If you've been responsibly saving for your retirement over the years, congratulations!
However, while successfully building a nest egg is quite an accomplishment, remember that what you do after you retire can be just as crucial to your long-term financial health as what you did to prepare for your retirement. In other words, after you retire, you need to have a plan.
Determine your income needs and take stock
If you're getting close to retirement, now is a good time to evaluate your situation and figure out how much income you may need after retirement. Check your accounts regularly, and see if you might need to boost your contributions in order to catch up.
A good rule of thumb is that you'll need about 80% of your pre-retirement income in order to maintain your quality of life after you retire. So, if your final salary from your job is $100,000, plan on needing about $80,000 in income during your first year as a retiree. Then figure out where that money will come from.
Or better yet, start coming up with a post-retirement budget in order to get a more accurate idea of your income needs. Many people find that they can live comfortably on much less than 80% of their pre-retirement salary -- especially those who lived relatively cheaply before retiring -- so do some number-crunching to see how much you'll need. The Teachers Insurance and Annuity Association of America has a good template to help you start budgeting.
Now is also a good time to go to the Social Security Administration's website and estimate how much income you can expect to receive from Social Security. Subtract this amount from your estimated income need, along with any income you'll have from a pension or other sources, and you'll have an estimate of how much income will need to come from your savings -- 401(k)s, IRAs, etc.
Many experts say that in order to ensure that your money lasts as long as you do, you should plan to withdraw 4% of your savings in your first retired year, and then increase this amount each year to keep pace with inflation. Although you should never take such simple blanket advice as gospel, it can help you estimate how much money you'll need to save up for retirement. So divide the amount you'll need to withdraw from savings each year by 0.04. If your nest egg is coming up short, it may be time to buckle down and increase your savings rate as much as you can.
What to do with your savings now
One common mistake retirees and pre-retirees make is getting far too conservative with their investments. Specifically, many people aim to reduce risk by moving out of stocks and into fixed-income investments like bonds. While it's true that bonds produce a steady, predictable stream of income, there are a few problems with this approach.
First of all, investing all of your money in bonds virtually guarantees that your portfolio won't keep up with inflation. If you have a $1 million portfolio and invest it all in 30-year Treasuries, in 30 years your investments will still be worth $1 million. So your income needs will rise as your cost of living gets more expensive, but your income will stay the same, and you won't have any more assets with which to generate additional income.
Secondly -- and this is especially true right now -- bond prices can fall dramatically as interest rates rise. And the long-dated bonds that pay the highest interest get clobbered the most. The value of a bond is based on the interest rate it pays (coupon rate) relative to the prevailing market rates. So, if you buy a 30-year Treasury with a 3% coupon rate, and the market rate spikes to 4%, your bond could lose nearly a third of its value. I realize that retirees generally don't plan to sell bonds anytime soon, but if you get in a bind and need to free up some cash, bonds are the last place you want all of your money to be.
One rule of thumb is to subtract your age from 110 to determine what percentage of your portfolio should be in stocks. For example, a 75-year-old might have roughly 35% in stocks and 65% in bonds. This will allow your portfolio to grow over time and will help your income stream grow without forcing you to sell your investments. If you can stomach a bit of risk, you might even subtract your age from 120 and leave a greater portion of your portfolio in stocks. It all comes down to how prepared you are, both financially and emotionally, to take some risk in exchange for higher growth potential. Check out this article for more information about stocks that make great retirement investments.
Use some strategy with your withdrawals
Many retirees have several different account types, such as 401(k)s, IRAs (traditional or Roth), and regular brokerage or savings accounts. And the order you tap into them can make a big difference.
When you first retire, your best bet is to use taxable accounts first in order to allow your tax-advantaged retirement savings to continue to grow.
Once your taxable accounts are used up, the next logical place to withdraw from is your traditional IRA and 401(k) accounts. These accounts require you to start taking distributions by the time you reach 70-1/2 years of age, and the money you withdraw will count as taxable income.
It generally makes sense to tap into Roth IRAs last, as they have no minimum distribution requirement, and all qualified withdrawals are tax-free. So it makes sense to allow money in these accounts to grow for as long as possible, as you won't take a tax hit no matter how big it gets.
A great first step
Coming up with a financial plan for your retired life is a great first step, but it's important to re-evaluate things every so often. For example, after your first year, if it seems like your savings are being depleted a little faster than you'd like, it may be a good idea to cut back.
In other words, the best thing you can incorporate into your retirement planning is adaptability. Life happens, so it's best to be prepared to adjust your strategy accordingly.
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