your home.
“What people need to do is determine what their expenses will be during retirement on a weekly or monthly basis,” says Halliwell. “Once you know that, you should be able to cover all your fixed expenses with fixed income sources.” Fixed expenses are what you know you’re going to spend money on, like rent, mortgages, taxes, utilities, food, taxes and health care. These don’t include vacations, gifts and other nonessentials.
Sarenski recommends determining your comfort level and what you need to live on. “Try to pay for your needs with a fixed asset since you’re less likely to run out of money if you can pay for your needs with a regular, guaranteed stream of income,” he says.
How much do you need saved?
“For most people, the primary fixed income source is social security,” says Halliwell. “Some people, not many, will have a pension plan on top of that — military, teachers, government workers, and few people from corporate America.”
Since your income stream may not cover your needs, your savings or home equity can be used to bridge the gap. Experts suggest having this amount, adjusted for inflation, set aside.
“For most people, the equity in their home is the single largest investment,” says Stammers. Making a decision about your home and whether to use that equity sooner rather than later is key — people who wait until the last minute tend to get caught in reverse mortgages.
If you have a shortfall, investment strategies can help your money grow.
Consider creating an income stream with a total return approach, suggests Halliwell. If your Social Security and pension doesn’t cover your monthly expenses, put three to five years worth of money that will cover this shortfall in savings accounts. Invest the rest of your savings in some sort of portfolio with a risk tolerance that you’re comfortable with. “Since you’ve set money aside, you don’t have to worry about market fluctuations,” says Halliwell.
If you have a shortfall and feel uncomfortable spending down your portfolio, consider part-time work or a lifestyle change that will lower expenses. “Practically speaking, everyone hits that tipping point and they change something,” Halliwell adds. “That doesn’t mean that catastrophic expenses don’t occur, it just means they stop spending.”
How do you minimize your tax liability?
Since your income will be lower, so will your taxes. Along with money in your retirement accounts, to help manage your tax liability, you’ve ideally been able to put money away outside of your retirement accounts.
“You have to do some really good tax planning because taxes will have a big impact when you’re in retirement,” says Stammers. “It’s really important to have money in different accounts so you have some tax flexibility.” You should have a mix of tax-deferred, tax-free and taxable accounts, including 401ks, IRAs and Roth accounts, as well as additional investments in taxable accounts, to do this.
Tax planning when you first retire is extremely important, as this will help you take advantage of deductions, credits and different tax rates for investments. “This means you have to figure out how much money from your retirement account versus after-tax savings that you’ll use,” says Sarenski. “Consider talking to a professional with a tax background as you plan.”
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