After years of saving and investing, you can finally see the big
day -- retirement. But before kicking back, you still need to
address a few matters. Decisions made now could make the difference
between your money outlasting you or vice versa.
Calculating Your Retirement Needs
First, figure out how much income you may need. When retirement
was years away, this exercise may have involved a lot of estimates.
Now, you can be more accurate. Consider the following factors:
- Your home base -- Do you intend to remain in your current home?
If so, when will your mortgage be paid? Will you sell your current
home for one of lesser value, or "trade up"?
- The length of your retirement -- The average 65-year-old man
can expect to live about 17 more years; the average 65-year-old
woman, 20 more years, according to the National Center for Health
Statistics. Have you accounted for a retirement of 20 or more
- Earned income -- The Bureau of Labor Statistics estimates that
by 2015, 10% of women and 20% men aged 65 or older will still be
employed. If you continue to work, how much might you earn?
- Your retirement lifestyle -- Your lifestyle will help determine
how much preretirement income you'll need to support yourself. A
typical guideline is 60% to 80%, but if you want to take luxury
cruises or start a business, you may well need 100% or more.
Health care costs and insurance -- Many retirees underestimate
health care costs. Most Americans are not eligible for Medicare
until age 65, but Medicare doesn't cover everything. You can
purchase Medigap supplemental health insurance to cover some of the
extras, but even Medigap insurance does not pay for long-term
custodial care, eyeglasses, hearing aids, dental care, private-duty
nursing, or unlimited prescription drugs. For more on Medicare and
health insurance, visit www.medicare.gov.
- Inflation -- Although the inflation rate can be relatively
tame, it can also surge. It's a good idea to tack on an additional
4% each year to help compensate for inflation.
Running the Numbers
The next step is to identify all of your potential income
sources, including Social Security, pensions, and personal
investments. Don't overlook cash-value life insurance policies,
income from trusts, real estate, and the equity in your home.
Also review your asset allocation -- how you divide your
portfolio among stocks, bonds, and cash. Are you tempted to convert
all of your investments to low-risk securities? Such a move may
place your assets at risk of losing purchasing power due to
inflation. You may live in retirement for a long time, so try to
keep your portfolio working for you -- both now and in the future.
A financial advisor can help you determine an appropriate asset
|Robber Baron: Inflation
|Here's how a 4% inflation rate would erode $400,000 over a
25-year period. Because inflation slowly eats away at the
purchasing power of a dollar, it's important to factor inflation
into your annual retirement expenses.
|This example is hypothetical and for illustrative purposes
A New Phase of Financial Planning
Once you've assessed your needs and income sources, it's time to
look at cracking that nest egg you've built up. First, determine a
prudent withdrawal rate. A common approach is to liquidate 5% of
your principal each year of retirement; however, your income needs
Next, you'll need to decide when to tap into tax-deferred and
taxable investments. The advantage of holding on to tax-deferred
investments (employer-sponsored retirement plan assets, IRAs, and
annuities) is that they compound on a before-tax basis and
therefore have greater earning potential than their taxable
counterparts.1 However, earnings and deductible
contributions in tax-deferred accounts are subject to income tax
upon withdrawal -- a tax that can be as high as 39.6% at the
federal level. In contrast, long-term capital gains from the sale
of taxable investments are taxed at a maximum of 20%. The key to
managing taxes is to determine the best strategy given your income
needs and tax bracket.
Also, tax-deferred assets are generally subject to required
minimum distributions (RMDs) -- based on IRS life expectancy tables
-- after you reach age 70½. Failure to take the required
distribution can result in a penalty equal to 50% of the required
amount. Fortunately, guidelines do not apply to Roth IRAs or
annuities.1 For more information on RMDs, call the IRS
at 1-800-829-1040 or visit www.irs.gov.
A Lifelong Strategy
A carefully crafted retirement strategy also takes into account
your estate plan. A will is the most basic form of an estate plan,
as it helps ensure that your assets get disbursed according to your
wishes. Also, make sure that your beneficiary designations for
retirement accounts and life insurance policies are up-to-date.
If estate taxes are a concern, you may want to consider
strategies to help manage income while minimizing your estate tax
obligation. For example, with a grantor retained annuity trust
(GRAT), you move assets to an irrevocable trust and then receive an
annual annuity for a specific number of years. At the end of that
period, the remaining value in the GRAT passes to your beneficiary
-- usually your child -- generally free of gift taxes. Another
option might be a charitable remainder trust, which allows you
and/or a designated beneficiary to receive income during life and a
tax deduction at the same time. Ultimately, the assets pass free of
estate taxes to a named charity.
It's easy to become overwhelmed by all the financial decisions
that you must make at retirement. The most important part of the
process is to consult a qualified financial professional, a tax
advisor, and an estate-planning attorney to make sure that you're
prepared for this new - and exciting - stage of your life.
|How Much Can You Withdraw?
|This chart can give you an idea how much you could potentially
withdraw from your nest egg each year. For example, if you begin
with $400,000 in assets and expect an average annual return of 5%
over a 25-year retirement, you could potentially withdraw $18,000
per year. Withdraw more than that each year and you may outlive
your money. Also consider: This chart doesn't take income taxes
into account, which can range from 10% to 35%, depending on your
|Assumes 5% average annual return, and that withdrawal rate is
adjusted for annual 4% inflation rate after the first year. This
example is hypothetical and for illustrative purposes only.
Investment returns cannot be guaranteed.
Points to Remember
- Several factors influence the amount of retirement income that
you'll need, including your housing cost, the length of your
retirement, whether you have earned income, your retirement
lifestyle, health care and insurance costs, and the rate of
- It's important to identify all of your potential income
sources, and divide your portfolio's asset allocation so your
investments are better positioned to support you throughout
retirement, which could last 20 or more years.
- It's also crucial to figure out the percentage of retirement
assets you can afford to withdraw each year, and when to tap into
tax-deferred and taxable investments.
- Failure to take the required minimum distribution from many
tax-deferred accounts after you reach age 70½ can result in
a tax penalty equal to 50% of the required amount.
- A sound retirement financial strategy includes an effective
estate plan, which can help maximize current income while
minimizing the tax bite to you and your heirs.