A couple of years ago, we wrote an article called The Best Is Yet to Come, which explained why retirees are happier and more content than younger folks. One factor fueling retiree happiness is financial security. To that end, we help people with retirement planning so that they will not have to worry about every expenditure. In today’s column, we give an overview of the most common retirement planning questions.
1) How do I know whether I have enough money to retire?
Some people obviously have more money than they will ever spend, but most retirees are not in that situation and, therefore, need a plan. Some people use spreadsheets, which can give a false sense of security because they assume a consistent return on investments each year. There are too many variables, such as one-time inflows/outflows, inflation, and the variability of investment returns. The best projections are created using retirement planning software that can run hundreds or thousands of scenarios, using randomized investment returns. This type of retirement planning will give you a range of outcomes, the median (most likely) outcome, and the probability of success (i.e., not running out of money).
For more details on this topic, read: Planning for Retirement – What’s the Best Strategy?
2) What are the steps in retirement planning?
Think of two sides to retirement planning. The financial side and the “what do I want to do with the rest of my life” side. I recommend finding a financial advisor (like us) who can help you with both. The human emotional side is often referred to as “retirement life coaching” and can really help people make the transition into retirement.
Most pre-retirees are more focused on the financial aspects. To that end, financial advisors use various programs to determine the likelihood of a retiree outliving his or her money. The output of any retirement planning program will only be as good as the data you put into it. That’s called the “garbage in, garbage out” principle. So you need to provide your financial planner with reasonably accurate numbers in the following areas:
- Planned Spending:
- Core retirement living expenses – How much you plan to spend in after-tax dollars each month/year, and
- Large one-time expenses – This includes items such as cars (if you pay cash), home remodeling, a child’s wedding, etc.
- Do you have expenses that end during retirement (e.g., mortgage)?
- Financial assets – You will need a list of all your accounts (e.g., 401k, IRAs, cash in the bank, real estate) and all your liabilities (mortgages, car loans, consumer debt).
- Retirement income sources – List the expected amount and potential start dates for Social Security, pensions, annuities, rental income, and part-time employment. Also, list expected one-time inflows such as selling a piece of real estate or an expected inheritance.
You can expect your financial advisor to ask you about your risk tolerance, preferences, and past experiences.
A good article related to investing your money in retirement is: Volatility Matters for Retiree Investors.
3) How much will I spend in retirement?
Most people’s spending remains at about the same level as pre-retirement. The adjustments to pre-retirement spending typically involve one of these:
- Changes in the amount of travel spending
- Changes in healthcare costs, especially if you are retiring prior to age 65 when you will be eligible for Medicare.
- Changes in your housing costs based on downsizing or paying off your mortgage.
- Expensive new activities or hobbies (e.g., golf, shopping)
A good article related to this topic is: Retirement Spending – Are You Overestimating?
4) How much should I budget for healthcare costs in retirement?
I recommend approximately $5,000–$7,000 per person, per year beginning at age 65, depending on your health and family history. A study by Fidelity estimated that the average 65 year-old couple will spend $285,000 on healthcare over the course of their retirement. I tried to find other estimates that were lower, but most other estimates I found were higher. Apparently, women typically incur more healthcare expenses than men during retirement ($150,000 for women vs. $135,00o for men).
The $285,000 includes your premiums for Medicare parts B and D, which account for about a third of your total retirement healthcare expenses. The remaining two thirds comes from deductibles, co-pays, and medical services not covered by Medicare. Long-term care expenses are also not included in the $285,000 figure, but should be part of your retirement planning.
For more detail on this topic, read: Healthcare Costs: Budgeting for Them in Retirement.
5) At what age should I collect Social Security Benefits?
The program was designed for workers to start collecting at their Full Retirement Age (FRA), which is 66 if you were born during or before 1954. Your FRA increases by 2 months for every year after that up to a maximum FRA of 67 for those born in 1960 or later. You can opt to collect as early as age 62, but your benefits are reduced by approximately 6.25% for every year prior to your FRA. On the other hand, your benefits will increase at 8% each year you delay benefits beyond your FRA. You can defer up to age 70, in which case your benefits would be 32% higher than the age 66 amount.
