What do you want to do in retirement? The first step that I recommend taking is determining what retirement looks like to you. Previous generations used retirement to slow down life. The extent of their retirement may have been watching television and taking an annual cruise. As they have with so many other things, Baby Boomers are rebelling against the standard and redefining retirement. Many retirees are now starting new careers, working part time, volunteering, playing golf, or traveling the globe.
There is no wrong way to retire, so create your own vision. When you decide, what retirement looks like for you, try to estimate an annual price tag. You may find that your expenses will be vastly different than your friends’ or coworkers’ – which is okay. It’s your life, and you’ve worked hard to enjoy it.
How much income will you need? Retirement articles often state that the “average” retiree needs 70 to 80% of his or her current income in retirement. These figures are just that: average. Today you likely spend 40, 50, 60 hours or more between commuting and your typical work week. When you retire, you may fill that void with an activity that comes with a significant price tag.
Those same articles may also state that you will pay less in taxes during retirement. Ask anyone you know who has retired, and they may tell you that taxes are still a high priority for them. When you retire, your home may be paid off (or nearly so), you will no longer be adding to your retirement plan, and any children you may have are no longer at home (hopefully). To complicate matters, the income you receive from your 401k and pension may be taxable. If your deductions have decreased and your expenses have remained the same, you might pay more in taxes during retirement than you do today.
Where will you get the income? Unless you have a pension, the bulk of your income will likely be generated by your retirement plan (401k, TSP, 457, or 403b). Because you may need income for more than 20 years, you may decide to continue with a diversified portfolio of equity and fixed-income investments. Many people assume that this portfolio will provide them with at least a 7% return, so they immediately begin withdrawing 7% from their retirement accounts.
While receiving an average return of 7% on your investments might be feasible, this income strategy fails to plan for market downturns and inflation. If the stock market has shown us anything over the past ten years, it’s that you can see tremendous gains or significant losses in a very brief period of time.
Inflation can also play a factor. If you withdraw 7% per year and earn 7% per year, the only way you will be able to meet cost of living increases will be tapping into your principal. While most retirees find withdrawing their principal acceptable, this is not something that you will likely want occurring early in retirement.
What about Social Security? This depends on your age and faith in the government’s plans for the future. I’ve found that many people in their late 50s plan on receiving Social Security and they include it in their retirement projections.
People 55 and younger have less confidence in Social Security. Some count on receiving half of their projected benefit while others, especially those younger than 50, leave Social Security out of their projections. The latter believe that if they receive Social Security it will either augment their lifestyle or increase their retirement security.
Once again, the decision is a personal one. If you are 55 or younger and have a firm belief that Social Security will exist in your retirement years, I suggest that you cautiously estimate your benefits.
When can you afford to retire? To calculate your retirement date, you need to estimate your life expectancy. Due to the advances in medical care, many now believe that projecting out to age 90 or 95 is a wise decision. I tell my clients not to worry about the date as we’ll meet once or twice between now and then. It always gets a laugh, but the joke touches one of the essential elements of your retirement plan: review your plan on a regular basis.
Another must is discussing your retirement plans with your partner/spouse. While it won’t be affordable for everyone, many want to retire in the same year as their partner/spouse. The affordability gap may be a result of a significant age difference, and age effects how we prepare for retirement. Younger investors are more likely to accept ups and downs in the market as they have a longer time horizon. Additionally, they have more time to accumulate funds. For those who are approaching retirement, the focus shifts from building to protecting their assets. You may want to find a solution that allows you both to enjoy retirement while you are young, active, and healthy.
After you assess your goals, expenses, assets, and income, you should be able to determine when you can afford to retire. In some cases, this may mean that you can retire sooner than you anticipated. For those who need to push back retirement, other options exist. By decreasing your expenses, starting a new career, and/or working part time, retirement might be affordable at a more desirable age.
Remember, retirement is unique to each individual/couple. Determine what you want for yourself and create a strategy around your goals.