Deciding When to Retire

Retiring sounds so appealing when you’ve had a frustrating stretch at a job you’re not particularly enjoying. But some folks really enjoy working and aren’t eager to have wide-open daily schedules day after day, week after week. Deciding when to retire and what to do in retirement is an intensely personal decision. You need to consider many financial and personal considerations and questions, and we thoroughly address them in this chapter.

Even when you’re healthy, the job market may not be. Your employer could suffer financial hardship and reduce its workforce. Or maybe you’ll be lucky enough to retire early (even though it’s unplanned) because your employer offers you a buy-out package that’s too good to turn down. Or worse, you may lose your job with little notice and few benefits.

Ideally, when caught in one of these situations, you would obtain another job and continue it until your planned retirement age. Unfortunately, events may not unfold that way. The economy, the job market, and your age could work against you. Finding another job, at a compensation level you’re willing to work for, may not be possible.

Even when you leave a full-time career voluntarily, you may plan to work part time for a few years. Or you may assume that if the first years of retirement are more expensive than planned, you could return to work at least part time. Yet a part-time job you assumed would be easy to find may not be available at all or may be available at a much lower level of pay than you expected.

WHAT FOCUS GROUPS SAY ABOUT PLANNING FOR RETIREMENT

The Society of Actuaries conducted some interesting focus groups with folks early in their retirement years. They honed in on people who had investment portfolios of at least $100,000 and who needed that money along with their Social Security and pension benefits to meet their retirement expenses.

Most of these people didn’t consult advisers and plan all that much for their retirement. Instead, they were more concerned with quitting work by a particular age. A number of focus group participants commented that their retirement decision came down to a “feeling” that they could swing it. Consider these comments from three different retirees:

“I thought you were supposed to retire when you are about 65 and thought I would try it.”
“I never sat down and thought ‘I am 59, and in 30 years I’ll be 89. Have I allocated enough for 30 years?’ I never did that. Theoretically, I should have.”
“We take it day by day. I can’t worry about what is going to happen tomorrow.”

The focus groups also found that retirees were spending more than they expected on entertainment and travel, prescription drugs, and gas. It also wasn’t unusual for retirees to overlook inflation. And finally, although retirees were concerned about the potential for high medical and long-term care expenses, they did little planning around those expected expenses.

Knowing How Much You Really Need for Retirement

Most people have a long-term financial goal of retiring someday. For some, doing so means leaving paid work behind entirely. To others, simply cutting back on work or doing something completely different on a part-time basis is most appealing.

If you don’t plan to work well into your golden years, you need a reasonable chunk of money to maintain a particular lifestyle in the absence of your normal employment income. The following sections help you get started on determining how much money you need and come to grips with those numbers.

Figuring out what portion of income you need

If you’re like most people, you need less money to live on in retirement than during your working years. That’s because in retirement most people don’t need to save any of their income, and many of their work-related expenses (commuting, work clothes, and such) go away or greatly decrease. With less income, most retirees find they pay less in taxes, too.

On the flip side, some categories of expenses may go up in retirement. With more free time on your hands, you may spend more on entertainment, meals out, and travel. The costs for prescription drugs and other medical expenses also can begin to add up.

So what portion of your income do you really need as you make your retirement plan? The answer isn’t simple. Everyone’s situation is unique, so examine your current expenditures and consider how they may change in the years ahead. (Check out the chapters in Book 4 for more information on budgeting and managing your expenses.)

To help figure out how much money you need, keep the following statistics in mind. Studies have shown that retirees typically spend 65 to 80 percent of their pre-retirement income during their retirement years. Folks at the lower end of this range typically

Save a large portion of their annual earnings during their working years
Don’t have a mortgage or any other debt in retirement
Are higher-income earners who don’t anticipate leading a lifestyle in retirement that’s reflective of their current high-income lifestyle

Those who spend at the higher end of the range tend to have the following characteristics:

Save little or none of their annual earnings before retirement
Still have a significant mortgage or growing rent to pay in retirement
Need nearly all current income to meet their current lifestyle
Have expensive hobbies that they have more time to pursue

Carefully look at all your expenses and anticipate how they may change.

Grasping what the numbers mean

When determining how much money you need for your retirement plans, you want to think in terms of your goals and how much you should save per month to reach your desired goal given your current situation.

