Because of the current bear market, many people are rethinking their retirement plans. Individuals preparing for retirement in the next couple of years may now be considering pushing back that date. Other people are trying to figure out whether or not it still makes sense for them to retire.
The decision to retire depends on a number of different factors, from how much income is necessary on a monthly basis to predicted expenses. Potential retirees should crunch the numbers and figure out whether or not they are comfortable with their projections. In general, the first step in deciding whether or not retirement is feasible is figuring out how much money you will likely have once you are no longer working.
How to Approach the Question of Retirement Income
When individuals start calculating their retirement income, they should start with Social Security, since this is a guaranteed benefit. The average Social Security benefit in 2019 was just under $1,500 per month, but the maximum available is $2,861. Because of this large range, people should make sure they understand how much they will get.
The final calculation depends on earnings history and age at which benefits are claimed. Social Security payments max out at the age of 70 and are almost double what recipients would get if they elected to receive them at the earliest age possible, 62. The Social Security website provides personal estimates of a likely payment, so individuals can use that tool to get an idea of what to expect.
Several other items will factor into the income calculation, including pensions and any planned part-time work. People should also consider home equity if they plan to sell their homes and relocate in search of less expensive housing. Importantly, both of these items can help make up the difference between expected income and monthly expenses, but each has its drawbacks.
For example, retirees may not be able to work as expected or may need to hold off on selling a home because of market issues. Finally, the majority of monthly income typically comes from retirement investment accounts. A rule of thumb that people often use is withdrawing 4 percent in the first year and then continuing with adjustments for inflation, but other models also exist. The 4-percent rule can help people get an idea of likely investment income.
Approaching the Question of Retirement Expenses
Calculating expenses in retirement can involve a significant amount of guesswork. However, these numbers often become more reliable in the years before retirement so it is worthwhile to revisit the issue at that time. Typically, financial planners recommend thinking of expenses in terms of necessities, desires, and contingencies.
For the most part, Social Security, pensions, and other streams of guaranteed income should cover necessities. People can consider purchasing an annuity to increase guaranteed revenue to fill in the gaps. Then, money for discretionary funding can come from retirement plans and other investments. For contingency expenses, individuals should create a reserve that stays intact until needed and is replenished when necessary.
Everyone will have a different budget. In the necessity bucket, most people include expenses related to housing, groceries, transportation, utilities, and insurance. Individuals should also consider healthcare costs, taxes, and debt payments if they have them. Taxes usually drop in retirement, but they can still consumer 5 to 6 percent of income.
In terms of discretionary spending, the budget often includes travel, entertainment, clothing, furniture, and services like housekeeping. These expenses should be able to be eliminated or at least scaled back in the event of an extended market downturn to safeguard your nest egg and keep it from running out too quickly. Spending often needs to be curbed during these periods since your nest egg will not be growing at its usual rate.
Creating a Contingency Plan for Retirement
Contingency expenses are often overlooked when budgeting for retirement. Failing to account for these costs can lead to bankruptcy. Unexpected medical expenses or repair bills become much more difficult to absorb into the budget without work income.
For this reason, retirees tend to need a larger emergency fund than they had prior to retirement. People in the workforce should have enough money set aside to cover expenses for about three to six months. Once retired, individuals should shoot for having enough to cover a year’s worth of expenses.
Normal, ongoing expenses should be covered with guaranteed income rather than your emergency fund. However, unexpected major repairs to your home or vehicle as well as medical issues are considered emergencies. People should try to deal with issues prior to retiring, if possible, but the unexpected can still happen. In terms of healthcare, people should make plans to pay for their long-term care, which is not covered by Medicare.
Another contingency that individuals need to plan for is inflation. A mild rate of inflation of about 3 percent causes prices to double in 24 years. Some expenses, especially healthcare, can climb even faster. Social Security is adjusted for inflation, but increases in prices can make investment portfolios decrease in value.
Retirees should have some plan for hedging against inflation, whether that means real estate or Treasury inflation-protected securities. Some fixed annuities also have inflation adjustments. Another option is keeping more of a nest egg in equities as they typically increase in value at a rate higher than annuities, but this involves accepting some risk.