The 5-Factor Formula for Retirement SuccessSubmitted by TR Financial Management Group, LLC on April 6th, 2015
The decision to retire is a major one and often filled with many uncertainties. To bring some clarity and confidence to your decision-making process, giving due consideration to these 5 factors will bring you vastly closer to making a sound choice.
- What is your actual, outgoing cashflow?
Many people assume retirement spending will be 80% of one’s working income. This oversimplification can be misleading. Rather, take the time to diligently track your expenditures for 2-3 months. Roughly categorize each into one of the following three types:
- Routine/recurring: This includes all of your normal household and living expenses such as food, utilities, transportation, mortgage, etc. This represents your baseline monthly spending and should be relatively consistent month to month.
- Unexpected: While these are called unexpected, many should be anticipated. This includes car repairs, new tires, new roof, plumbing repairs, HVAC work and so on. I have discovered that this category can be surprisingly high at times.
- Discretionary: This category represents those expenditures that are truly a matter of choice. I include vacations, eating out, membership fees and other similar expenses in this group. It is the only one of the three that can be readily reduced if needed.
After 2-3 months, you should have a good representation of your actual spending. Once in retirement, do not expect that number to drop significantly, if at all. What you will likely discover is that your routine/recurring and unexpected expenses represent a significant portion of your monthly spending. These needs have to be met each month so know these numbers and plan accordingly.
- How will you monetize your retirement assets?
As for retirement savings such as regular savings accounts, IRA’s, 401k’s, there are two primary options to consider:
- Immediate annuities: In essence, a lump sum of money is given to an annuity provider in exchange for a monthly check, often for the life of the annuitant. This simple product can be readily compared amongst various providers to ensure fair terms. I recommend avoiding any variable annuity products due mainly to their inherent complexities and higher embedded costs.
- Monthly account withdrawals: This option keeps the retirement funds on your balance sheet and under your control. Do recognize that based on your withdrawal rate and investment performance, depletion of your accounts is a possibility to be considered and managed (as does the resulting stress!). For rough estimating, the 4% rule is reasonable. This works out to 1/3% per month in pretax income when taken from an IRA.
For some people, a combination of these two options will be preferred using the annuity to provide predictable monthly income and retirement savings for supplemental funds.
The other often untapped source of retirement income is a person’s home. If you are 62 or older and have at least 50% equity in your home, you may be eligible for a reverse mortgage. In some cases, a person’s mortgage payment can be eliminated. In others, a lump sum payment or monthly income is possible. Consult a qualified reverse mortgage broker for more information regarding your situation.
Now, total these sources of income. Compare the result to your numbers from question #1. Any significant gaps that cannot be closed by your social security benefit need to be resolved. In this situation, hoping the gap will “fix itself” is not a good plan!
- How will you spend your time?
Depending on the demands of your career, retirement can be akin to stepping off a fast-moving train: you come to an abrupt stop! You lost your social network (they still have jobs). You have no outside interests (you were too busy working). If you are in this situation, then you are probably eagerly anticipating retirement. As an alternative, consider “down shifting” instead. Take a less demanding position that provides you the opportunity to explore other interests and activities while still working. This will feel less abrupt and you will still have earned income. You will sleep better for it. To retire successfully, one needs activities that engage the intellect and provide for healthy stimulation and occupation. Don’t fall into the sedentary trap of passivity and boredom. Know how you will remain active both physically and mentally.
- Where will you spend your time?
This is your community and primary residence so choose wisely. Certainly, the significance of your social network should not be underestimated. Having family and friends nearby is a factor for many. You also have other helpful relationships such as medical, dental, repair persons, etc. While you may have always dreamed of moving to Florida, you may not have considered all that goes into re-establishing yourself in a new community. Lastly, be wary of the “dream house” trap. A large home can be a significant ongoing expense.
With that being said, there are wide variations in the state income tax rates. Moving from a high tax state to a lower one could mean thousands in tax savings. It is fairly easy to find comparisons of these tax rates, or ask your tax preparation professional for assistance.
For those of you who are more adventurous, many retirees have opted to sell nearly everything and live the RV lifestyle, traveling from place to place as they desire. Or, living abroad may sound appealing. Many foreign countries offer lower costs of living in very beautiful surroundings. International Living is a publication that can provide more information for this lifestyle choice.
- What is your Social Security filing strategy?
Social Security is an important benefit package. And, the associated rules can be quite complicated. Depending on a variety of factors such as age when filing, marital status, life expectancy and the timing of benefits collection, there can be significant differences in the lifetime cumulative benefits received. In some cases, it can be tens of thousands of dollars in extra benefits. Be certain to consult an advisor with the tools to help you make an informed decision in this aspect of your retirement decision-making.
In closing, finding your solutions to these five factors will require a bit of effort. In the end, though, you will make an informed and rational retirement decision allowing you to transition with both confidence and peace of mind.