You will collect the same amount whether you start receiving benefits at 62, 70, or any age in between if you live to the average life expectancy for someone who is already 65. You should start collecting early (62) if you are in poor health, with reduced longevity. You should defer as long as you can (70) if you or your spouse expects to outlive the average life expectancy.
It is important to remember than when one spouse dies, the surviving spouse keeps the larger of the two benefits. So, it is a good idea for the spouse with the highest benefit to let his or her Social Security increase as long as possible so that the surviving spouse will have the largest benefit.
For a more detailed explanation, read: Social Security Benefits – Frequently Asked Questions.
6) How should I change my investments when I am getting close to retirement?
The idea that you need to invest more conservatively once you are retired (or nearing retirement) is only partially true. You should invest more conservatively (i.e., reduce volatility) in accounts from which you are taking withdrawals. The higher the withdrawal rate, the less volatility you should assume. For example, you should target lower volatility in an account that is distributing 5% per year compared to an account that is distributing 1-2% per year. The risk is that the money withdrawn after an account has declined will never have a chance to participate in the inevitable market rebound. It is further recommended that retirees have some “safe” money from which they can take withdrawals for a few years in the event of a significant market decline. Those safe investments can be held as part of the investment portfolio (short-term bonds) or separate from the portfolio (bank money). This pool of safe money enables you to let your more volatile investments rebound before you need to sell any of them.
Many retirees have accounts they do not plan to touch for many years, if ever. Those accounts can remain invested more aggressively (for growth).
7) Should I take the lump sum pension option or lifetime payments?
This will be a big decision as you do your retirement planning. The right decision depends on your personal situation. Here are a few quick bullet points to help you think about it. In general, you should take the lifetime payments when:
- You (and/or your spouse) are in good health and have longevity in your family
- You have a low risk tolerance
- You are not overly concerned about leaving money to heirs
- You need the full amount of money offered by the pension payments to cover your retirement living expenses
Take the lump sum if:
- You are in poor health and/or expect below average longevity
- You would need to withdraw 4% or less from the lump sum to cover your retirement living expenses
- You have a higher risk tolerance and leaving money to heirs is important to you
For more on this topic, read: Pension Decision: Lump Sum or Lifetime Payments?
8) Should I put my retirement savings in annuities?
You are a good candidate for annuities if:
- You and/or your spouse are in good health and have longevity in your family
- Less than 60-80% of your desired retirement income will be covered by guaranteed income sources (e.g., Social Security or Pensions)
- You have a few years until you need to begin taking income (This allows you to buy the annuity and let the level of guaranteed income grow.)
For more on this topic, read: Annuity: When Is It A Good Solution?
9) Do I need a Will or a Trust?
Having a will or a trust is an integral part of retirement planning. A will simply indicates which beneficiaries are to receive which assets, and who will oversee your affairs after you’re gone (executor). I recommend using an attorney to draft your will in order to minimize the chance that anyone will successfully be able to contest it. Some people hand write their wills to save time or money. A handwritten will is valid, although it should be notarized and witnessed (or you can videotape yourself reading it aloud). You can also get a basic will from a legal forms store or online at a site like legalzoom.com.
A will is certainly better than not having any estate planning documents. However, the problem with a will is: 1) it can be challenged in court, 2) your heirs will likely have to go through probate (a potentially expensive and time-consuming legal process), and 3) you lose confidentiality because your financial affairs can become public record.
Most people with significant assets use a revocable living trust as opposed to (or in addition to) a will. This beautiful set of documents is usually presented in a nice-looking three-ring binder and costs two to three times as much to create as a will. The trust enables you to name beneficiaries and a “successor trustee” who takes over when you are no longer capable. The main advantage of the trust (compared to a will) is your heirs get to avoid probate, your affairs remain private, and it is much more difficult to contest a trust than a will.
The other advantage of the trust is it can remain intact and continue to hold and distribute assets for many years after your passing. For example, you can instruct your successor trustee to distribute assets to your children when they reach a certain age, or distribute the assets over a period of years. Another popular retirement planning strategy is to name an income beneficiary, who gets the income from your trust after your death (e.g., spouse from your second marriage) and then residuary beneficiaries who get the assets after the income beneficiary dies (e.g., kids from your first marriage).
Retirement planning requires taking into account several factors including pensions, social security benefits and annuities. If you have any more retirement planning questions that were not covered in this post, feel free to contact us. Have a great week!