Published April 26, 2013
A few days ago I had a prospective client, Richard, come in to my office to discuss his retirement plans. He had no idea what he needed to do to make his retirement a reality. Almost everyone out there dreams about the last years of their life being relaxing and carefree but don't really know how to plan for it. Richard wanted to retire in about a year but needed help figuring out a plan that would let him retire at that time. We met two different times and came up with a plan for his situation. This article outlines the things you need to think about if you are like Richard and are ready to retire but need some guidance.
There is a lot of planning and saving that needs to happen before you can have that ideal retirement.
There are so many people out there that think they’ve worked hard for their retirement and that Social Security will give them the retirement of their dreams. Actually, many experts suggest that you’ll need at least 70% to 90% of your preretirement income to maintain the standard of living you’ve been accustomed to. Social Security isn’t as “secure” as many people think!
You need a financial plan that includes all of your bills, debts, etc., as well as sources of income and everything else related to your financial life. The first step to retirement planning is estimating your retirement income needs. You can use your current expenses as a starting point, remembering that your expenses may change by the time you retire.
Healthcare costs will go up and it’s inevitable that your health will decline as you age. Most importantly, you must remember to take inflation into account when planning. The average annual rate of inflation over the last 20 years is 3%, according to the US Department of Labor.
A financial plan isn’t just based on expenses. You will also need to try to determine your life expectancy and when you want to retire. You can use the government statistics of life insurance tables to get a realistic estimate. These estimates are based on age, gender, race, health lifestyle, family history, etc. I always ask the question during a consultation, “Which do you fear most, dying or outliving you income?” Thirty nine percent will say dying and 61% say outliving their income!
The final portion of a financial plan includes your income, as well as savings or investment accounts. You should speak with a financial professional who can help evaluate your investments or savings account to see if they are giving you the best returns possible. Many people I’ve met have several accounts but they just aren’t the right matches for their goals.
Let’s leave Social Security out of the picture. If you have a pension or a 401(k), you have more options, right? You’ve saved more money, so you should be able to retire earlier. Actually if you’re expecting to receive pension payments, early retirement could have a negative effect on that plan. The greatest growth of benefits occurs during your final years of employment. Retiring early could reduce your monthly benefits and, if you’re banking on using your 401(k) savings before you turn 59 1/2, you’ll usually pay a 10% penalty in addition to income tax. You won’t be eligible for Medicare until you turn 65, so you will need to factor in the cost of health insurance until your Medicare kicks in and postponing retirement, as an option, lets you add to your savings.
Let’s look at employer sponsored retirement plans. These accounts, like a 401(k), are extremely powerful tools and probably the best way for you to save for retirement. Your contributions come out of your paycheck as pretax contributions (reducing your current taxable income) and any investment earnings grow tax deferred until withdrawn. If someone plans to retire before age 59 1/2, there is a 10% penalty charge. A 401(k) or any other employer sponsored plan is a great savings tool for retirement, possibly the best. Many people leave behind a 401(k) they had at a previous employer and this is can be a nice source of retirement savings. Just because you left your old job, it doesn’t mean the 401(k) was canceled.
You have options! You could roll the funds into your new 401(k), if your new employer plan has a lot of allocation choices, this could be a great option. Or, if the company is small and doesn’t have a lot of allocation options, you could roll the funds into an IRA. An IRA also features tax deferred growth earnings.
Depending on your situation, a great option for anyone receiving an inheritance, especially age 50-80, is an annuity. Annuities are a great successful way to provide income during retirement. Based on the type of annuity, some or all of the funds can be passed to your children or even grandchildren as a legacy.
Annuities are generally funded with after-tax dollars and they come in three different flavors: Fixed, variable and fixed index. A fixed annuity sounds like its name; it pays a fixed set rate of interest on the money placed in the annuity. This rate could change periodically: For example, some insurers will pay a much higher rate of interest, say (6%) for an initial period, and then pay no less than a lower rate (3%) after the first year. Fixed annuities are conservative investments for individuals who prefer fixed rates of return without any surprises.
Variable Annuities allow you to invest money in several sub accounts; these subaccounts will invest in stocks, bonds, and money market accounts, etc. The amount of earning that will be credited to your annuity account will depend on the performance of the underlying sub accounts. You will assume some risk, as some years you may do well and others you might lose money.
A popular alternative is a Fixed Index Annuity. FIA’s are a hybrid between a fixed and a variable annuity, without the risk. When you purchase a fixed index annuity, the issuer agrees to pay a return on your account that is tied to the stock market. However, the issuer guarantees to pay you no less than a guaranteed return in a given period, if the return on the stock market falls below the minimum percentage. Simply put, if the market does well, you can earn above average returns on your annuity; if the market falls in value, your annuity will credit you the previously agreed guaranteed rate of return without any losses to your principle or interest earned.
The good news is that retirement planning is easier than it used to be, thanks to many tools and resources. While I only skimmed the surface, there are many options available for anyone planning to retire or those already retired. I encourage you to speak with a financial professional and establish a plan.