I recently spoke with some families who are just entering retirement age, and it surprised me how vulnerable that group can be. You save your entire life for retirement and once that time finally comes, there are a ton of unknowns, and what’s worse, people and companies that want to take advantage of you and steal your hard-earned dollars. Here are a few best practices that can help ensure that your entry into retirement is a happy time and not something to stress about.
Who Should Manage My Money?
There are a lot of concerns once you retire, mainly that you will outlive your money. This leads some people to think that they need someone that will help make sure they don’t run out, and the problem with this is there is no shortage of people that will take your money and promise to make this dream come true. According to Morningstar’s U.S. Active/ Passive Barometer reports, there is no proof that an actively managed fund will outperform passive investment options. So what exactly does this mean? If you pay someone to help you manage your funds (either in retirement or before), there is a better chance you will make LESS money than if you put it in a passive fund that tracks the S&P 500. The data from Morningstar’s report shows only 43% of actively managed funds outperformed passive funds over a 10-year period. That less than half! One of the biggest reasons for this is the fees these fund charge for their services, so even if they can offer marginally better performance, you lose that advantage once you account for their fees.
So who should manage your retirement funds? Well you should! That’s one of the reasons we have created Freedom Finances, to give you the tools and knowledge you need to manage your own finances. Whether you want to actively manage your own funds or just check on things every couple of years and make small modifications, we want you to have the knowledge needed to not fall victim to the many traps investors and retirees fall into.
How Much Can I Take Out?
Great question! There are a couple of things to consider when deciding how much you can withdraw each month or year in retirement. There are obvious things you should consider such as your needs (mortgage, groceries, insurance, healthcare, ect). For this we will assume you have enough to cover your basic needs and would like to know how much to take out so you don’t run out of money!
- 4% Rule
- This rule allows you to take out 4% of your total investment portfolio per year and claims you will never run out of funds:
- The idea is that with an average return of 8-10% per year over the long run, 4% will allow you to weather poor performing years and still never worry about depleting your savings.
- If you have $1,000,000 in retirement savings, you would be able to safely withdraw $40,000 of it.
- Depending on your retirement account you may owe taxes on this withdrawal (traditional 401(k)s are taxed as earned income, where Roth IRA’s can be withdrawn tax free).
- This rule allows you to take out 4% of your total investment portfolio per year and claims you will never run out of funds:
- Accounting for taxes
- It is important to consider tax treatment on the funds you take out (withdrawals of $11,601-$47,150 are taxed at a 12% rate but anything from $47,151-$100,525 are taxed at 22% which is almost double):
- In this situation, if you can live with only $45k this year it may make sense to wait until the next year to withdraw the remainder, so you pay less in taxes overall.
- Where you live can cost (or save) you thousands:
- The average state income tax rate is around 5% (with states such as California and New York having the highest rate, over 10%).
- There are several places that charge no state income tax such as Florida, Wyoming, Alaska, and South Dakota:
- If you move to one of these states prior to retirement and start to withdraw once you have residency, you could save yourself on average 5%.
- While some of these states do have higher sales tax and other things that should be taken into consideration, this can be a great way to get more of your retirement dollars.
- It is important to consider tax treatment on the funds you take out (withdrawals of $11,601-$47,150 are taxed at a 12% rate but anything from $47,151-$100,525 are taxed at 22% which is almost double):
So to recap, you should aim to keep your yearly withdrawals around 4% and ensure you are taking out money at the best possible tax bracket. If you are wanting to relocate in retirement, it may also be beneficial to look at states that do not charge any state income tax to stretch those dollars even further for you (just make sure you consider other potential costs as well).
A few other things to consider for your retirement:
- In many cases you can still work and earn income if you are able to:
- For social security, there are earning limits depending on if you are at full retirement age or not so you will want to make sure you don’t earn more than that or it can start to impact your social security payments.
- Maximizing your social security benefits:
- You can claim social security as early as 62 but this cuts your benefits by about 30%
- You get about 100% of your benefit if you wait until 66-67 and you maximize your benefit at 70 so don’t delay past that.
- Your benefit is based on the highest earning 35 years of work you had (adjusted for inflation):
- If you haven’t worked a full 35 years, they will consider your earnings $0 for the missing years.
- If you work 36 years, they will only consider the 35 highest earning years (in this case sometimes it makes sense to work an additional year to replace a lower earning year with a higher earning year to maximize benefits).
- You can claim social security as early as 62 but this cuts your benefits by about 30%
- Budgeting for healthcare:
- Healthcare accounts for a significant cost in retirement, much higher than most people are used to during their working career.
- Everyone’s health situation is unique, and it is extremely important to figure out what programs like Medicare and Medicaid will cover and ensure you have enough to cover for the unexpected.
- Inflation will negatively impact your buying power:
- Even if you have money that isn’t “losing” value, over time inflation will make those dollars’ worth less.
- The last decade has seen an average inflation rate of just under 3% so any investment earning at least that will keep up with inflation.
- Leaving money to family:
- While this shouldn’t be your primary focus in retirement, it is nice to have something to leave your family members when you are gone.
- Remember, this isn’t a lottery your family is winning…. Enough to cover end-of-life expenses, expenses of managing your estate, etc.
- While this shouldn’t be your primary focus in retirement, it is nice to have something to leave your family members when you are gone.
With these tips you should be able to enter retirement with confidence that your funds will last you several years and ensure you don’t eat away the savings you spent a lifetime acquiring with fees, taxes, and unnecessary “services”. Don’t be afraid to learn a little bit more about your finances because over the course of your retirement it can save you thousands of dollars!