Some folks hear a number — a big, bad number like $3.8 million — and it gets stuck in their head. That number is the size of the nest egg they believe they need to achieve a particular standard of living throughout their retirement.

Instead of obsessing about a large number, it’s better to examine your own standard of living that can be provided by the assets you’ve accumulated or will likely accumulate by a preferred retirement age. You can then begin to put the numbers into perspective for your own individual case (see the later section “Crunching the Numbers”).

Eyeing the Components of Your Retirement Plan

To meet your retirement goals, you need a firm grasp of what resources are available to help you. In addition to government benefits such as Social Security, company-provided pensions and personal investments round out most people’s retirement income sources. This section takes a closer look at these elements.

Social Security retirement benefits

Social Security is intended to provide a subsistence level of income in retirement for basic living necessities, such as food, shelter, and clothing. However, Social Security wasn’t designed to be a retiree’s sole source of income. When planning for retirement, you’ll likely need to supplement your expected Social Security benefits with personal savings, investments, and company pension benefits. If you’re a high-income earner, you particularly need to supplement your income — unless, of course, you’re willing to live well beneath your pre-retirement income. (See Book 4, Chapter 4 for more discussion on Social Security.)

If you’re still working, you can estimate your Social Security retirement benefits by looking at your most recent Social Security benefits statement, which the federal government sends annually to adults age 25 and older. Statements usually are mailed three months before your birthday. If you can’t locate your most recent statement, you can get one fairly quickly either by requesting it online at www.ssa.gov (click on the Your Social Security Earnings Statement tab on the home page) or by calling 800-772-1213 and requesting form SSA-7004 (“Request for Social Security Statement”). You also can set up a “my Social Security” account on the Social Security website that lets you obtain updated benefits estimates, verify your earnings, and take other actions.

Like many people, you may be concerned about your Social Security. You may be afraid that it won’t be there when you retire. Although you may have to wait until you’re slightly older to collect benefits or endure more of your benefits being taxed, rest assured — Congress has been reluctant over the years to make major negative changes to Social Security, because doing so would risk upsetting a large and highly active voting bloc of retirees and near retirees.

With your Social Security benefits statement in hand, you can see how much in Social Security benefits you’ve already earned and review how the Social Security Administration (SSA) determines these numbers. With this information, you can better plan for your retirement and make important retirement planning decisions.

Looking at your estimated benefits statement

Your Social Security benefits statement can give you important information about your estimated retirement benefits. On Page 2 of this annual statement, you see information like the following (unless you don’t have enough work credits, which are awarded for every year you earn money):

You have earned enough credits to qualify for benefits. At your current earnings rate, if you continue working until:
- Your full retirement age (67 years), your payment would be about $1,543 a month
- Age 70, your payment would be about $1,924 a month
- If you stop working and start receiving benefits at age 62, your payment would be about $1,064 a month

These statements are pretty self-explanatory.

Assumptions: Discovering how your benefits are estimated

Along with your benefits estimates, the SSA also discloses the assumptions used to come up with your numbers and some important caveats. You should understand the assumptions behind the estimates we talk about in the preceding section. Why? These are projections, and depending on your earnings in the years ahead, your expected benefits may change. Here’s what the SSA says:

Generally, the older you are and the closer you are to retirement, the more accurate the retirement estimates will be because they are based on a longer work history with fewer uncertainties such as earnings fluctuations and future law changes.

If you stop and consider this assumption, it does make sense and is true of about any forecast or estimate. The further into the future you try to project something, the more likely it is that the estimates may be off base.

To understand what could throw off future estimates, keep the following in mind as you dig a little deeper into the SSA’s assumptions:

If you have enough work credits, we estimated your benefit amounts using your average earnings over your working lifetime. For 2017 and later (up to retirement age), we assumed you’ll continue to work and make about the same as you did in 2015 or 2016. We can’t provide your actual benefit amount until you apply for benefits. And that amount may differ from the estimates stated above because:
1. Your earnings may increase or decrease in the future.
2. After you start receiving benefits, they will be adjusted for cost-of-living increases.
3. Your estimated benefits are based on current law. The law governing benefit amounts may change.

In other words, the SSA assumes that your future earnings will annually be about the same as your earnings in the most recent couple of years. Therefore, as their own cautions highlight, if you expect your future work earnings to change from your most recent years’ employment earnings, your expected Social Security retirement benefits also will change.

