Knowing When You are Financially Ready to Retire

Some people love the work they do, but the fact is that is not the experience for most people. Therefore, one of the biggest financial priorities people have is setting themselves up for retirement so they can spend more of their time doing things that they do love instead of working for a paycheck. In past generations, it may have been easier to understand when you were financially prepared to retire because at that time, most workers who spent a long time working for an employer would be eligible for some type of monthly pension benefit. The combination of that pension and a Social Security check, which most workers would expect to receive, allowed earlier generations to feel more comfortable about leaving the world of work. In today’s world, however, most workers are not eligible for a pension check and thus are likely to be relying on Social Security and supplementing that with their own life savings and/or income from post-retirement work to replace the income they earned while working. Of course, there is nothing wrong with working in your “retirement”, and there can be many reasons to consider doing so for financial and non-financial reasons. We discussed some of the non-financial issues related to retirement readiness in our July 2023 issue of the newsletter, which are also extremely important to think about. Unfortunately, many people do work in retirement because they have to, not because they want to. If you want to be in a position where you can decide if you want to work or not in your retirement years, there are several items you need to figure out, and we will discuss a few of those key items in the remainder of this issue of the newsletter.

Understanding Your Income Needs…and Wants
Just like it is important to understand where your money is going during your working years, it is at least as important to have a good handle on where your money will be going in retirement. If you are a long way from reaching that age, it can be a more challenging exercise to estimate your retirement expenses, but taking your best guess at it is a valuable exercise to help you begin understanding the level of income you will need to bring in when you get to that point. As you go about this exercise, whether doing it yourself or with the help of a financial professional, it is a good idea to break your expenses into larger categories, such as Essential Expenses and Discretionary Expenses. As the name suggests, Essential Expenses are for the things you can’t do without, and likely will include things like expenses related to housing and food. Discetionary Expenses, on the other hand, are things you would like to do but don’t have to do, such as participating in hobbies and traveling. More often than not, these Discetionary Expenses are the very things you have dreamed about doing in retirement, so you should not treat them as if they are unimportant just because they aren’t essential. You should build them into your expectations, understanding that because they are not essential, the level to which you will spend on them may be more a function of what you have available, so you may need to be more flexible on those items. As you assess the level of all of your retirement expenses, it is important to recognize that some expenses are fixed, while others are likely to increase in cost due to inflation over time. It is also valuable to consider that some of the claims on your income while working, you may be different or non-existent when you are no longer working. For example, in retirement, you very well could be in a different tax bracket and pay less in taxes than while working, or you may no longer pay for certain employer benefits that you have while working. On top of that, if you have been contributing to a workplace or other savings program, chances are that you may not want or need to continue doing that in retirement. Even though that is not an expense per se, it is a place where your money may be going out. Another item that can be very different in retirement is the cost of health insurance. First of all, once you reach age 65, Medicare comes into play, and there are a multitude of options you can choose from, each with their own cost structure. Secondly, if you had employer health insurance coverage while working, any premiums you paid were likely pre-tax, so you effectively were paying less for your health insurance even than what came out of your check. Beyond these items, there are many nuances to potential changes in your income needs and wants in retirement, so this is a critical piece of determining your retirement readiness.

Identifying Your Sources of Predictable Income
The reason for discussing predictable income is that once you have left the routine of work, you may decide to do some work to earn income, but you may do so on a less consistent basis. But just because you may not be bringing in earned income doesn’t mean any of the bills stop coming in, so it is an important thing to have predictable income coming in to cover your expenses, in particular those Essential Expenses discussed earlier. For most of the population, Social Security will be at least one of the predictable sources of income for you in retirement. We could spend several issues on Social Security alone in terms of choosing when to start taking income, strategies for filing, etc., but key items to understand about Social Security are that it is in fact a predictable source of income that tends to increase with inflation because of its cost-of-living adjustment (COLA) provision. While there are legitimate concerns about the state of the Social Security system due to demographic issues, those who are eligible for their Social Security benefit can feel confident that they will have it as a vital piece of their income in retirement. Another source of predictable income is lifetime pensions, which as noted earlier, are becoming less common for people to have. If you will be eligible for a pension benefit, count yourself fortunate and in the minority. An important note about employer pension benefits is that some provide a fixed amount for life, while others have COLAs, so it is important to understand how your benefit works. If you do not have an employer pension and/or are still coming up a little short on covering your ongoing income needs, one way to bridge the gap is to take a portion of your personal assets and through the use of a contractual investment, like an annuity, to create what amounts to your own personal pension.  

Tapping Your Personal Savings
Unlike the predictable sources of income discussed above, when you make withdrawals from your personal savings, there is no certainty that you will be able to make those withdrawals throughout your lifetime. Therefore, when you are deciding how much to take from your savings, you have to be mindful that whatever amount you take out now could result in limiting what you will have available to withdraw later. Your personal savings can consist of money in the bank, retirement plan investments (employer and personal), and non-retirement plan investments of many types. As you seek to determine your retirement readiness, this source of funds is often the big wildcard because there is no set amount that you are allowed to take out, and the value of what you have may vary based on how your investment performs. All of that contributes to perhaps the biggest fear people have about retirement, running out of money. When you consider both the predictability of income needs you have in retirement as well as the unpredictability of things you may need money for in the future or want to spend money on, it places a great deal of importance on how you manage your personal savings so that they can address those income requirements but also be sustainable throughout your lifetime. This also is a topic that could cover many pages on its own, but the key takeaway from this discussion is that you need to have a well-defined plan for how you are going to structure and use your personal savings to make the most of your retirement years.

Fitting the Puzzle Together
What we have laid out in this issue is some sequential steps to figuring out how ready you are to take the plunge into retirement. The decision to retire is more than just picking out a date on the calendar based on your age. It is a decision that should involve very careful assessment and planning to make sure you have put yourself in a position financially to meet your needs and enjoy the dreams you’ve envisioned, and that you’ve thought carefully about how you want to fill your newfound time freedom in such a way that those years are all that you hoped they would be.

Stewardship Emphasis

Flying by the seat of your pants may seem fun and exciting, while creating a plan seems boring. The beauty of having a well thought out plan is you can build in the fun you want into the plan.

The Empowerment Channel    |   Volume CCXXVI   |    Dedicated to Promoting Financial Education through Stewardship