Start with a Retirement Budget
The first thing you need to do is carefully list all of your current expenses and come up with an accurate budget. Next, go through the budget and adjust it to account for any expenses that you believe will be higher or lower after you retire.
For example, if your employer currently pays for your medical insurance, or you have a company car, those expenses may be higher after you retire.
On the other hand, if you currently pay high individual insurance premiums and you plan to use a Medicare Advantage Plan with low premiums after retirement, your medical expenses may be lower. In addition, if you have high fuel and auto costs due to a long commute, those expenses will be reduced, too.
Don't forget to include the cost of hobbies and travel during your retirement year. Owning a boat or traveling extensively can add a substantial amount to your retirement costs.
Obtain Accurate Estimates of Your Pensions and Social Security Benefits
Once you have estimated your expenses, you will need to get an accurate estimate of what you will receive in pensions and Social Security benefits. You should be able to obtain this information from your pension plan administrator and from the Social Security administration.
Compare your retirement expenses to your retirement income.
If there is a gap (and for most people there will be), you will either need to downsize or fill that gap from your liquid assets.
What is the best strategy for doing that?
Required Minimum Distribution Rules
If your assets are in an IRA, you are required to draw minimum amounts from your account once you turn 70 1/2. The amount you must withdraw is calculated based on your life expectancy, using factors listed in IRS Publication 590. The owner of an IRA simply divides their total year-end portfolio balance by the life expectancy factor listed for their age. Each year you will need to repeat this process. The amount you must withdraw will vary depending on your age and the success of your investments. The withdrawal percentage increases as you age.
According to Kiplinger's Retirement Report for May, 2015, this strategy out-performs other systems for drawing down your assets. In addition, if most of your assets are in a traditional IRA, this is the strategy that you are required by law to follow.
Spending Only the Portfolio's Interest and Dividends
For those retirees who have their money invested outside traditional IRA's, in a Roth IRA or investment account, for example, they may hope to leave the principal to their heirs. As a result, they may decide to only use the portfolio's interest and dividends for their personal expenses.
There are two potential risks with this type of asset withdrawal plan:
1. They might not have enough interest and dividends to meet their needs.
2. They might choose stocks based only on their dividends, rather than on whether they are good long-term investments with growth potential.
However, assuming you do not have either of those problems, this system works well for people who hope to leave an estate to their loved ones or to a favorite charity.
The Four Percent Withdrawal Rule
Another option that is simple to follow is for the retiree to simply withdraw 4 percent of their liquid assets the first year and then increase that base amount by three percent of the withdrawal amount each year, to account for inflation. In other words, if you have $100,000 in assets, you would withdraw $4,000 the first year, $4,120 the second year, $4,243 the third year, etc.
With this plan, it is very unlikely that you would outlive your assets. Even with only a tiny return on your investments, they should about 25 years. If you started at age 65, your assets would last until age 90. If you receive an average return over the years, your assets could last much longer.
However, if you were hoping to leave money to your heirs, it is possible that you would draw down all your assets and there would be nothing left. If returns remain very low during that period of time and you lived well past the age of 100, it is also possible that you could outlive your assets.
How Should You Draw Down Your Assets?
One factor you will need to consider is how large your retirement deficit is and which asset withdrawal plan will best fill that gap.
That is why you need to start with a reasonable budget first. If you know that your gap is going to be larger than you can fill using any of the asset draw-down systems, you may need to make some adjustments to your lifestyle ... perhaps moving to a smaller residence, paying off your mortgage or other bills before retiring, or making additional adjustments.
With adequate retirement savings and a little financial planning, you should be able to retire and not spend your "Golden Year" fretting over your finances.
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My biggest surprise was a positive one. My commute while I was working was a long one. Instead of spending just under $400 for gas each month, I about $40, but that's not all, my car insurance went down considerably, since I am driving far less now.
ReplyDeleteYes, there are many things that can be less expensive after retirement. The cost of commuting is one of them!
DeleteAs you mention life expectancy is really the key in all this. Since I plan to live to 110, I've got a lot of calculating to do! : )
ReplyDeleteYes, if you plan to live to be 110, you should get that calculator out! :)
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