Don’t get hung up over expected cost-of-living increases. Later in this chapter, these increases are incorporated into the analysis. The third point about future benefit law changes is considered in Book 4, Chapter 4.

If you want to delve into different scenarios for your Social Security benefits, you can try the SSA’s online Retirement Estimator at www.socialsecurity.gov/estimator.

Pensions

When putting together your retirement plan, you also want to consider any pensions you have available to you. You may have previously worked for an employer offering pension benefits, or you may currently work for a company with such a plan. Also known as a defined benefit plan, a company pension plan is one that your employer actually contributes to and invests money in to fund your future pension payments.

In a typical plan, the employer may put away about 8 to 10 percent of your salary (this money is actually in addition to your salary, because the money isn’t taken from your income as it would be if you were contributing to a retirement plan such as a 401(k) plan). The money is then invested mostly in a mix of stocks and bonds (as it is in a balanced mutual fund).

Two terrific attributes of pension plans are as follows:

The savings happen automatically. Unlike a retirement savings plan like a 401(k), you don’t have to think about your pension plan. You don’t have to cut back on your spending or complete any forms. Your employer is putting away money on your behalf month in and month out.
You don’t experience any investment hassles or challenges. The pension fund manager does all the heavy lifting with regard to investing the money. So there’s no need for you to research or monitor financial markets or investments.

If your current or previous employers have a pension plan and you may have accumulated benefits, request a copy of each plan’s benefit description and a recent statement of your earned benefits.

Based on your years of service, your benefits statement will show you how much of a benefit you’ve earned. Your current employer’s statement or the person or department that works with benefits may also be able to show you how your pension benefits will increase based on working until a certain future age.

Investments

The many types of investments you may have are an important component of your retirement plan. These investments may come in various forms, such as bank accounts, brokerage accounts, mutual fund accounts, and so on. Your investments may or may not be in retirement accounts. Even if they aren’t, they still can be earmarked to help with your retirement.

Take an inventory of your savings and investments by gathering recent copies of your statements from the following types of accounts or investment options:

Bank accounts — checking (especially if it holds excess savings), savings, CDs, and so on
IRA accounts
Taxable accounts at brokers and mutual funds
Employer retirement accounts, including
- Profit-sharing plans
- Employee stock ownership plans (ESOPs)
- 401(k)s, 403(b)s, and so forth
Investment real estate

You simply need to take an inventory of your current assets and use that information in the later “Crunching the Numbers” section to determine where you stand regarding retirement planning.

IN GOOD HANDS: KNOWING YOUR PENSION IS PROTECTED

Many people don’t realize how safe their pension benefits actually are. Even if the company goes under, pension assets are held separately and are backed up by the Pension Benefit Guaranty Corporation (PBGC). The PBGC is a federal agency created by the Employee Retirement Income Security Act of 1974 (also known as ERISA) to protect pension benefits in private-sector pension plans, also known as defined benefit plans. PBGC guarantees basic pension benefits earned, subject to limits, including

Pension benefits at normal retirement age
Most early retirement benefits
Disability benefits
Annuity benefits for survivors of plan participants

PBGC doesn’t guarantee health and welfare benefits, vacation pay, or severance pay. The maximum benefit amount that PBGC guarantees is quite substantial.

Your home’s equity

If you’ve owned a home over the years and it has a decent amount of equity in it (the difference between its market value and the mortgage debt owed on it), you can tap into that equity to provide for your retirement. To do so, you have two primary options:

Sell your home. After you sell your home, you can either buy a less costly one or rent one.
Take out a reverse mortgage. With a reverse mortgage, you draw income against your home, which is accumulated as a debt balance to be paid once the home is sold.

If you’re pretty certain you want to tap your home’s equity to help with retirement, consider how much equity you would use. And check out the chapters in Book 6, which deal with these two options in detail.

Crunching the Numbers

For purposes of retirement planning, what matters most is where you stand today as far as reaching your goal. So you need to crunch some numbers to get a handle on your situation. One of the best ways to do so is to use available retirement calculators, either online or with a hard-copy workbook. These resources can walk you through the calculations needed to figure out how much you should be saving to reach your retirement goal. The information you collect and the questions you answer earlier in this chapter allow you to hit the ground running with the number crunching.

Among the mass market website tools and booklets, try the one from T. Rowe Price at www3.troweprice.com/ric/ricweb/public/ric.do. The T. Rowe Price Web-based Retirement Income Calculator is a user-friendly tool, and the website says it takes about ten minutes to complete. If you’re organized and have your documents handy, you may cruise through it that quickly, but otherwise you’ll more than likely need 20 to 30 minutes.

