You may think you’re prepared for retirement by having a retirement savings account, but have you developed a retirement income plan? Here’s what you need to know to ensure a comfortable retirement.
Much has been written about how to save for retirement. It’s harder to find information on what to do when you’re ready to retire and need to start drawing on your investments to supplement your income. It is something you should carefully plan for, and that planning will benefit you whether retirement is around the corner or still many years away.
Here you will find what every investor needs to know when planning for retirement, including easy steps you can take to develop an effective retirement income plan. A sound plan will help ensure that you can fully enjoy all the benefits of being able to set your own schedule, devote more attention to your interests, and spend more time with family and friends.
What is a retirement income plan?
A retirement income plan is a roadmap you can follow to make sure you have sufficient income to meet the lifestyle you want to have in retirement. It will help you figure out how much money you have, what you’ll need, and the best way to manage your money once you can no longer rely on a regular paycheck.
What steps are required to create a retirement income plan?
There are four steps you can follow to develop a thorough retirement income plan. Gathering the information you will need may take a little effort, but the details you collect will be crucial to your plan.
Step 1: Estimate what your expenses in retirement will be. If you’re a planner who has always kept a monthly budget, you’re off to a good start. Many people aren’t that disciplined, and it is easy not to track your income vs. spending when you have a steady paycheck. That will stop once you retire. To build an effective retirement income plan, you will need to first figure out what your expenses are.
So what is a good annual income for retirement? There is no magic number because everyone’s lifestyle needs are different. The general rule of thumb is that you will need 70% to 80% of your pre-retirement income to live on when you stop working, but your individual needs, lifestyle and goals can raise or lower that number significantly. So list all the usual monthly expenses, like housing, utilities, transportation, entertainment, and all the rest. Will your house be paid off or will your household expenses actually go up if you plan to finance a second home? Don’t forget, if you intend to wait until you’re in your 60s to retire, being a “senior citizen” will offer certain privileges. Be sure to research the benefits seniors in your town may receive, like a potentially lower rate on property taxes.
How much traveling do you plan to do? If it’s a lot, be sure to budget for it. Don’t forget to plan for medical expenses, too. Even when you reach age 65 and can qualify for Medicare, you may still need supplemental insurance and also have to pay for a variety of out-of-pocket medical expenses. Consider that even adult children may require some financial support, and you may want enough pocket money to spoil your grandchildren.
Step 2: Inventory what all your sources of income will be. Your income in retirement could come from multiple sources, including your personal savings and investments, workplace retirement plans, and Social Security. If you have worked at several firms over the course of your career and have vested retirement benefits with different past employers, be sure not to overlook any of those accounts. Adding up the balance of all these accounts will reveal the size of your nest egg.
If you’re still many years away from retirement, use modest estimates of what the future growth on your accounts may be. Using no more than an annual return of 6% on stocks, for example, may prevent you from overestimating the future growth your investments will experience.
You’ll also have to estimate how much you can safely withdraw from your investment accounts annually once you’re in retirement. If you don’t want to exhaust the principal in your accounts and run the risk of running out of money, the general rule is not to withdraw more than 3% to 4% per year of your principal. Consider some retirement accounts have Required Minimum Distributions (RMDs), or minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 72.
Though they are far less common today than they once were, you may also have a traditional pension. Unlike a 401(k) or a 403(b) plan, for which the value of your account depends on the performance of investments you select, a traditional pension will provide a regular monthly benefit that is based on your earnings and years of service. The company or union you have your pension with can give you an estimate of what your monthly retirement benefits may be.
For Social Security, you can get an estimate of your future benefits that is based on your actual earnings. You’ll need to get, complete and return to the Social Security Administration the request for this benefits statement.
If you’re fortunate to have income from other sources, like annuities you invested in or rental income from properties you own, be sure to include those in your income projections. Don’t forget you will also have to pay taxes on many of your sources of income, including Social Security benefits if your total income from all sources is above certain amounts.
Step 3: See if your income will fall short of your expenses, and if it does plan how to make up for the shortfall. If your income will exceed what you are likely to spend, congratulations. You have done a good job preparing for retirement. But if your income seems likely to fall below what your expenses will be, you’ll have to figure out how to make up the difference. The simplest solution, of course, may be to postpone your projected retirement date for a few years and have more time to save and invest.
Still, you may have other options. For example, if you’re an empty nester, would you be willing to reduce your housing expenses by downsizing to a smaller, more affordable home? Do you want to completely stop working? If not, would a part-time role help you make up your income shortfall? If you’re ready to bring your current career to a close, would you consider doing something completely different as a part-timer?
Step 4: Determine how to manage your investments in retirement. When you are investing for retirement, you have one primary investment objective – growth of your principal. But as you approach retirement and once you enter it, two other words will become much more important to you – income and stability. Still, don’t assume you can go entirely conservative with your investments. Today’s long lifespans mean you could spend 20, 30 or even more years in retirement. To avoid running out of money, you will need some growth to combat the impact of inflation and to ensure you do not exhaust your principal too soon. A financial advisor can help you determine what is the best allocation for you to have to stocks and bonds during your retirement years.