How to Retire in 2021
Steps for a Smooth Transition Into Retirement
Retirement is a major life milestone and it comes with many changes. Your routine will be different, your finances change, and the general transition can be mentally and emotionally taxing. If retirement is on your calendar for 2021, it’s time to make or review your plan so the process is as smooth as possible. Nobody teaches you how to retire when you leave your job, but the steps below can get you started on the right foot.
1. Save the Dates You Don’t Want to Miss
Maximize benefits and avoid being penalized by scheduling essential retirement-related milestones on your calendar.
Apply for Social Security 4 Months in Advance
Sign up for Social Security benefits four months before you’d like to start receiving income. It’s the earliest you can apply, and it gives the Social Security Administration time to process your request.
Most people can take Social Security retirement benefits as early as age 62. However, you get a bigger monthly payment if you wait until your full retirement age. Full retirement age is between 66 and 67 years old, depending on what year you were born. If you claim early, your benefits are permanently reduced. Plus, if a surviving spouse takes over your benefits, the amount they receive is based on the reduced amount.
To maximize your monthly Social Security income, wait until age 70 to claim. When you delay claiming after your full retirement age, benefits increase by as much as 8% per year.
Sign Up for Medicare 3 Months Before Age 65
Most people get Medicare at age 65, and you can sign up for Medicare as early as three months before the month you turn 65.
If you’re still working as you approach age 65 and your job (or your spouse’s job) provides health care, ask your benefits department and insurance providers how to handle Medicare. The rules are extremely complicated. You might need to sign up for Medicare even if you have group health coverage, and missing your first enrollment deadline can cause significant problems, such as a gap in coverage and a late enrollment penalty.
If your employer provides retiree health care, you most likely need to enroll in Medicare as well. Retiree programs typically complement the benefits you get from Medicare, offering things like prescription drug coverage, for example. However, it’s smart to compare your employer’s retiree benefits against alternatives like Medigap and Medicare Advantage plans.
If You’re 72, Set Up RMDs
If you have money in pre-tax retirement accounts, the IRS requires you to take required minimum distributions (RMDs) from those accounts each year after you’re 72. Examples include:
- Traditional IRAs
- 401(k), 403(b), and 457(b) plans
- SIMPLE and SEP plans for small businesses
- Other retirement accounts with pre-tax money
If you reached age 70 on or after July 1, 2019, you do not have to take RMDs until you turn 72. Technically, you can wait until April 1 of the year following the year you turn 72 to take your first RMD. That might make sense if you want to hold off as long as possible, but you don’t have to wait that long if you don’t want to.
The penalty for missing an RMD is 50% of the amount you were supposed to withdraw. For example, if you were supposed to take $10,000 and failed to do so, the excise tax would be $5,000.
When your money is in a workplace retirement plan like a 401(k), you might not need to take RMDs until after you retire (unless you own more than 5% of the employer sponsoring the plan).
2. Plan for Health Care Expenses
According to Fidelity Investments, a 65-year-old couple should plan to spend $295,000 out-of-pocket on health care expenses during retirement (ignoring potential long-term care costs). While that number is staggering, you’ll spread those costs over the rest of your life.
If you’re at least 65 years old, you’ll probably use Medicare for basic services like doctor visits and hospital stays. If you paid Medicare taxes while working, you should ideally pay no premium for Medicare Part A. If you didn’t, you’ll pay up to $458 per month in 2020, and $471 per month in 2021. The standard premium for Medicare Part B is $144.60 per month in 2020 and $148.50 in 2021, though it could be higher depending on your income.
Traditional Medicare does not cover things like long-term care, hearing aids, and routine dental and vision care. You can purchase additional insurance from private carriers to get help with those expenses.
If you retire before age 65, you need to figure out how to stay insured until Medicare kicks in. Several options include:
- Continuation of benefits: You might be able to keep your employer’s health plan for up to 18 months with COBRA (or state continuation programs, if you work for a small organization). If you go this route, expect to pay a substantial amount. Your former employer typically stops paying for your coverage, so you’re responsible for 100% of the premiums.
- Spouse’s plan: If you have a spouse with employer-provided health insurance, you can potentially switch to that plan. This may be a relatively affordable option if the employer pays a significant portion of monthly premiums.
- Individual policy: You can purchase health insurance directly from an insurance company. Check your state’s health care marketplace for more details. Be prepared for sticker shock because health insurance for older adults may not be cheap.
- Retiree health care from an employer: Some organizations offer post-retirement health care coverage. If you’re fortunate enough to have that option, compare the retiree health care package to other alternatives. Some employers provide a subsidy to help you pay for retiree coverage, making it easier to stomach, but you still might be better off with an individual plan or a spouse’s coverage.
Once you’ve estimated how much health care coverage will cost, be sure to include it when determining your overall need for income.