The following sections walk you through steps for using the T. Rowe Price retirement planning tools to get a better assessment of your financial numbers as you prepare for retirement. T. Rowe Price is the example, but please note that you can select another company’s tool if you prefer.

Understanding assumptions and how they work

Whether you use a retirement calculator online or via a work booklet, make sure you’re aware of the different assumptions used. This section details those assumptions. It specifically looks at the T. Rowe Price assumptions and online calculator. To make the best use of this site, review the following important key assumptions. If you choose not to use this online tool, you can use the discussion of the assumptions that follow for other retirement planning tools, including the T. Rowe Price work booklet.

Asset allocation: The calculator asks you to enter your current allocation (mix of major investment classes) and then to select an allocation for after you’re retired. For the retirement allocation, you can choose a fixed 40 percent stock, 40 percent bond, or 20 percent money fund, or you can have the mix gradually shift away from stocks each year that you’re in retirement. Either choice is fine, but we have a slight preference for the latter of the two options.

The calculator doesn’t include real estate as a possible asset. If you own real estate as an investment, you should treat those assets as a stock-like investment, because they have similar long-term risk and return characteristics. You should calculate your equity in investment real estate.
Age of retirement: For this assumption, you plug in your preferred age of retirement, within reason of course. (For example, plugging in age 53 is pointless if you’ve selected that age knowing that the only way to accomplish that date is by winning the lottery.) Depending on how the analysis works out, you can always go back and plug in a different age. Sometimes folks are pleasantly surprised that their combined accumulated resources provide them with a decent enough standard of living that they can actually consider retiring sooner than they thought.
Social Security: The T. Rowe Price calculator asks whether you want to include expected Social Security benefits. You definitely should include your Social Security benefits in the calculations. Don’t buy into the nonsense that the program will vaporize and leave you with little to nothing from it. For the vast majority of people, Social Security benefits are an important component of their retirement income, so do include them.

Based on your current income, the T. Rowe Price retirement program will automatically plug in your estimated Social Security benefits. As long as your income hasn’t changed or won’t change dramatically, using their estimated number should be fine. Alternatively, you can input your own number using a recent Social Security benefits statement if you have one handy. Or use the Retirement Estimator at the Social Security website (www.socialsecurity.gov/estimator).

After you enter your personal information and decide on the preceding assumptions, you’re ready to finish the calculations on the T. Rowe Price website. Price’s completed analysis shows how much you can live on per month and then compares that with what you’re stated goal or amount was. The calculations include doing 1,000 market simulations, and it works 80 percent of the time. (See the nearby sidebar “Monte Carlo retirement simulations” for a more detailed explanation of this type of modeling, if you’re interested.)

The T. Rowe Price analysis allows you to make adjustments, such as your desired age of retirement, rate of savings, and how much you expect to spend per month, to what age you’d like your savings to last. So, for example, if the analysis showed that you have much more than enough to retire by age 65, try plugging in, say, age 62 and, voilà, the calculator quickly shows you how the numbers change.

Making the numbers work

After you crunch the numbers, you may discover you need to save at a rate that isn’t doable. Don’t despair. You have the following options to lessen the depressingly high savings you apparently need:

Boost your investment returns. Reduce your taxes while investing: While you’re still working, be sure to take advantage of retirement savings accounts, especially when you can gain free matching money from your employer or you’re eligible for the special tax credit from the government. When investing money outside of retirement accounts, take care to minimize taxes. For more on investing strategies, see Book 4, Chapter 3.
Work (a little) more. Extend the number of years you’re willing to work, or consider working part time for a few years past the age you were expecting to stop working.
Reduce your spending. The more you spend today, the more years you’ll have to work to meet your savings goal. See Book 4, Chapter 2 to find out how to manage your spending in retirement.
Use your home’s equity. If you didn’t factor in using some of your home’s equity into your retirement nest egg, consider doing so. Some people are willing to trade down into a less costly property in retirement. You also can take a reverse mortgage to tap some of your property’s equity. (Book 6, Chapter 2 has more on this.)

Dealing with excess money

Believe it or not, some folks accumulate more than they need to achieve their desired lifestyle. Often, this is a surprise to the client, so some folks have a hard time believing the good news.

