Retiring from your job is a major milestone in your life. The thought of retiring after (typically) 30+ years of work can be incredibly exciting, and somewhat stressful. Once you retire, it can be difficult to re-enter the workforce—especially at the income you earned before retiring. Before you submit your retirement notice to your employer, it’s essential to make sure you’re truly ready. The only way to know you’re truly ready is to develop a retirement plan.
That begs one important question: what exactly should be included in your plan? The answer to that question is going to be slightly different for everyone, but there are several key topics that need to be addressed in nearly every retirement plan.
I’ve listed several questions below—each corresponding to an important retirement planning issue. At a minimum, your retirement plan should answer each of these questions.
Of all the retirement planning issues on this list, the decision of when you retire is probably the most important decision for your retirement plan and your life. There’s no “right” answer to this question—there are simply trade-offs to consider.
Retiring earlier leads to fewer years of portfolio growth and more years of portfolio withdrawals, which will reduce the amount you can spend each year after retirement.
Delaying retirement leads to more years of portfolio growth and fewer years of portfolio withdrawals, allowing you to spend more when you retire.
When you develop your retirement plan, I encourage you to run a few different scenarios with various retirement dates to test the impact of this decision. The “right” answer for you will depend primarily on how much you enjoy your job and how much retirement spending you need.
Retirement isn’t necessarily an all-or-nothing decision. If you dislike your current job but aren’t quite ready to fully retire, you can always work part-time at a job you enjoy to supplement your income. If you’re married, you can also consider the option of one spouse retiring while the other works for a couple more years.
For each possible retirement age, your retirement plan should determine how much you can spend each year in retirement. When you combine your retirement income sources with the income generated from your assets, the result will be your total retirement income before taxes. You (or your financial advisor or CPA) will need to estimate how much you will owe in taxes and subtract that from your total income to arrive at your after-tax income.
The nice thing about retirement is that you no longer have to save, so you can spend 100% of your after-tax income if you want. Keep in mind, the cost of living will increase over time, so you will need to make sure your plan allows you to increase your spending over time if you want to maintain your current lifestyle.
How you invest your money will have a significant impact on your retirement. The “right” investment allocation will depend on your financial goals and tolerance for fluctuation in your account balance.
The most important investment decision is how much you will invest in stocks vs. bonds. Stocks fluctuate wildly but offer the potential for significant long-term growth. High-quality bonds are very stable but don’t provide much growth potential.
Once you figure out your ratio of stocks vs. bonds, you have to decide how you’ll diversify your portfolio across different types of stocks and bonds, what investment vehicles you’ll use (for example, mutual funds, ETF’s, individual stocks, etc.), and when you’ll rebalance your portfolio.
If you’re like most people, withdrawals from your investment portfolio will make up a substantial portion of your retirement income. If you want to maximize your retirement lifestyle while minimizing the likelihood of running out of money, your portfolio withdrawal strategy must account for your specific time horizon, asset allocation, and financial goals. You also need a system for identifying when to adjust your portfolio withdrawal amount based on the investment returns you earn throughout retirement.
It’s common to retire before retirement income sources such as Social Security or pension income begin. If that is the case for you, you need to make sure you can withstand larger portfolio withdrawals until those income sources start.
Minimizing taxes throughout retirement will keep more money in your pocket, reduce the likelihood of running out of money, and maximize the legacy you leave to your children or charity.
Fortunately, there are many opportunities to reduce taxes through smart planning. For example, if you have multiple types of investment accounts, withdrawing from your accounts in the right order and holding your investments in the right type of accounts (known as “asset location”) can lead to substantial tax savings. If your income is low, there may be opportunities for Roth Conversions or Capital Gain Harvesting.
These are just a few examples of the many possible strategies that are used by retirees to minimize taxes over their lifetime. The strategies you use will depend on your specific financial circumstances.
Most pension plans have multiple options for claiming your benefits. For example, you may be able to claim a lump sum or guaranteed income with various survivor percentages for your spouse if you die.
Your retirement plan should compare the various benefit options so that you can choose the option that is best for your life. It’s particularly important to carefully evaluate the tradeoffs between choosing a lump sum option vs. a guaranteed income option (often called an “annuity” or “pension” option) because they are two very different animals.
