After working in this industry for over 25 years, I notice that the same questions are frequently asked by clients that are preparing for this next chapter in their life. Below are some of those retirement planning questions and my responses. I’ll start with the most common question by far.
Q: How much money do I need to retire?
A: If you ask Siri this question, she states, “I could not say”…so obviously your iPhone can’t help. The rule of thumb is 25 times your first year’s expenses. But what will your first year’s expenses be? The closer you are to retirement, the easier that question will be to answer, but if you are unsure, I suggest 70%-80% of your current annual income. If you think you will spend $100,000 annually in retirement, then $2.5 million is your answer. Here’s a link to a simple Retirement Expense Worksheet to help you get started.
Keep in mind that how much you should aim to save is dependent on the lifestyle you plan to live during retirement, as well as your other income sources (social security, pension income, inheritance, rental income, etc.) and any outstanding debt. And, of course, life expectancy will also play a large role in factoring your need.
Ultimately, when planning for retirement, it is best to conduct a full retirement plan to truly get an understanding of the amount that is right for you.
Q: Why do I need a retirement plan?
A: A retirement plan can help you analyze your (anticipated) income and assets versus your (anticipated) expenses. The typical person will need to fund 25-30 years of expenses. What most people tend to forget is that inflation dramatically changes the amount you need at the start of retirement versus the middle or end. Expenses can double in a 20-year period given average inflation, so any retirement plan will need to include this component. Additionally, medical expenses usually rise even faster than inflation, so that must also be considered, as well as investment returns and taxes.
A qualified financial planner should be able to help you analyze all these components. Additionally, a planner should produce a cash flow statement outlining the retirement funds coming in versus going out annually, as well as estimate the amounts that you should be able to safely draw from your accounts. Knowing your budget is key to making sure you don’t run out of funds early.
Q: Should I retire early if I can afford to? How do I stay happy in retirement?
A: Assuming you’ve crunched the numbers with your financial advisor and determined that you have enough funds to retire, this is not a financial question but an emotional one. Many of my clients have retired only to find they are unhappy and bored, and soon return to work! Making sure you have a plan for how to spend your time during retirement is key to a successful retirement.
There are a few vital areas humans need fulfilled to feel happy:
- Social: Stay connected. I am inspired by the broad range of activities my clients are involved in—senior hiking clubs, yoga and swim classes, golf lessons, joining (or starting) a book club, traveling, and even taking a part-time job at a winery.
- Health: It is important to stay physically active and stay healthy—join a gym, take classes at the senior center, garden, cook from scratch, or just get out and walk. A dog will keep you moving and get you out walking!
- Intellectual stimulation: Your brain needs regular stimulation to stay healthy and sharp— read, take a course online or at your local community college, learn a new skill…the list is endless.
- Purpose: Have a purpose each day. Do something new or contribute back to the world. I have had clients volunteer to foster kittens, train therapy dogs, serve meals to the homeless, or tutor children online. There are so many options, and the world always needs more good-hearted people to help wherever they can.
Q: When should I start taking Social Security?
A: I always say, if we knew how long you were going to live, I could tell you! You can take social security as early as age 62 and as late as age 70, but if you take social security at age 62, you get up to a 30% monthly benefit reduction…for life! Also, if you are working and end up earning too much money, part of your social security can be taken away from you. If you wait until your full retirement age to take social security (which varies from age 65-67, depending on what year you were born), then no funds would be taken away even if you work (part time, I hope!) during retirement.
Many clients ask, “If I will receive the most social security benefit if I wait until age 70, shouldn’t I wait until then?” Well, if you wait until age 70, then you are out the funds you could have been taking from your full retirement age (age 65-67, depending on your birth year) to age 70. For example, if at age 65 you would receive $24,000 each year in social security benefits, then you would lose over $120,000 (plus inflation adjustments) if you wait to take social security at age 70 ($24,000 per year x 5 years).
So, yes, by waiting until age 70 to start taking your social security you will receive more per year—from full retirement age to age 70, social security increases by about 8% per year. In my example, your annual social security benefit would go from $24,000/year to over $35,000/year (an $11,000/year increase) if you wait until age 70. The real question is, how long would you have to live to make up for the benefits not taken earlier (in this example, $120,000)? For many, the age to live beyond is somewhere in the early to mid-eighties.
If you have longevity with funds to live on, then wait to take your social security benefits until age 70, but if not, consider taking social security at full retirement age. Your financial advisor can run the calculations as part of your retirement plan to help you make this decision.
Q: How do I replace my paycheck in retirement? Social Security just isn’t enough.
A: You are right. Social Security was never meant to cover all your retirement needs, so one must save and invest beforehand. For most people, it’s best to take additional funds for living expenses from a taxable account while allowing tax-deferred accounts (IRAs, 401(k)s, annuities, etc.) grow as long as possible. At age 72, you must take required minimum distributions (RMDs) from tax-deferred accounts, so this is the time at which the draw strategy changes. Your advisor can help you to create monthly income—which would be funded from stock dividends and capital gains, as well as bond interest. Eventually, you will need to dig into principal, unless you wish to leave to your heir(s).
Q: How much cash should I keep in retirement?
A: For most, 6 months to one year of expenses minus reliable income sources (social security, pensions) is ideal. Don’t forget to add in funds that might be needed for large purchases in the following year, such as a car, vacation, or home remodel. The best place for money needed in less than one year is in cash (to preserve capital).
Q: Should I downsize my home?
A: Of course, the obvious response is that if you cannot afford to maintain your home, then you should downsize. Many retirees are shocked that they should set aside funds to maintain their home, but we receive calls weekly from clients that, almost apologetically, tell us that they need to take funds out to repair their roof or fence, update a bathroom, replace their water heater…the list goes on.
The typical annual cost to maintain a home is about 1% of market value (not to say that you would spend that all in one year, but it does average out to that cost). So, if you have a $1 million dollar home, budget for a $10,000 annual maintenance expense. If after considering all costs, you believe that you can afford (and would like) to keep your current home, decide if you really want to maintain a home (and possibly even a yard!) at age 80 or 90.
If you do decide to downsize and move out of the area, it is usually best to rent in the new area before committing to buy. I have had many clients move only to find that the new area was not a fit for many reasons including their healthcare plan had no offices nearby, or the social or political views of the neighbors did not align with theirs. Try a location on for size before committing.
In summary, if you’re in your fifties or early sixties, it is always best to have both a financial (and life!) plan for how you will both afford and purposefully spend the next chapter of your life. Creating a roadmap will help get you to where you want to go while leaving some room to roam and explore. Afterall, not everything life throws our way can be planned.