Want Retirement Income? 4 Steps You Must Take
As you begin to think about where your retirement income will come from, take the time to work your way through the four steps below. They'll give you a great overview of the relevant issues to think about in order to create the retirement income you'll need.
Plan, Plan, Plan
One of my favorite quotes, by Jim Rohn, says, "If you don't design your own life plan, chances are you'll fall into someone else's plan. And guess what they have planned for you? Not much."
Whether you're one year away from retirement, five years away, or fifteen years out, start planning now. Read everything you can about retirement income strategies and investments. Those who plan will have more retirement income than those who don't.
One of the ways you can plan is by using an Excel spreadsheet or a piece of graph paper and begin to layout your retirement income plan in the form of an annual timeline. This helps you visually see what you'll have coming in and going out. You can also play around with some of the online retirement income calculators, but be cautious with your assumptions. A plan is only as good as the assumptions you use. For example, if you expect to earn average investment returns, well, that means during half the time periods you'll most likely get a result that is below average.
Averages are composed of good times and bad times.
Learn as If You Were Five
Rather than thinking about investment returns, now is the time to think about investment strategies that will maximize the reliability of your lifetime retirement income. You may need to approach this from a fresh perspective and unlearn old ways of thinking.
Sound retirement income strategies involve combining sources of guaranteed retirement income with investments that offer enough growth to allow your income to keep pace with inflation. This requires a different way of investing than what most people focus on during their accumulation years. The focus is no longer on getting the highest returns - it is now a focus on securing a reliable outcome.
As your planning gets more detailed you will want to address questions such as if you should pay off the mortgage before retirement. If you have a pension plan you'll want to look at the pros and cons of taking a lump sum distribution vs. a lifetime annuity. These decisions can have a big impact on your retirement security so you'll want to do your research instead of winging it. And don't rely on the old information you heard. There are many money myths out there which are not true.
We've also watched people make terrible decisions because they decided to do the same thing as their friend or co-worker without evaluating how that decision applied to their own situation. The decisions that are best for your neighbor or co-worker may not be the decisions that are best based on your circumstances. Each decision needs to be approached with an open mind.
Give Careful Thought to the "When"
Although you may be anxious to retire, you'll want to weigh out the pros and cons of retiring early. Early retirement, meaning before you reach 65, requires more savings or a willingness to live on less. One of the biggest early retirement expenses you'll face is the cost of healthcare. Once you reach age 65 Medicare begins and then some of this cost is subsidized. Up until then, health care insurance premiums can be hefty.
In addition, your ability to earn a living is a powerful asset; don't be too quick to cut it off. In the financial world, we call this your human capital asset. For many people, their career is one of the biggest assets they have and ending it prematurely can be expensive.
Choosing the right time to retire can mean the difference between an enjoyable retirement, or one fraught with money worries.
Calculate After-Tax Income
You may pay less in taxes in retirement, you may not. Don't use assumptions or guesses as they are likely to be wrong. Retirees regularly underestimate the impact taxes will have on them during their retirement years. Sometimes they forget about taxes altogether. For example, if you are using a rule of thumb like the 4% rule you may think you can withdraw $4,000 per $100,000 of savings. What if that $100,000 is in an IRA or 401(k)? After taxes, that may leave you with only $2,000 - $3,000 to spend.
When planning for retirement income, learn what sources of retirement income will be taxed. Then estimate your after-tax income so you know how much you'll have available to meet your living expenses. Keep in mind that many things will change over time. If you pay off your mortgage you may have less itemized deductions. As you get older you'll be required to take more of your IRA which means more taxable income and perhaps a higher tax rate. When Social Security starts, it may be taxed.
Hopefully, you'll only retire once. If you do your planning right, you'll have a successful transition into retirement. Working with a great tax professional or qualified retirement planner can help bring accuracy to these projections so you enter retirement knowing exactly what to expect.