Retirement is a major lifestyle change. In addition to deciding how to fill your newfound free time, you also need to revise your financial plans since you’ll no longer have money coming in. And the sooner you develop sound money management skills appropriate to your current life stage, the better off you’ll be.
To help you out, we’ve rounded up advice from three Motley Fool retirement experts about the first thing they believe retirees need to know once they’ve left the working world behind for good. Here’s what they said.
Having a withdrawal strategy is critical
When you have hundreds of thousands of dollars in your retirement fund, it’s easy to fall into the trap of thinking that your savings will last forever. But when you’re spending a decade or two (or more) in retirement, that money may not go as far as you think.
For that reason, it’s crucial to have a withdrawal strategy. Knowing how much you can safely withdraw from your retirement fund each year can help ensure you don’t run out of money too soon.
The most common withdrawal guideline is the 4% rule. This states that you can withdraw 4% of your total savings during the first year of retirement, then adjust your withdrawals each year after for inflation. So, for example, if you have $500,000 saved, you could withdraw $20,000 the first year.
That number may seem low, but keep in mind that inflation will take a toll on your savings over time. Your $500,000 nest egg may seem like a lot, but in 10 or 20 years, that money won’t be worth as much as it is now.
The 4% rule isn’t perfect, and it does have its flaws. For instance, it assumes that you’ll be spending roughly the same amount every year. In reality, though, many retirees spend significantly more in the first few years of retirement as they travel, pick up new hobbies, or renovate their home. Then, their spending levels may taper off, only to pick back up later in life when they start experiencing expensive health issues.
Another downside is that it doesn’t account for the length of your retirement. The 4% rule assumes you’ll be spending around 30 years in retirement. If you follow the withdrawal guideline, your savings should last approximately that long. However, not everyone will spend 30 years in retirement, and the number of years you spend in retirement will affect how much of your savings you can withdraw each year.
Despite its drawbacks, the 4% rule can give you a general idea of how much you can afford to withdraw each year. For a more accurate guideline, you may choose to talk to a financial advisor to develop a withdrawal strategy that’s specifically tailored to your unique situation.
Regardless of whether you work with a professional or not, be sure to think about how much of your savings you plan to withdraw each year. Creating a strategy now will result in a much more financially comfortable retirement.
You’ll pay taxes on a number of key income sources
Maurie Backman: Many seniors are surprised at how high their tax burden is during retirement. The reason? A number of popular income sources aren’t eligible for tax-free treatment.
First, let’s talk IRA and 401(k) withdrawals. Unless you’re saving in a Roth IRA or Roth 401(k), the money you take out of your savings will be taxed at your ordinary income rate. Furthermore, unless you have a Roth IRA, once you turn 72, you’ll be forced to remove money from your savings in the form of required minimum distributions, so that will create an automatic tax bill for you unless you have a Roth 401(k).
Then there’s Social Security. If those benefits are your only source of income during retirement, then you’ll probably get to enjoy them tax-free. But if you have other income at your disposal, you’ll probably pay taxes on those benefits, the amount of which will hinge on your provisional income.
Your provisional income is calculated by taking your total non-Social Security income and adding that to 50% of your annual benefit. If your total falls between $25,000 and $34,000 and you’re single, you could face taxes on up to 50% of your benefits. If your total lands between $32,000 and $44,000 and you’re married, the same applies. Meanwhile, if your provisional income exceeds $34,000 as a single tax filer or $44,000 as a married couple filing jointly, you could be taxed on up to 85% of your benefits.
And that’s just federal taxes. There are also 13 states that tax Social Security, so depending on where you live as a senior, you may lose even more of that income.
Finally, if you’re entitled to a pension from your former employer, you may find that those payments are taxable. Whether that happens depends on the specific type of pension you have and where you retire to.
The point, therefore, is to read up on taxes ahead of retirement so you’re not completely caught off-guard. There may be steps you can take to shield some of your income from taxes as a senior, so going in prepared could spare you a world of financial stress.
Your healthcare is probably going to be more expensive than you’re anticipating
Christy Bieber: It’s a sad fact of life that people tend to require more healthcare services as they age. Unfortunately, many retirees are shocked at just how expensive all of this medical care can be. That’s especially true for those who were counting on Medicare to provide comprehensive coverage.
The reality is, if you’ve retired before 65, you aren’t going to be eligible for Medicare yet. You’ll either need to keep coverage through your current employer under COBRA or buy a policy on the individual market. Neither option is cheap.
And your costs don’t end once Medicare kicks in. In fact, Medicare has a number of exclusions, including hearing aids and dental care. You’ll also have premiums and coinsurance costs to pay. And while you can sign up for Medigap or Medicare Advantage to get more comprehensive coverage, these programs come with additional monthly charges.
The result is that retirees can spend hundreds of thousands of dollars on medical care over the course of retirement. And that’s not even including long-term care, if it becomes necessary. Preparing for these expenses is essential. This means shopping for the right insurance coverage, saving up a dedicated fund for healthcare, and perhaps spending less on the fun stuff early in retirement in case you get sick later.
This may come as a shock if you expected Medicare to cover everything you need. But it’s better to plan and prepare sooner rather than later, as you don’t want to be caught in a situation where you need medical services you can’t afford.
By maintaining a safe withdrawal rate and planning for the impact of taxes and healthcare spending, you can ensure your retirement will be as financially secure as possible. That will make your later years a lot less stressful.
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