Though retirement can be a rewarding period of life, it can also be stressful, particularly from a financial standpoint. In fact, many retirees are caught off guard by rising expenses and inadequate savings, so much so that it puts a real damper on their golden years. Here are a few steps you can take before retirement to avoid falling victim to a similar fate.
1. Estimate your expenses
Many people expect their living expenses to drop dramatically in retirement, and it's that very assumption that dooms them from the start. As a general rule, you should expect to need about 80% of your pre-retirement income to live comfortably as a senior.
The reason? Other than contributions to a retirement plan (which you won't need to make in retirement), most of your living expenses are likely to stay the same. Some, like healthcare, might even go up. And when you think about the things you spend money on during your working years, it makes sense. It costs money to put a roof over your head, to own a car, and to cover utility bills. Similarly, your food and personal care needs won't decline in retirement, so why should your spending?
That's why it's wise to map out a retirement budget in the years leading up to that period, and figure out what your expenses are likely to cost you. Don't forget to account for things like entertainment and travel, especially since you'll have more free time to occupy. If your living costs start to look higher than what you might have anticipated earlier on, you can compensate by holding off on retirement a bit longer to save more, or by adjusting some expectations -- or both.
2. Understand Social Security's role in your retirement
Social Security helps millions of seniors pay their bills, but those benefits aren't designed to sustain you in retirement without additional income. If you were an average earner, Social Security will replace about 40% of your pre-retirement earnings, but we just learned that most seniors need about double that amount to maintain a decent lifestyle.
Now, you can take steps to boost your benefits by holding off on filing past your full retirement age. In doing so, you'll snag an 8% increase for each year you delay up until age 70, at which point that incentive runs out. Even so, don't expect your benefits to cover all of your living expenses in retirement, because chances are, they won't even come close.
3. Assess your savings
Once you create your budget and figure out how much income you'll need to cover your living expenses in retirement on a yearly basis, you'll need to make sure you have enough money in savings to stay afloat. One good way to do so is to use the 4% rule. The rule states if you begin by withdrawing 4% of your savings balance your first year of retirement, and then adjust subsequent withdrawals for inflation, your nest egg should, conceivably, last 30 years.
Now let's be clear: The 4% rule isn't perfect. But it is a good starting point to work from, especially since it can help you properly assess your savings.
Let's imagine you run the numbers and determine that you'll need $48,000 a year to pay your living expenses in retirement. Let's also assume that $18,000 of that will come in the form of Social Security benefits, leaving you with an annual gap of $30,000 to fill. If you multiply $30,000 by 25 as per the 4% rule, you'll arrive at $750,000 -- meaning, you should have roughly $750,000 in your IRA or 401(k) in time for retirement. If you're close -- say, you're sitting on $720,000 -- you can probably tweak a few expenses and make it work. But if you're looking at only, say, $600,000, you're best off delaying retirement, working a few extra years, and padding your savings before bringing your career to a close.
If postponing retirement isn't an option (maybe your company is closing and you're not sure you'll find a comparable job at your age), you can look at making major cuts in your budget, or continuing to work in some capacity to bridge the income gap you're facing. But make sure you have a plan if you enter retirement short on savings, because if you don't, you'll risk running out of money later in life.
The more you do to prepare financially for retirement, the less stress you'll encounter down the line. The above moves will help you avoid a host of money-related upheaval when you're older, so don't retire until you've checked all of them off your list.
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