The best option for you will depend on multiple factors including your preference for guaranteed income, emotional tolerance for fluctuation in your investment portfolio, your tolerance for changes to your retirement income, your legacy goals, and your spouse’s need for income if you die before them. I wrote about the considerations involved in this decision in more detail in my article Lump Sum Vs. Annuity.
Social Security is the largest source of guaranteed income for most retirees. The rules of Social Security are complex, but at the simplest level, you have the option to claim benefits anywhere between the ages of 62 and 70. For each year you delay claiming past 62, your benefit will increase up until you turn 70.
Changing your Social Security claiming age can have a material impact on your financial plan, so it’s important to test various claiming strategies to find out which option maximizes your income and minimizes the likelihood of you running out of money.
Keep in mind, you don’t necessarily have to claim Social Security the same year you retire, but if you plan to delay claiming your Social Security benefits beyond your retirement age, you’ll need a plan for how you’ll cover your retirement expenses in the years before your benefits begin.
If you want to learn more about the ins-and-outs of Social Security, I recommend you check out Jim Blankenship’s book, “A Social Security Owner’s Manual.”
Healthcare is one of the biggest expenses for retirees. Health insurance premiums and potential out-of-pocket costs must be included in your retirement planning to ensure you can cover these expenses.
It’s particularly important to account for healthcare expenses if you plan to retire before you become eligible for Medicare at age 65. If you can’t get health insurance through your employer or your spouse’s employer, you can purchase health insurance through the healthcare marketplace, which can be extremely expensive. Sometimes, you can keep your income down through smart planning and qualify for a health insurance subsidy to partially offset the cost of insurance, but that’s not always possible.
The planning isn’t over when you turn 65. Once you’re eligible for Medicare, you’ll need to decide whether you will choose Traditional Medicare or a Medicare Advantage Plan. If you go with Traditional Medicare, you’ll have to research and select a prescription drug plan and a Medigap policy. If you choose a Medicare Advantage plan, you’ll need to research plans in your area.
Long term care expenses represent a substantial, highly uncertain expense to retirement plans with costs ranging from $0 to several hundred thousand dollars.
According to an article published by Morningstar1, approximately 40% of individuals who reach age 65 will go into a nursing home. Of the people who do go into a nursing home, the average stay is 2.44 years, and about one out of ten stays longer than five years. The cost of care varies tremendously depending on where you live and the type of care you receive, but the national average cost of a private room in a nursing home is just over $100,000/year according to Genworth’s 2018 Cost of Care Survey2.
If you want to ensure you can fund the costs of high-quality long term care without depleting your assets, you need to plan for these expenses in advance. You can buy long term care insurance or “self-fund” long term care expenses by setting aside money for that purpose. There are pros and cons to each of those options, and you ultimately have to decide which choice is right for you. If you’d like to read more about using insurance vs. self-funding, check out my article: Should I Purchase Long-Term Care Insurance?
The unfortunate reality is that many people can’t afford the cost of insurance and don’t have enough money to set aside for long term care expenses. In these cases, you may choose to exclude long term care expenses from your plan to allow you to enjoy your healthy years. If you end up needing long term care, you’ll spend down your assets and rely on Medicaid to cover your expenses.
If you’re married, you need to test the impact of you or your passing away earlier than anticipated. An early death usually causes a reduction in income due to the loss or reduction of pension or Social Security income.
Your retirement plan should determine how much you or your spouse could spend if one of you passes away early on in retirement. You want to make sure that the surviving spouse will have enough income to support their lifestyle. If that’s not the case, you should adjust your plan and may need to consider purchasing life insurance.
Very few people have the expertise to answer all of these questions on their own. If you need help developing a solid retirement plan, I recommend finding a fee-only financial advisor to guide you through the process. The stakes are high when you transition into retirement. Good financial planning and investing can be the difference between running out of money and leading a happy, stress-free life.
- 40 Must-Know Statistics About Long-Term Care by Morningstar
- Cost of Care Survey 2018 by Genworth
Blog Posts by David Ruedi, CFP®, RICP®:
- Should I Purchase Long-Term Care Insurance
- Concentrated Stock with Large Gains
- Do You Have Your Retirement MBA?
- The Psychology of Social Security Claiming
- What to Expect When You're Investing
- You Can't Rely on the 4% Rule
- Lump Sum Vs. Annuity
- What Does a Financial Planner Do?
- Preparing for the Later Years of Retirement