3. Know Your Income Needs
An essential part of a successful plan is determining how much money you need on an annual basis. Having a target helps you know if you’re on-track or if you need to make adjustments. Ask yourself how much you plan to spend each month, and what additional expenses might come up each year. There are at least two ways to estimate your spending in retirement.
Income Replacement Ratio
You might assume that you’ll spend at a similar level in retirement, with a slight reduction in spending. For example, you no longer need to pay payroll taxes or save money for retirement. Plus, any expenses related to work (like commuting and clothing) may be significantly reduced.
An income replacement ratio can help you estimate how much of your current income you will need. According to the U.S. Government Accountability Office, target income replacement rates typically range between 70% and 85% of pre-retirement income. Fidelity found rates to be somewhat lower—between 55% and 80%. If you currently earn $100,000 per year, based on an 80% replacement ratio, your target becomes replacing $80,000 of annual income.
Using your current income as a base can be problematic if your expenses change. For example, if you’re responsible for your own health care premiums when you retire (and your employer has been paying insurance premiums for you), an income replacement method might not sufficiently account for the added expense.
Detailed Monthly Budget
A more granular approach is to make a list of your expenses, similar to a monthly budget. This method allows for the most control and insight into your spending. You can remove expenses that are temporary (if you’ll pay off the mortgage after eight years in retirement, for example) and budget for periodic items, like a big vacation every three years.
To create a detailed spending plan, start by tracking your current spending over several months. Add irregular costs (quarterly or annual payments, such as insurance premiums or property taxes), plus the estimate of health care costs calculated above. Don't forget to add any other costs you anticipate during retirement.
Set a spending goal no matter what method you use. With a spending plan in place, you can better avoid unpleasant surprises and improve your chances of having the resources you need available.
You’ll never predict the future perfectly, but you need a starting point. Do the best you can with the information you have today.
4. Inventory Your Income and Assets
Social Security benefits and any pensions from an employer are two common types of income and are considered “guaranteed.” Those payments are likely to last for your entire life, and they don’t depend on how your investments perform.
Your ultimate goal is to figure out how to retire comfortably with that base of income plus supplemental withdrawals from your retirement savings accounts.
When we talk about retirement savings, we're referring to all money you've earmarked for retirement, whether it's in an official retirement account like an IRA, invested in a taxable brokerage account, or simply cash in the bank.
Nine out of 10 people age 65 and over receive Social Security benefits, and the average retirement payment was $1,514 per month in 2020. Your monthly benefit might be higher or lower, depending on your earnings history and when you claim benefits. Review your Social Security statement to understand how much you can expect to receive at different ages.
Unfortunately, the calculations that determine your monthly Social Security payment are getting less generous, especially after 2021. The penalty for claiming early, before full retirement age, is not new, but as the full retirement age rises (from 66 to 67 years old, depending on when you were born) your benefits are reduced more now than they used to be.
For those born in 1955 or later, the full retirement age rises more quickly than in years past. As a result, claiming early leads to increasingly severe benefit cuts. And if you delay claiming, the calculation is also less generous: Your benefit amount stops growing once you reach age 70, so you have fewer years to get those delayed retirement credits.
If you’ll receive pension income from an employer, you can include that income in your “guaranteed” base. But you need to find out if your pension will interfere with Social Security retirement benefits. For example, some people have worked for both private organizations that pay into Social Security, as well as government organizations that do not. When that’s the case, you might see your Social Security benefits reduced or eliminated altogether. Ask your employer and the Social Security Administration if you need to worry about the Windfall Elimination Provision or Government Pension Offset.
Retirement and Savings Accounts
Guaranteed sources of income might not meet your spending needs. If that’s the case, you’ll need to withdraw from your accounts to supplement your base income.
Your retirement assets are most likely in an employer-provided retirement plan like a 401(k), 403(b), or 457 plan. Additionally, you might have savings in IRAs, annuities, high-yield savings, or taxable accounts. Take stock of where all of your money is and how it is invested. As you near retirement, you need a plan for managing and drawing on those assets.
If you need help strategizing your withdrawals or finding the right investment mix in retirement, a financial planner can help you create an income plan.
5. Review Your Investment Risk
Your first few years in retirement are critical for your investments. Market losses in those years can have a surprisingly large impact on your chances of success—and increase the odds of running out of money.
Completely eliminating risk (keeping everything in cash) leaves you vulnerable to inflation: You might find it hard to keep up with rising prices and pay for the things you need over several decades. But taking too much risk can backfire. Finding the right risk level is challenging because you need to make assumptions about the future and weigh the pros and cons of different portfolios.
This is another situation in which talking to a financial planner can be prudent. They can help you allocate risk across the investments in your portfolio in a way that reflects your income needs and risk-tolerance level.
