Are You Ready for Retirement? There Are Many Factors That Go into Answering That Question

Today, more and more people are planning their retirement around their own internal evaluation of their readiness to retire rather than an external milestone such as a work anniversary, which was typical in the past. That means each person needs to carefully consider what their personal goals are, the importance of work in their everyday lives, and also their financial capacity to maintain their lifestyle when they stop earning a salary.

In this article we will look at a few of the considerations that pre-retirees will want to evaluate as part of their retirement planning.

Most people focus on how much they have saved for retirement. However, in retirement the most important metric is how much you spend. In our experience most people spend about the same amount of money each year in retirement as they did before they retired, excluding things like mortgage payments, which may change, and excluding potential additional travel expenses. You need to know your expenses in order to figure out your ability to retire.

It is surprising how few people know how much money they spend each year. Calculating your spending does not have to be a painful budgeting exercise. We like to suggest people choose either a bottom-up approach or a top-down approach depending on which suits them better.

In a bottom-up approach you start with a detailed worksheet and put in your monthly or annual expenses. Ideally you track your expenses for at least three months or more in order to get a picture of multiple line items you spend money on. Online applications like Mint.com can help track and categorize expenses.

In a top-down approach, you want to look at your total money flow for a year rather than individual line items. With this approach you start with your take-home pay for the year, add (or subtract) the change in your checking account balance, add (or subtract) changes in savings, add in any other sources of income (such as tax refunds or gifts), and subtract any unusual outflows. This approach is preferable to people who want to know the bottom line of how much they spend without getting lost in the details.

Everyone wants to know how much money they need to accumulate before they can safely retire. The truth is that this number is different for every person depending on how much they spend, their Social Security benefit, and other sources of income they may have.

An easy way to begin thinking about how much you want to accumulate is to use a 4{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} annual withdrawal rate. The notion of a 4{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} safe withdrawal rate has been shown in multiple studies to be a safe rate to take from your retirement savings without depleting your portfolio over a 30-year period.   This simplified approach does not take into account our current low interest and dividend rate environment or large purchases such as cars, but it is a good place to begin as it can give you an idea of whether your savings are in the right ballpark.

To start you will want to estimate your expenses, add an additional 15{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} for income taxes (for a rough estimate), subtract your estimated Social Security benefits and other income sources to give you the amount of annual cash flow needed to come from your assets. Divide this number by 4{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} to give you a rough approximation of the retirement savings you will want to accumulate.

For example, if you have $80,000 of expenses and add $12,000 for possible income taxes (which will vary widely for each person depending on sources of income and deductions) you can estimate your annual cash flow needs to be $92,000. Now if you subtract your estimated Social Security benefit of $25,000 and your spouse’s benefit of $12,500 you will need $54,500 per year to come from your assets. Dividing $54,500 by 4{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} would give you a target of $1,362,500 for retirement savings.

Many people will find themselves behind as they approach 60 years of age and will want to maximize their savings while they are still working. For high-income earning medical professionals you will want to maximize your pre-tax earnings in tax-advantaged retirement accounts. If you work for a non-profit hospital you will want to maximize your 403(b) contribution to $23,000 per year and investigate whether you also have the ability to save an equal amount in a 457 deferred-compensation plan.

If you own a small practice you will want to talk to your plan consultant to make sure you are taking maximum advantage of profit-sharing plans. You may also want to investigate defined benefit plans, which can allow you to save up to $200,000 per year on a tax-deferred basis but come with rules that you need to fully understand.

According to the Employee Benefit Research Institute, only 14{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of private sector employees have a defined-benefit pension plan. That means Social Security benefits are becoming an increasingly important part of retiree’s income sources. The rules governing Social Security are quite complicated and take into account many life circumstances that make planning for your benefits a very individualized analysis.

Your Social Security benefit is calculated based on a 35-year work history.  You can access your projected benefit information by logging into the “My Account” section of the www.ssa.gov website.  Once you login you will find your benefit at full retirement age (currently 66 to 67). Your age 62 monthly benefit is 75{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of your full retirement benefit and your age 70 benefit is 132{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} of your full retirement benefit.

You should know that there are special rules impacting spouses, divorced spouses, surviving spouses, and workers collecting public pensions in Massachusetts, among others. In addition, there are some strategies available to help couples maximize their lifetime benefits by filing for and then suspending benefits to allow your spouse to collect spousal benefits from your work record.

While the average Social Security annual benefit is about $15,000, high- income earners may have a full retirement benefit up to about $30,000 per year. Delaying benefits until age 70 could mean an annual benefit up to about $40,000. Social Security benefits are a big part of most people’s retirement plan, making it important to understand how to maximize your benefits given your personal situation.

Most people realize that they will be covered by Medicare in retirement, but they often fail to realize that Medicare is not free and there are a variety of coverage options that can be enormously confusing.

Traditional Medicare has four coverages to consider. Part A covers hospitalization. Part B covers doctors and medical procedures. Part D is prescription drug coverage. Many people also choose to get a Medigap supplemental policy to cover costs Medicare does not cover. Part B currently costs $104.90 per month per person if your income is less than $170,000 year as a couple. Part D will cost about $470 per person and a Medigap policy could cost $2,000 per year or more per person. All together, a couple may be paying $8,000 in health insurance premiums, which needs to be accounted for in your retirement expenses.

Instead of traditional Medicare you could choose a Medicare Advantage plan, also known as Part C. Medicare Advantage plans are simpler than traditional Medicare because you only have to deal with one insurance plan instead of multiple plans. Medicare Part A and Part B coverage is rolled into these plans although you will need to continue paying Part B separately, which usually comes out of your Social Security check. A Medicare Advantage plan may cost $1,600 per person on top of the Part B premiums of $1,259 for a total cost for a couple nearing $6,000 or possibly more.

You will want to carefully weigh how your health history, need to see specialists, and the corresponding copays and deductibles match up with huge number of Medicare coverage choices and the resulting costs.

There is a free program in Massachusetts called SHINE that can help you navigate Medicare choices. And don’t forget that long-term care is not covered by Medicare and also needs to be carefully considered before you retire.

Retirement is not the one size-fits-all model it was 40 years ago. Today, prospective retirees are carefully weighing their own personal circumstances and their desire to continue working past “normal” retirement ages. Start planning early so you can understand your options and adjust accordingly. v