Approaching your retirement date is exciting, but it can also be scary. Once you quit your job for good, you're entirely dependent on whatever sources of retirement income you've developed during your working years, plus whatever you might be able to earn after you retire. If that money comes up short, you could spend retirement barely scraping by instead of living life to the fullest.
Luckily, there's a pretty reliable way to avoid that frightening predicament.
Picking the right retirement date
Many retirees choose a retirement date based entirely on age. It might be age 62, because that's when they can first claim Social Security; age 65, because that's the "traditional" age for retirement; or some other age that just seems like the right point at which to quit working. The problem is, age isn't the only (or even the most important) factor in deciding your retirement date. Instead, you should your retirement date should be the day on which you'll have sufficient sources of income to keep you going indefinitely.
Finding your retirement income sources
Most retirees can depend on at least two sources of retirement income: Social Security benefits and the balance in their 401(k) or IRA. If you're fortunate enough to have other sources of income, such as a workplace pension, so much the better.
Pulling up your Social Security statement (which you can do by creating an account on ssa.gov) will give you a good idea of how much you can expect in Social Security benefits. However, this number isn't entirely dependable. For one thing, if you're still years or even decades from retiring, you can expect considerable changes to your earnings during the intervening years -- and those changes will affect your benefits. If your career suffers a setback and your earnings drop, so will your Social Security benefits. If you're promoted and your paycheck flourishes, the opposite will happen. Once you get closer to your retirement date, changes to your earnings become less of a factor, but there's still a definite possibility that the program itself will either suffer cuts or receive additional funding. The bottom line: Don't expect your Social Security statement to be right on the money.
You have more control over your retirement savings, but they're still somewhat dependent on the fortunes of the stock market and the health of the economy. If the stock market is booming when you retire, you're in luck: You'll be able to take fairly generous distributions from your accounts without depleting them. But if the market suffers a major crash right around the day you retire, your investments may not be able to generate the income you need.
Projecting your retirement income
So how do you figure out how much retirement income you'll really have? For starters, it's better to be pessimistic than optimistic. In an ideal world, you wouldn't factor Social Security benefits into your retirement income calculations at all. If you treat those benefits entirely as extra money, then cuts to the program and similar issues won't cause any trouble for your retirement plans.
Unfortunately, most workers can't afford to finance retirement entirely with their savings. If you're one of them, try assuming that you'll receive 80% of the benefits listed on your Social Security statement for your planned retirement date. That way, if you do indeed get all of your estimated benefits (or more), you'll have some extra money to play around with; but if benefits are cut shortly after you retire, you'll still be OK.
As for your retirement savings, it's best to assume that during your first few years of retirement you'll take no more than 3.5% per year of the total balances in those accounts. If the stock market flourishes you'll likely be able to take more than that, but if you happen to retire at a moment when the market is not doing so well, you should still have ample income while leaving enough capital for future years. For example, if you have $600,000 in your 401(k), multiply that number by 0.035 and you'll see that you can safely take out at least $21,000 per year after you retire.
You can estimate how much you'll have saved up by using a retirement calculator; it's best to assume no more than a 7% average annual return, which is the historical average of the stock market (including inflation). For example, let's say you're 40 and plan to retire at 67, your current 401(k) balance is $100,000, and you're contributing $5,000 per year. The calculator will tell you that your balance at retirement will be $1,019,875.
What if it's not enough?
Let's say you combine 80% of your projected Social Security benefits with 3.5% of your retirement account balances, and the resulting total isn't enough for you to live on (something that you can determine using a retirement expense calculator). In that case, you'll likely need to delay your retirement by a few years in order to improve those numbers. Delaying your retirement helps in two ways: First, it can increase your Social Security benefits, and second, it gives you more time to build up your retirement savings balances.
Your Social Security benefits are partly dependent on your age at the time you first claim them. Claim your benefits before "full retirement age," and you'll be penalized by up to 30%; claim them after full retirement age, and you'll get delayed-retirement credits that can increase your benefits by as much as 24% over the base amount.
For example, let's say your base Social Security benefit amount is $1,500 per month. If you retired and claimed your benefits at age 62, you'd get just $1,050 per month in benefits. If you waited until age 70 to claim your benefits, you'd max out your delayed retirement credits and end up with a benefit of $1,860 per month. By waiting eight extra years and retiring at 70 instead of 62, you'd increase your retirement income by $9,720 per year for the rest of your life.
Delaying your retirement can also help improve your retirement savings balances, but only if you do your part by making contributions. In fact, your best course of action at this point is to contribute as much as you can, right up to the annual contribution limit if possible. The money you contribute won't have a great deal of time to grow, so you need to max out those contributions to really make a difference in your future income.
It's no fun to put off the retirement you've been anticipating for years, but if doing so will ensure that you can spend retirement free from money worries, the wait will be more than worth it.