How do you know when you can retire? The answer seems
simple: When you have enough income coming from your investments and other
sources to sustain your lifestyle.
The problem for many retirees and those who are starting to
think about retirement is they don’t have a firm handle on how much money they
spend each year. Not knowing that number or planning for it can be the
difference between someone having a great retirement and someone running out of
money.
Luckily, this is usually easy to figure out. Most people
have one or two checking accounts from which all the bills are paid — credit
cards, mortgage, cash withdrawals, etc. On your bank statement, banks total up
everything that happened with your account during the month, including:
Starting balance
Deposits (how much new money came into the account)
Withdrawals and debits (how much money came out of the
account)
Ending balance (how much money was left at the end of the
month)
All you do is take the last 12 monthly total withdrawal
numbers and add them up. That total is how much money is going out the door
each year. This can be a little shocking, as we see most people are off by
about 30%, and sometimes much more.
Knowing the dollars going out the door will give you a
clearer idea of how much money needs to come in the door in retirement.
Remember, that last stage of your life could last 20 to 30 years or more —
basically as long or longer than many people live in one house. After you know
how much you spend in a year, it’s time to carefully craft a plan for
retirement income.
Look at it this way: Building a solid retirement income plan
is similar to constructing a sturdy, comfortable house. Like the home-building
process, there are three main components to a financial plan for retirement:
the foundation, the walls and the roof. Here is a breakdown of each and how it
pertains to your retirement planning:
The foundation
Foundational money is money that needs to be secure and
produce predictable income that will last for your lifetime. You don’t want to
have money that you know you need to live off of in a place where it could lose
value.
This is predictable money — you know how much is coming in,
when it’s coming and how long it will last. Foundational money, which should be
used to cover your core expenses, includes such funds as those from Social
Security, pensions and rental properties.
It’s worthwhile for some people to delay taking Social
Security. For example, a single person without many assets might want to work
as long as possible and delay Social Security benefits to increase their
monthly check. Full retirement ages (FRA) for Social Security span from 66
years to 67 years.
Delayed retirement credits are a reward Social Security
gives you for putting off claiming your retirement benefit. Credits accumulate
for every month from your FRA until age 70 that you postpone filing for
benefits. Those delays add 8% per year for every year you wait. For example,
wage earners who reach full retirement age at 67, but delay claiming benefits
until age 70, will receive an extra 24% tacked on to their monthly payment.
With pensions, having the joint-and-survivor benefit option
is crucial in providing a financial safety net for a surviving spouse. If the
pension earner selects the survivor’s benefit, that means a guarantee of steady
income to the surviving spouse, sometimes 50% or 75% of the original benefit.
People sometimes select the lifetime-only benefit because it pays the highest
monthly benefit, but it will be paid only while the pension-earning spouse is
alive.
The walls
Much like the walls of a home provide protection from the
weather and help support the roof, the walls in a retirement plan are stable,
relatively safe investments with minimal risk that add security for the
retiree. These funds include certificates of deposit, fixed annuities and
bonds. They are much less volatile than stocks, provide dividends and interest,
and allow one to pull money for special occasions, vacations, hobbies and
things retirees typically like to do during their first 10 years of retirement.
A fixed annuity provides a predictable source of retirement
income. It offers a guaranteed rate of return, regardless of whether the
insurance company earns a sufficient return on its own investments to support
that rate. The risk is on the insurance company. One downside of a low-paying
fixed annuity is it may not keep up with inflation.
Top-paying CDs pay higher interest rates than most savings
and money market accounts in exchange for leaving the funds on deposit for a
fixed period. They offer lower opportunities for growth than stocks and bonds,
but have a guaranteed rate of return.
High-quality bonds offer a steady, though relatively low,
return with a low risk to the principal investment. Interest payments in
retirement are a good way to supplement income. The key difference between
bonds and annuities is that the interest payments come for a set period with a
bond, whereas annuities often pay for the rest of your life.
The roof
These are riskier types of investments, such as stocks,
mutual funds, exchange-traded funds, real estate investment trusts (REITs),
precious metals like gold and silver and variable annuities. These funds should
have a 10-year-plus time horizon on them and, since the point of having them is
to realize financial growth, they are the best sources for keeping up with
inflation.
With a house, most people have to re-shingle the roof after
a certain period of time because it takes a beating from the weather. The same
can be true of the markets: Their volatility means, at times, one needs to
adjust.
Putting the roof on your financial house involves calculated
risk for long-term growth. The rule of 100 is a helpful guide to determine the
maximum percentage of a portfolio that should be invested in risky instruments.
Take the number 100, subtract your age, and that number determines the
percentage of money that can be at risk. The closer you get to retirement, the
lower percentage you should risk in the roof.
For example, a 55-year-old, following the rule of 100, would
invest 45% of their portfolio in stocks and mutual funds, while someone who is
65 would dial it down to 35%.
Your home is built to last. Likewise, your retirement plan
should be solid from the foundation to the roof. And like a well-built home can
bring happy memories for decades, a financial strategy carefully balancing
security with growth can give you the enjoyable retirement you deserve.
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