When Should I Retire?
It’s question most of us ask ourselves. Really, it boils down to “when will I know when I’m ready to retire”?
With most Americans living well into their seventies, and many into their eighties and nineties, planning for retirement has become not only more important, but also more complex. As an example, when the first Social Security check was issued in 1940, average life expectancy for those born in that year was 61 for men and 65 for women1, and only 9 million Americans lived to be 65 or older2. By 2010, average life expectancy for those born in 2010 had grown to 76 for men and 81 for women1, and the number of Americans 65 and older had exploded to 40.3 million1, and the numbers keep rising. Clearly, having a comfortable income for all those years will be important and require more complex planning than it did back in 1940. In addition, as people live longer, the costs of medical care and assistance with daily living activities, begin to play an increasingly larger role.
Therefore, proper retirement planning must include several factors:
- The monthly budget
- Non-recurring expenses
- Sources of income
The Monthly Budget
Having a good handle on your monthly expense budget is critical to achieving a comfortable retirement. It is the foundation upon which retirement income goals are based. Said another way, knowing how much you will be spending on a monthly basis will allow you to plan for the income that will cover those expenses.
One idea that works well for understanding you budget is to track all expenses for a period of three months and take the average. This way, you are less likely to miss routine expenses that do not necessarily occur every month, for example: car maintenance and repair, school supplies, and clothing. Be sure to track every expense, and to be practical about tracking how much you’re really spending, as well as whether this is a comfortable budget for you. A common mistake is that, when doing this exercise, some people pull back on their spending or don’t account for every dollar, in order to have a lower budget. In real life, this is not typically sustainable, and ultimately creates hardship in retirement due to insufficient income. A good spot check for this: Is the amount I’m setting every month, equal to my income less my budgeted expenses? If so, then have I lived comfortably during the three months I was tracking my budget. If not, there’s probably expenses I’m not accounting for or trying to ignore.
In preparing for retirement, permanently reducing your monthly budget via strategies such as paying off your house, life insurance, and outstanding debt (and not adding back to it), will enhance your ability to plan for a successful retirement.
Unfortunately, taxes are a fact of life, and most of us will be paying them in retirement just as we did during our working years. And, with Federal budget deficits being what they are, the likelihood of lower taxes in the future seems unlikely.
When looking at retirement income, it is important that you allow for taxes. In other words, if your anticipated monthly income in retirement is equal to your projected budget, it will not be sufficient to cover your expenses. Be sure consult an expert regarding what your taxes will likely be when you plan to retire, and add this figure to your needed income.
Inflation, or the cost of living, will continue to rise during our working years and our retirement years. This is a critically important consideration when planning for retirement. Based on historical inflation trends, the cost of living has doubled approximately every 20 years. And, while we cannot project definitively what inflation will be in the future, it is certainly prudent to plan for it to grow at least at historical trends. Therefore, if you’re 45 and plan to retire at 65 (20 years), then you must plan for a monthly budget of at least two times your current budget. Moreover, if you think you are likely to live 20 years into retirement, you will need to double that figure again in order to have a comfortable budget for those years of your life.
One of the other key factors in considering inflation is that some retirement costs can inflate at a much higher rate than overall inflation measures like CPI. For example the inflation rate for medical care and health costs tends to rise more quickly than the cost of milk. Because a larger portion of most retirees’ budget tends to be medical care than groceries, this is a worthy piece to take into consideration.
The “wild cards” in retirement are typically the non-recurring expenses. These fall into two categories: infrequently purchased items, and emergency expenses.
Infrequently purchased items are such things as cars, durable goods (stove, dishwasher, and vacuum cleaner), household improvements (carpeting, new roof, kitchen and bathroom upgrades), and miscellaneous other items like helping with the grandkids’ college education, the 50th wedding anniversary celebration trip, etc. While this is not a comprehensive list, we all will have expenditures that will require significant outlays, and which must be accounted for in our planning.
Emergency expenses are the items that we don’t expect (or hope won’t happen) but inevitably do. To name a couple, there’s the occasional major plumbing or roof repair issue, and for some, the relative in need of some assistance.
Setting aside the necessary funds will keep these items from derailing a comfortable retirement.
Sources of Income
Where will your retirement income come from? How reliable will it be? And, will it keep up with inflation?
Retirement income can come from various sources: Social Security, pension funds, retirement savings (401k, IRA, Roth, etc.), investment income (annuities, mutual funds, etc.), business income, and rental income, among others.
Programs such as Social Security and pensions can provide consistent and reliable income for retirement (provided they remain solvent). In addition, Social Security is indexed to inflation (goes up each year the same amount as inflation), and many pensions have a built-in annual increase.
Other sources of income need to be managed closely to provide and maintain income flow. While it is beyond the context of this article to delve into this topic, some considerations will be: return on investment, longevity or viability of the investment (e.g. will my business continue to exist, or be productive, long after I’ve left it?), depletion of the investment (e.g. will my IRA money last for the rest of my life?), ability to maintain the investment (e.g. how well will I be able to continue to manage my real estate holdings as I age?)
The goal is to have a reliable income for retirement, preferably from various sources so as to diversify and reduce the risk of any one source not panning out. The income should be comfortably above the monthly expense budget to allow for non-recurring expenses, and the potential of increased inflation and/or taxation.
Lastly, while having a well thought-out income plan is key, it is just as important to have a protection plan to address issues that are likely to arise during retirement. Consider the following facts and considerations:
On average, women outlive their spouses by 4-5 years (and, in almost every case, one spouse will survive the other). Consideration: If your retirement is very strongly funded, you may not be leaving your spouse with enough to be comfortable. Life insurance can be an appropriate remedy to replenish retirement savings.
A projected 68% of Americans over 65 will need some form of long term care during their lifetimes3. And, the average cost of nursing-home care in the US is over $70,000 per year, and is growing at an average rate of 405% per year (Morningstar.com). Consideration: Long Term Care insurance can pay for nursing-home care as well as in-home care so that these costs do not drain retirement savings prematurely.
So, “when should I retire”?
The answer is in the delicate matrix of these factors. As you and your advisor consider where you stand on each of these things and how they are expected to change in the future, you can begin to see when the most financially viable time for retirement can be. Too many times retirement dates are set by dissatisfaction with work, market fluctuations or other outside frustrations. These “trigger points” can lead to a retirement decisions that is not well-structured and potentially an underfunded retirement.
Once you are in the “red zone” of retirement—approximately within 10 years—start strategizing these factors with a qualified advisor so you can know what your options are and what you need to do in the meantime to get there prosperously.
2Social Security Administration