One of the most pressing concerns for many people is whether they will be able to achieve financial security during their retirement years, particularly if they intend to retire at a relatively young age. It’s a crucial question to consider, as nearly half of the individuals end up retiring sooner than they originally anticipated, whether by choice or due to unforeseen circumstances like illness or job loss. This means the savings you have accumulated throughout your career will need to last longer, even if you stop contributing to your retirement accounts like a 401(k).
Retiring at 55, for example, can have different implications compared to retiring at 65. People in their fifties may need to make their retirement savings last an additional decade or more. Early retirees often face higher expenses, such as mortgage payments or tuition bills, and may have to cover the full cost of health insurance until they become eligible for Medicare.
Given these factors, it becomes crucial for early retirees to employ effective strategies to create a reliable “retirement paycheck.” They must consider questions such as: Will I be able to cover all my expenses and maintain my desired lifestyle during retirement? How much can I withdraw monthly without compromising my long-term financial security? What are the tax implications and trade-offs involved? Working closely with financial and tax advisors can help answer these questions and develop an income stream that supports you throughout your retirement.
Follow these six steps to create a “retirement paycheck” that can sustain you for 30 years or more.
1. Calculate Your Expenses
The first step is to sit down with your spouse or partner, if applicable, and your financial advisor to calculate your regular expenses. These typically include housing, food, transportation, insurance, and additional costs like charitable donations, education expenses, travel, and gifts.
2. Identify All Income Streams
Next, identify the sources of income you can utilize to create a monthly “paycheck.” This may involve considering severance packages, pensions, retirement accounts (such as traditional or Roth 401(k) or 403(b) plans, traditional and Roth IRAs), Social Security benefits, rental income, and disability benefits.
Once you clearly understand your finances, work with your financial and tax advisors to determine an appropriate overall withdrawal strategy. When planning for retirement, your advisor will consider various factors such as your assets, age, income sources, taxes, and other relevant information. If you are currently spending more than your estimated monthly retirement income, your advisor may suggest making changes such as postponing retirement, taking on part-time work, or adjusting the date for claiming Social Security benefits. It may also be necessary to identify areas where you can reduce expenses.
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3. Consider taxes
It’s not just about knowing how much you can withdraw from your income sources each month; you also need to consider each withdrawal’s tax and investment implications. Your advisors can provide guidance on the tax-efficient order of withdrawals. Generally, it is advisable to withdraw from taxable accounts first, followed by tax-deferred accounts, and finally, tax-free accounts. This sequence minimizes the tax impact, as withdrawals from taxable accounts are often taxed at lower rates compared to traditional retirement accounts.
4. Consider When to Start Collecting Social Security
Other considerations include deciding when to start collecting Social Security benefits. While you can begin at age 62, delaying can lead to increased benefits until age 70. Consult your financial advisor to evaluate whether claiming benefits earlier or later aligns with your financial goals. Additionally, if you have the option, consult your tax advisor regarding the implications of choosing between a lump sum or monthly pension payments.
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5. Review Your Investment Portfolio
Review your investment portfolio to ensure your retirement funds last for 30 years or more. In a low-interest-rate environment, an excessively conservative portfolio may not provide the necessary growth. Collaborate with your financial advisor to establish a suitable asset allocation mix that matches your risk tolerance and tax sensitivity. It is advisable to broaden your investment portfolio beyond fixed income, including dividend-paying equities, real estate investment trusts (REITs), and alternative investments, all within a well-considered diversification framework.
6. Conduct An Annual Review Of Your Retirement Plan
Lastly, it is essential to regularly review your retirement plan with your financial advisor. Market conditions, inflation, personal goals, and other factors can necessitate adjustments. By staying proactive and making informed decisions, you can effectively manage your retirement assets and have confidence in your financial future.
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