When people think about retirement, they often say their biggest worry is outliving their retirement savings. So, how do you know if you’ll enough money to last the rest of your life in retirement?
To answer this question, the most obvious place to start with would be an assessment of how much you saved and with which retirement vehicle did you use to save. Did you save using a before tax retirement vehicle or an after-tax retirement vehicle such as a Roth IRA? Many people will have saved with a 401k, 403b, SEP, Traditional IRA or SIMPLE IRA and some will have pensions. The list goes on.
Also, it’s important to learn as much as you can about Social Security and when the best time would be for you to start withdrawing your benefits. Should you start taking benefits as soon as you can at age 62 or should you wait to the max age at 70 when the benefit stops increasing? This is an individual assessment that could always use the outside help of a trusted financial professional. Also, what about spousal benefits? Are you eligible to draw off your spouse? There are many questions that need to be answered here.
What about health coverage? Once again, that depends on each situation individually. One may still be working and decide to stay with their employer health insurance after age 65. Just be sure the employer coverage is what Medicare considers “creditable coverage” or you could be assessed a late enrollment penalty later from Medicare. Most who are not working go on Medicare and Medicare can be excellent coverage if you pick the right supplement to go with Medicare. How about the possibility of home health care or long-term care? I mentioned home health care and long-term care because this care is very expensive and unless you have the right coverage, the cost of this care could drain your retirement savings. It’s very important to have a good estimate of the cost of care and have the right coverage in place when planning for your retirement.
With that being said, I think we can all agree that most Americans are living longer, and inflation and taxes are increasing at a record pace. Usually, the only thing that doesn’t increase is income in retirement because almost everyone in retirement is on a fixed income.
So, how do we not run out of money?
First and foremost, we need to minimize tax as much as possible. As mentioned earlier, most retirees’ funds will come from a combination of Social Security benefits and retirement savings from company sponsored retirement accounts. And while it might not be shocking that money saved in most retirement plans are taxed, it’s a bit of a surprise to most retirees that up to 85% of your Social Security benefit could be taxed if your income from all sources is above $34,000 annually for an individual filing and above $44,000 annually for a joint filing.
What about your company-sponsored plan or IRA? Since you received a tax deduction when you made your contributions, you will pay ordinary income tax (based on your current tax bracket) on the distributions based on your income from the previous tax year. And, if you don’t need the money then, you still need to take required minimum distributions (RMDs) by age 73 so the government can get their tax money.
How do you figure up RMDs? RMDs are different for each individual person. There are three different Uniform Lifetime Tables that can be found here.
There is the Uniform Lifetime Table for all unmarried IRA owners calculating their own withdrawals, married owners whose spouses aren’t more than 10 years younger, and married owners whose spouses aren’t the sole beneficiaries of their IRAs. There is Table I for single life expectancy and Table II for joint life and last survivor expectancy.
After you find which table you need to use, you simply divide the year-end value of your IRA or other retirement account by the distribution period value that matches your age on December 31st each year. Every age has a corresponding distribution period value so you must calculate your RMD value every year. The distribution period value decreases each year as you age so your RMDs will increase every year as life expectancy decreases.
And one more thing, taxes may rise in the future based on the current state of the economy and funding international interests. Further, 10,000-11,000 baby boomers are putting more of a strain on Social Security and Medicare. The Federal budget and the printing of money is also spiraling out of control.
However, one possible way to help save on taxes is to do a Roth conversion. So, what is a Roth conversion? A Roth conversion is when you take your money out of your traditional IRA, pay taxes on the money you take out and put that money into a Roth IRA to avoid paying taxes on distributions later. The optimal time to do this is between when you retire and just before age 73 when you need to start taking RMDs. At this point in your life, you’ll most likely be in a lower tax bracket then because you have stopped working.
Next, you need to manage your savings well. Your biggest priority in retirement is replacing your income from working the best you can with ongoing income from your retirement savings, Social Security, and other sources so you can pay your bills, and hopefully take some vacations. Since you are now switching from accumulating money while working to spending money you accumulated over the years, consideration must be given to other types of low-risk investments that can also generate the lifetime income needed in retirement while at the same time generate decent returns. Some great possibilities include annuities and dividend investing.
Lastly, and arguably the most important, downside risk must be managed well in your investments. One way to do this is to put a percentage of your money into a fixed index annuity. With FIAs, you can also withdrawal up to 10% of your money penalty-free while the rest of your money continues to grow and is protected from market risk, which is extremely important in retirement. Plus, your money grows tax-deferred! And after the surrender charge period is over, you can then annuitize your annuity and get lifetime income payments to supplement your other retirement income. The increase in income will also help in times of inflation.
To summarize, it’s important to do a thorough analysis of your situation to make sure you don’t run out of money in retirement, and everyone’s situation is unique. Don’t leave your retirement up to chance! Reach out for help from a qualified financial planner.
