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You’ve worked hard for most of your life, and it’s time to live off the fruits of your labors.
No more worrying about pleasing the boss or customers or finding ways to put up with difficult coworkers. No more fighting traffic. No more performance evaluations or interminable meetings. Suddenly, your time is your own. You can take up a hobby or volunteer for a worthy cause. You can even work part-time, if you like.
But if you’ve failed to plan and save or if life just deals you a bad hand, retirement can be a time of major struggle.
Even under the best of circumstances, retirement can be disorienting for a lot of people, who suddenly find they miss the structure and purpose of full-time work. For many, the answer is to just give it time. But when financial problems enter the picture, it’s not that simple.
There are a few misconceptions, or myths, that many people hold about retirement. For example, many people believe Social Security will be enough for all their expenses in retirement and that Medicare will be sufficient for their medical bills.
These government programs do not provide the security many people expect. And often, people don’t have the luxury of deciding when to retire. In fact, according to the 2019 Retirement Confidence Survey from the Employee Benefit Research Institute, 40 percent of U. S. retirees said they retired earlier than they’d planned because of layoffs or health issues.
Planning for Retirement
According to the U.S. Department of Labor, the average American spends about 20 years in retirement.
The earlier you start planning and saving for your retirement, the better off you will be when the time comes. If it’s easier, start with a small amount and gradually increase it each month.
When Can I Retire?
Full retirement age, as dictated by the Social Security Administration, is currently 66 years and two months for people born in 1955 and is projected to rise to 67 for anyone born in 1960 or later.
People can receive early retirement benefits at 62 years old, but those who do so will permanently reduce their benefits to only 70 to 80 percent of the full benefit amount. Additionally, retirees can access their tax-protected retirement savings at age 59 ½ without penalties.
The Wobbly Three-Legged Stool of Retirement
Traditionally, financial planners used the metaphor of the three-legged stool to describe planning for retirement. The three legs were Social Security benefits, personal savings and pensions.
But the three-legged stool no longer symbolizes the current state of retirement because pensions, also known as defined benefits plans, have become a thing of the past. Today’s retirees must turn to retirement savings accounts, such as 401(k)s.
Experts say retirees need to replace an average of 70 percent of their pre-retirement income. But that is really closer to 100 percent for low-wage earners and less than 70 percent for people who have higher incomes.
According to a report from the Center for Retirement Research, the typical household nearing retirement with a 401(k) has just about $135,000 in retirement savings. Putting all that money into an annuity would yield about $600 in monthly income.
Even more worrying: the report says nearly a third of all households nearing retirement have no retirement savings at all.
Based on research and available data, the stool on which Americans’ retirement rests is becoming increasingly wobbly and may eventually amount to nothing more than kindling.
Social Security is the government program that provides a stream of income for most American retirees.
Nearly 90 percent of Americans receive Social Security benefits, which represent about 33 percent of income for older people.
The amount of the benefit payments is determined by how much the retiree earned when working and the age at which he or she retires. People who have to quit working before full retirement age can apply for Social Security disability benefits.
Social Security’s trust fund is projected to run out of money in 2034. At that point, according to the administration, tax revenue would be enough to cover 80 percent of scheduled benefits.
Americans are increasingly reliant on personal savings to fund retirement. But most have not saved as much as they need, and that situation is expected to get worse.
A report by the National Institute on Retirement Security found that retirement savings of working Americans are “deeply inadequate” and may place the possibility of retirement out of reach for many. According to the report, 77 percent of Americans fall short of even conservative targets for retirement savings based on their age. And a large majority of workers can’t meet a savings target that is substantially reduced.
Meanwhile, life expectancy continues to increase. In fact, according to a 2017 report from the World Economic Forum, half of Americans born in 2007 may reach the age of 103.
The report, produced as part of the Forum’s Retirement Investment Systems Reform project, estimated a $28 trillion gap between the amount that Americans should have saved for retirement and what they actually saved in 2015. The retirement savings gap is expected to explode to $137 trillion by 2050.
This risk can be minimized by purchasing an annuity, which provides income for life, no matter how long a person lives.
Pensions and Employer-Sponsored Retirement Savings
Just 23 percent of all workers and 15 percent of private-sector workers participate in pension plans, according to the Pension Rights Center. At the same time, 40 percent of all workers participate in a workplace retirement savings plan.