MONTE CARLO RETIREMENT SIMULATIONS

When you start doing number crunching for retirement planning, you begin to realize that the outcome is dependent on many variables. In addition, other factors, such as how investment returns change over time, can have a significant impact, especially over the short term, on your retirement plans.

Over the past century, the rate of inflation has averaged about 3 percent per year. Growth-oriented investments, such as stocks, have returned about 9 percent per year historically. Bonds and other fixed-income investments have returned about 5 percent per year.

Those are long-term averages, which are all well and good, but suppose that a worker decided to retire around the year 2000, and, like most retirees early in their retirement, he still had a healthy chunk of his investments in stocks. Because the stock market experienced severe downturns both early and late in the 2000s, his standard of living and ability and comfort with taking withdrawals from his retirement funds may be impacted.

A Monte Carlo simulation runs many different scenarios and calculates the likelihood (percentage of the time) that you will accomplish your retirement goal. The T. Rowe Price retirement calculator we walk you through in this chapter does Monte Carlo simulations and tests about 1,000 market scenarios to see how your retirement plans will work out in many different market conditions.

If you find yourself with extra money, the good news is at least you don’t have to worry about making sure you can continue your current standard of living during retirement. In this situation, consider taking either of the following actions:

Enhance your retirement. Don’t be afraid to enjoy yourself. While you’re still healthy, travel, eat out, take some classes, and do whatever else floats your boat (within reason, of course). Remember that come the end of your life, you can’t take your money with you.
Earmark a portion of your assets for your beneficiaries. You may want to leave something for your family members as well as other beneficiaries, such as your place of worship and charities. If so, you need to determine the approximate dollar amount for each of the beneficiaries. Estate planning is so important that the chapters in Book 5 are devoted to it.

Of course, life can throw you unexpected curve balls that could cause you to incur higher-than-expected expenses. But if you’re always preparing for rainy day after rainy day, you may lead a miserly, unenjoyable retirement.

Making Plans for Nonfinancial Matters

Getting caught up in the climb up the career ladder, burning the midnight oil, and accumulating wealth and possessions is easy in a capitalist society. In your pursuit, losing sight of some areas — the ones not about money — is also easy. These areas are just as important — if not more important — than your finances, which is why you should be working just as hard at planning them.

Personal connections

A lot of research shows that those individuals who have strong and healthy connections in their later years tend to be happier, enjoy better health, live longer, and live longer independently. As you’re preparing for retirement, make sure you spend time making and maintaining healthy personal relationships. Doing so is an investment that pays dividends by improving the length and quality of your life.

If you have children of your own (and perhaps they give you grandchildren), you’ve got a built-in network of younger folks to keep you actively involved. If you don’t have any children or grandchildren, or if you want more personal connections, you can forge friendships with people younger than you through your activities, hobbies, fellowship, and so forth.

Personal health

Your health is much, much more important than your financial net worth. Just ask folks who have major medical problems — especially those they could have avoided — if they wish they had taken better care of their health. Although anyone can experience bad luck or bad genes when it comes to health, you can do a lot to stay healthy and enjoy enhanced longevity and the best possible quality of life.

Activities, hobbies, interests

For folks who have had full-time jobs, retiring and having no job to occupy their days sounds alluring. However, some retirees feel a lack of purpose and miss the satisfaction that comes from meeting the challenges of work. A fringe benefit of most people’s work is the human interaction that comes along with it.

When planning for your future, consider the following as good substitutes for work, because they provide challenges and foster friendships and connections with others:

Activities and hobbies: Exercising is a good choice to include in long-term plans; it provides vast health benefits and opportunities to meet new friends and hang out with old ones. If you’re not into exercising, perhaps you can look at different hobbies you like, such as collecting something. You can meet interesting people and make new friends by going to auctions, garage sales, and such. People like to collect all sorts of things; just be careful you don’t spend too much money.
Part-time work: Working part time, especially when you have more flexibility in setting your hours, can be an excellent part of a retirement plan. It can provide enjoyments and a challenge — not to mention some extra dough.
Volunteering: Giving something back to society pays many dividends. You can find a zillion volunteer opportunities. Your place of worship, organizations that support a cause you believe in (for example, fighting cancer or heart disease), and schools are super places to start looking. Stumped for ideas? Try a service like VolunteerMatch (www.volunteermatch.org).

Developing a Retirement Plan