Planning for retirement is a daunting task. Your goal is to project your potential income and expenses to get a rough picture of what your financial situation might look like in retirement.
If retirement is approaching soon, try living for six months or more on your anticipated income to determine whether it is realistic. If it’s not, or your anticipated expenses exceed your income even without a trial run, you may have to reduce expenses or work longer, or both.
Even if the numbers look good, it would be wise to keep building your savings. You might take advantage of catch-up contributions to IRAs and Employer-provided retirement plans, which are available to those who reach age 50 or older by the end of the calendar year. It also makes sense to build a private pension that is tax-favored. One way to do this is to use your tax-savings from those IRA and retirement plans to fund a life insurance policy which can provide an alternate source of tax-favored income as well as other valuable living benefits.
Although with a little thought it may seem obvious, inflation is all too often ignored in retirement planning. In reality, inflation can insidiously erode the value of a fixed-income stream.
For example, at 3% inflation, someone retiring with a fixed annual payment of $100,000 could face a 25% reduction in their standard of living by year 10 and an almost 50% reduction by year 20.
This is not what most investors have in mind. Planning for inflation is critical.
In addition to planning for inflation, you also must be able to mitigate sequence risk by ensuring that investments do not have to be sold at the wrong time.
As you think about your income strategy, also consider ways to help minimize taxes in retirement. Would it be better to tap taxable or tax-deferred accounts first? Would part-time work result in taxable Social Security benefits?
Finally, health care should get special attention as you plan the transition to retirement. As you age, the portion of your budget consumed by health-related costs will likely increase. Although Medicare will cover a portion of your medical costs, you’ll still have deductibles, copayments, and coinsurance. Unless you’re prepared to pay for these costs out of pocket, you may need to purchase a supplemental insurance policy.
In 2015, the Employee Benefit Research Institute reported that the average 65-year-old married couple would need $213,000 in savings to have at least a 75% chance of meeting their insurance premiums and out-of-pocket health care costs in retirement. And that doesn’t include the cost of long-term care, which Medicare does not cover and can vary substantially depending on where you live.
These are just some of the factors to consider as you prepare to transition into retirement. Breaking the bigger picture into smaller categories may help the process seem a little less frightening.
It is also unfortunate that financial institutions are always trying to sell you the latest “magic bullet” that will “absolutely need” to be purchased from them to make you successful. Hopefully, you are beginning to realize that there is no such thing.
Remember, a financial decision in any one area of your financial life will inevitably impact other areas of your life. Financial planning should be “process” oriented, not “product” oriented.
The only way to prepare for a happy retirement is to focus on a strategy that incorporates multiple income sources, tax reduction strategies and risk management. You also need to make sure you keep up with inflation and prepare for increasing health care costs.
Your projections may get clearer as you develop a realistic picture of what your retirement will look like, based on your expected resources and expenses. Also, since life circumstances and economic situations constantly change, you need to be flexible enough to make changes along the way.
Lastly, you should copy strategies that the wealthy use with their money and implement those into your overall strategy as well.