By Jenny C. McCune
Bankrate.com
Retirement is on the horizon. You've planned diligently for the day you can quit working and start enjoying your post-employment lifestyle. But the actual mechanics of moving from collecting a paycheck to retiring on your savings and, for some lucky retirees, a pension, is more complicated than you might think.
Which assets do you tap first? How much money can you withdraw? Where do you get medical coverage? Finding the answers to these questions can befuddle the most conscientious retiree wannabe.
Kevin O'Fee, managing director of Retirement Planning Services at New York Life Investment Management in Parsippany, N.J., likens retirement planning to the Mona Lisa and transitioning into retirement to a Picasso abstract. Da Vinci's signature portrait is well-defined and structured, while Picasso's abstract works are just as beautiful, but more difficult to interpret.
Retirement Timing
The first question to answer as you head toward retirement is when should transition planning begin? Most experts say to start preparing and researching at least a couple of years before you intend to leave the workforce. The more time you leave for preparation, the easier it will be to meet your goals.
"You need to take as much of the mystery out of your retirement as possible," says Jim Bell, president of Bell Investment Advisors in Oakland, Calif.
Once you decide your timetable, then it's time to look at three specific retirement areas and how you plan to meet them:
1. Income needs: What income streams can you expect? Do you have a pension? How much is it and will the amount vary on when you retire? Also look over your personal retirement accounts. This includes 401(k) plans, individual retirement accounts, both traditional and Roth IRAs, as well as your savings and stock investments.
2. Expected expenses: Conventional wisdom is that a retiree needs 80 percent of his salary to retire comfortably. However, the actual amount can vary considerably depending on what type of life you're going to lead.
If you're planning to travel widely, that could increase what you'll need beyond the 80-percent mark. On the other hand, if you plan to work part-time for a while after your official retirement, you might not need as much cash upfront. Similarly, if you sell the family home and downsize to a condo, that could lower your retirement income needs. The living expense difference could be even more dramatic if you move to a small home in another region with a lower cost of living. The point is to make a realistic appraisal of how much money you'll need.
3. Life expectancy: Back when Social Security was instituted, people were lucky to live to 65. Now many of us are living into our late 70s, 80s and even 90s. Remember that annual life expectancies are medians, not averages. If you're healthy, you could live way beyond your age group's life expectancy. How long you anticipate living will impact how much money you will need for retirement. Obviously, the longer your life, the more years you'll be retired and the more income you will need.
Your answers to the questions raised in these areas should give you a reasonable idea of whether your planned retirement schedule is doable. If so, then it's time to look at some specifics to move from working to retiring.
Insurance Requirements
Financial responsibilities can lessen during retirement, reducing or eliminating the need for certain kinds of coverage, particularly life insurance. For most retirees, the kids are no longer financial dependents and your spouse will inherit your retirement income upon your death. That means you may be able to get by without a life insurance policy. Don't overlook your home and auto coverage. You may be able to cut back here, too.
But those premium reductions might be offset if you purchase a long-term care policy. New York Life representative O'Fee is an advocate of such insurance. "For some people, it is the right thing to do," O'Fee says. "I just bought some and I just turned 47."
Steve Vernon, however, believes that such insurance is a bad investment since it requires you to spend enormous sums for coverage you might not need. Vernon, author of Live Long and Prosper: Invest in Your Happiness, Health and Wealth for Retirement and Beyond (Wiley, John & Sons, 2004), recommends skipping the long-term care policy and saving what you spend on insurance premiums, between $1,000 and $2,000 annually. That way, he says, if you do require long-term care, you can just tap that savings account and the money will belong to you no matter what.
Rx for Retirement Health Care
One insurance area where retirees generally need more than their still-working colleagues is health care coverage, including prescriptions. You'll be eligible for Medicare at age 65. If you quit working before then, check with your employer to see if as a retiree you can get continued company health benefits. Married retirees might be able to get health-care coverage as part of a still-employed spouse's company provided plan.
If there's a health-care gap, consider buying catastrophic health insurance with a high deductible, says Vernon, who also is the Los Angeles retirement consultant for Watson/Wyatt. The monthly premiums are low enough so you'll be able to afford this coverage and if a catastrophic illness such as cancer strikes, it won't wipe you out financially, he says.
Decide Which Income Stream to Tap First
Choose which income source you want to initially draw from based on how you can maximize that income or eliminate any potential penalties. For example, put off tapping Social Security until your 70s. That will give you the largest check from Uncle Sam. Just be sure to run the numbers to make sure waiting really works for you.
As you wait for your government money, you may be able to start accessing your 401(k) without incurring any early-withdrawal penalties if you've turned 55. Don't forget the other tax implications. Whether you take your pension in a lump sum or in monthly payment could make a difference in how much tax you pay, says Jonathan Sard, a certified financial planner with Financial Alternatives of Atlanta.
Also examine which other funds that are not in retirement accounts, such as stocks or mutual funds, that you can cash in and pay only long-term capital gains taxes, which are lower than regular income rates.
Since individual circumstances vary greatly, it makes sense to go over your accounts, retirement and otherwise, with a financial adviser who is familiar with your unique situation.
Don't Withdraw Too Much Too Quickly
"You'll need a critical mass of investment to ensure a steady income," says Wells Fargo's Guthrie. If there's a gap between income and expenses in your early retirement years, she recommends bridging the gap by means other than withdrawing excessive amounts from your retirement funds in your early days of retirement.
Guthrie says a financially strapped retiree also could tap a home equity line or try a reverse mortgage, although she's not a big fan of either. If the numbers don't look good, Guthrie says the best thing is to postpone retirement for a couple of years and ensure your nest egg is large enough to carry you through your non-working years.
Re-Examine Your Asset Allocation
Since we're living longer and our retirement funds must last longer, it's no longer prudent to switch all your funds from high-risk, high-yield investments such as the stock market to low-yield investments with guaranteed returns in the early years of retirement. That said, your financial planner may wish to tweak the make-up of your retirement investments, and these should be re-examined as you age.
You also might want to consolidate retirement funds to increase your returns or examine switching to annuities. This can guarantee a set income stream, but take note of how it may increase or decrease your return and what administrative fees apply.
Update or Create an Estate Plan
In addition to determining how to make your money last the length of your retirement, you also need to look at what happens afterwards. If you haven't looked at your will in a while (or don't have one), reassess its provisions now. It's also a good time to draw up a living will.
In addition, make sure you've named beneficiaries for all the assets that require them. Be sure all these changes reflect any changes that might have been brought on by your retirement.
Easing Into Non-Working Status
Many financial experts say the "soft" side of retirement, how you plan on keeping yourself occupied once you are retired, is just as important as the financial logistics. For a lot of people, going cold turkey by stopping work entirely at age 65-plus isn't practical, from either a financial or a satisfaction perspective. Studies show that retirees who are active tend to live longer and be happier.
"Figure out how you will spend your time. Retirement can be a big emotional change for people," says Louisa Guthrie, senior vice president and regional manager of Wells Fargo's Private Client Services in Chicago.
California financial adviser Bell urges his clients to test drive retirement first. "It's good to start practicing while you're still working," Bell says. "Volunteer at the senior center. Go fishing. Find out whether you're going to get quickly bored or will really enjoy your retirement."
Working part-time through the early years of your retirement also will boost your income (just make sure it's not so much it also ups your tax bill, too) and still give you more free time than when you worked full-time, says Vernon.
Jenny C. McCune is a contributing editor based in Montana.
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