For those who have pensions in the private sector, the median annual income from them is less than $9,500 a year.
If you have a retirement savings account, such as an IRA or a 401(k), you should know that the law requires that you withdraw a minimum amount from the account every year when you reach age 70½. This minimum is known as a required minimum distribution, or RMD.
Health Care Costs in Retirement
As people live longer, health problems increase. Medicare does not cover all health care costs in retirement, leaving many retirees facing substantial medical bills, copays and insurance premiums. This doesn’t even count the cost of long-term care, which is not covered by Medicare. Medicaid covers long-term care, but only after a person’s savings are depleted and when income is extremely low.
Some research has found that out-of-pocket health care costs, not counting long-term care, average about 20 percent of total expenses for people aged 75 and older. In about 5 percent of households, healthcare expenses can eat up more than half of total income.
When long-term care costs are added to the equation, average health care expenses for people in their 70s go to $100,000 and even $300,000.
Researchers also found that women, with their longer life expectancies, have higher retirement health care costs than men. And somewhat surprisingly, people in good health tend to have higher retirement health care expenses because they tend to live longer.
A report by the Insured Retirement Institute in collaboration with Healthy Capital found that positive lifestyle choices can lead to financial savings in retirement. The report also suggested using annuities to generate reliable income to fund retirement health care costs no matter how long you live.
The top three retirement risks are inflation, market fluctuations, and longevity.
Inflation can diminish the value of a retiree’s savings. The Bureau of Labor Statistics gathers data on the average prices of consumer goods every month to establish the current Consumer Price Index.
The change in the CPI from one period to another determines the rate of inflation. If a retiree’s investments can’t keep up with inflation, their savings may run out sooner than they expect.
The stock market is another factor that influences retirement savings. If your money is invested in the stock market and the market takes a dive, you can lose a lot of money.
Because stocks are considered long-term investments, younger people have plenty of time for their investments to recover their worth. If you’re retired, your time horizon — that is the length of time your investment is held — is probably not long enough for you to get your money back.
One of the biggest retirement risks is outliving your savings. On its face, the idea of living long doesn’t seem like it would be bad. Everyone wants a long, healthy life. But retirees have to make their money last their entire lives. If they live long, they risk running out of money.
Longevity risk can be addressed through the purchase of life annuities, which provide an income stream no matter how long you live. Annuities, in fact, are insurance products, designed to insure against the longevity risk.
Other Tips for Planning for Retirement
It’s never too early to start thinking about retirement. As the saying goes, by failing to prepare, you’re preparing to fail. And when it comes to your finances, failure shouldn’t be an option.
- Take advantage of your employer-sponsored retirement plan.
- This is especially important if the plan offers matching funds. If you don’t get those funds, you’re essentially leaving free money on the table. But even without a match, the plan can help you save through automatic payroll deductions, and it can provide tax advantages.
- Start setting aside money from your paycheck.
- If you start saving early, you will be less likely to miss that money as you incorporate this habit into your financial life. Not only will you save more money, but the money you save will have time to grow into a healthy retirement nest-egg.
- Don’t touch your retirement savings.
- Don’t take from your future to meet a want or need today. You will pay a price for this later. When you transition to a new job, don’t cash out your 401(k). Instead, roll your retirement savings plan into an IRA, or leave the money in the plan to grow.
- Set up an Individual Retirement Account (IRA).
- If you don’t have access to an employer-sponsored savings plan, you still have the option of depositing funds into an IRA. The law allows deposits of up to $5,500 a year into IRAs, regardless of whether you have a 401(k) or another retirement savings plan.
- Purchase a deferred annuity.
- Money used to purchase an annuity will grow tax deferred, meaning earnings will not be taxed until you receive payments. However, unlike funds deposited into a traditional IRA or a 401(k), which are deducted from your income tax payments, your annuity premiums will be after-tax dollars.
You should also plan for the non-financial parts of retirement. Many retirees find themselves adrift without the anchor of a workday schedule. Start thinking about how you would like to spend your golden years. Traveling, hobbies and even volunteer work all involve some level of financial commitment. Once you know what you want to do with your time after retiring, you can account for these goals in your retirement planning.
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