If you’re not sure how much risk is appropriate, use a risk tolerance questionnaire to help you decide. Simply going through the exercise should help you think about what’s at stake and how various events might affect your finances.
6. Make a Withdrawal Plan
The best way to plan your retirement is to estimate year-by-year cash flows from your savings. But if you just want a high-level strategy, two popular approaches can help you understand how to manage withdrawals in retirement.
The amount you withdraw should be able to fill the gap between your guaranteed income sources and the amount you need to spend. Ideally, you can withdraw what you need without depleting your assets, and the strategies below might help you accomplish that.
If you’re facing a shortfall—and you won’t have enough assets to adequately fill the gap—you may need to make some changes. Two potential (but probably unwelcome) solutions are to delay retirement or plan on spending less each year.
The 4% Rule
Retirees often wonder how much they can withdraw from their accounts. The answer depends on several factors, and there’s no way to know in advance exactly how much you’ll earn (or lose) on those accounts. The 4% rule might help with initial estimates.
The 4% rule says that you can:
- Withdraw 4% of your retirement account each year
- Increase withdrawals with inflation
- Expect the funds to (hopefully) last for 30 years
There is no guarantee that your money will last for 30 years with the 4% rule, and your results depend on your investment mix and market behavior. That said, the rule was designed to survive some of history’s worst financial periods.
The 4% rule assumes that you invest 50% of your money in stocks and 50% in bonds. When taking income, you would likely sell a portion of your stocks and a portion of your bonds to keep the target allocation at 50/50. That said, this is a rule of thumb, and some variation is acceptable.
A bucketing strategy involves planning your withdrawals with different time segments, or “buckets.” For example, you might imagine the withdrawals you need to take and put them into three buckets:
- The next four years (your first few years of retirement, 2021 through 2025)
- The subsequent six years (2026 through 2031)
- The remaining years of your retirement (2032 and beyond)
For your first bucket, use safe investments, such as cash in government-guaranteed bank and credit union accounts. You don’t need to worry about what financial markets do—that money is safe, and you can spend according to your plan in the first few years. The second bucket might invest in a relatively low-risk mix of investments, such as a portfolio of mutual funds with 30% in stocks and 70% in fixed income. Over time, you replenish the first bucket from this portfolio.
The third bucket, which holds funds that you probably won’t touch for at least 10 years, could go into higher-risk investments. For example, you might build a portfolio of mutual funds with at least 70% of your money in a broadly-diversified stock portfolio. The goal for that bucket is to pursue long-term growth, but that doesn’t mean you need to take excessive risks. Over time, refill the second bucket with some of the money in your third bucket.
The bucketing strategy might not be the perfect retirement income strategy. That said, it is an intuitive strategy for risk-averse retirees, and it provides some peace of mind.
7. Don’t Forget About Taxes
Taxes leave you with less spending money each year, so you need to include taxation in your income plan. These are some of the biggest issues for retirees:
- Funds you withdraw from pre-tax accounts like 401(k) and 403(b) plans are subject to income tax, plus an additional 10% tax for early withdrawals (typically withdrawals made prior to age 59 ½).
- Pension income is usually taxable, so you can’t necessarily spend every penny of the income you receive.
- If your total income (including distributions from pre-tax retirement accounts) is high enough, your Social Security benefits might be partially taxed. For single filers, taxation on your Social Security starts when you reach $25,000 of income. For married couples filing jointly, the lowest threshold is $32,000 of annual income.
- A high income in retirement can result in increased Medicare premiums.
Before you retire, review how your taxes will affect your available income, Medicare premiums, and what percentage of your Social Security benefits will be taxed. And don’t forget to account for taxation on RMDs. It may be possible to reduce future taxes by selectively paying taxes in your early years of retirement.
Partial Roth conversions can help smooth out your taxable income and prepay taxes at today’s rates. That might make sense if you will have several years of relatively low income (before RMDs kick in, for instance), or if your investments decline in value.
8. Enjoy Your Retirement
With the steps above, you can address some of the most critical financial aspects of a successful retirement transition. Planning helps you improve the chances of getting the income you need for the rest of your life (and dodging some of the biggest retirement pitfalls).
With these steps behind you, you’re in a good position to focus on the most important things—like your relationships and spending your retirement years in a meaningful way.
- Keep track of important milestones to avoid penalties and maximize your retirement benefits.
- Determine how much you need to spend, and compare that need to any retirement income.
- You’ll probably spend down your assets over the rest of your life. Make a plan to avoid running out of money too soon.
- Health care expenses are uncertain, so start with some estimates and include those costs in your plan.
- Remember that taxes reduce how much you can spend on the things you need. Estimate how much you’ll pay, and explore ways to minimize your taxes in retirement.
The Balance does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.
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