If you’re anywhere near retirement age, you likely have retirement questions, especially when it comes to money. Questions about when to take Social Security; how to invest, both before and after retirement; whether you should pay off your mortgage prior to retiring; questions about annuities; and, of course, the biggie — how to know if you’ll have enough.
Following are short, simple answers to these common retirement questions.
If you’d like to learn more, we publish a lot of information concerning retirement. We also answer nearly every retirement question in our highly popular retirement course. Check it out: It’s got everything you need to replace retirement questions with clear answers.
Now, onto the Q&A. Each question is answered in a short (three to five minute) video, but if you’d rather read the answers, a rough transcript follows each one.
How much do I need?
Today we’re going to attempt to answer one of the most common, and critical, retirement questions: figuring out exactly how much money you need to have saved to pay for a happy, fulfilling, worry-free retirement.
This is probably the single most important retirement question, because the last thing you want to do is run out of money when you’re too old to make more. So, let’s go through this step by step.
Step 1: How will you spend your time?
If you plan to travel a lot, take up costly hobbies, live in a fancy retirement destination or do other extravagant stuff, you’ll obviously need a lot more than if you plan to downsize and age in an area with a lower cost of living.
In short, you can’t begin to estimate how much you’ll need in retirement without thinking about how you want to spend your retirement years.
Step 2: What will it cost?
Now, let’s move on to the next step: pricing it out. If you think you’ll be spending more in retirement than you’re spending now, estimate how much more. If you think it’s going to be less, estimate how much less.
I know, it’s not easy to guess how much you’ll spend tomorrow, much less years from now, but don’t sweat it. If nothing else, just use the amount you’re spending now. Don’t know that number? Start tracking your expenses. There are apps that will do it for you automatically. We recommend partner app YNAB (You Need A Budget), but there are plenty of options out there.
Step 3: Where’s the money coming from?
Once you have a handle on what you’d like to spend in retirement, it’s time to move on to the next step: figuring out where that dough is going to come from. One common way to guess at how much you’ll need in retirement is to use the 4% rule.
The 4% rule suggests that maintaining a mix of half stocks and half bonds will enable you to spend 4% of your savings every year without touching the principal.
Let’s use a simple example to illustrate. Assume you estimate you’re going to need about $4,000 a month during retirement. That’s $48,000 a year. Divide 48,000 by 4% and, according to the 4% rule, you’re going to need $1.2 million in savings in order to spend 48 grand annually for the rest of your life.
Another way to arrive at the same number is simply to multiply your annual income needs by 25. However you do it, the logic behind the 4% rule is solid. Half stocks, half bonds should return about 7% over time. After inflation, you should be able to easily withdraw 4% yearly without running out of money.
That being said, the nature of both markets and people can quickly change this calculus. If you suffer big stock market losses early in retirement, for example, that could lower your future withdrawals. Likewise, if you splurge with a big withdrawal in early retirement.
While the 4% rule makes it look like you’ll need a ton of savings, it’s probably not as bad as it looks. That’s because you hopefully have other sources of retirement income, like Social Security.
You can get an estimate of your Social Security in just a few seconds. Just go to ssa.gov and use their retirement estimator. If you’re going to get $2,000 a month from Social Security, now all you need is another $2,000 to hit your $4,000 income goal. So, that means you’d only need $600,000 in savings instead of $1.2 million.
Step 4: Growing your nest egg
And that leads us to our final step, other ways to add to your nest egg. How can you fatten those savings? Lots of ways. Examples:
- Downsize your home
- Work a little longer so you get a bigger Social Security check
- Work part-time during retirement
You get the idea. Even if you’re coming up short when you picture your life after retirement, there are things you can do, both before and after retirement, that can help.
Bottom line? Everyone’s different and so are their retirement solutions. The important thing is to step back, look at where you are today, think about what you want your retirement to look like and try your best to hit those savings goals. The sooner you start that process, the better.
How should I invest before and after retirement?
Once you’re retired, you want to have some fun. But what you don’t want is to worry that you’re going to outlive your savings. You’ve spent your whole life gathering nuts for the winter. Now it’s time to manage those nuts.
How to safely invest, both before and after retirement: one of the most common retirement questions.
In general, the balancing act is between leaving enough of your savings in stocks for growth while keeping another portion in safer stuff.
There are several proven systems to manage your money both before and after you retire. Let’s look at three of them.
Subtract your age from 100
One of the most common, and simple, ideas is the subtract-your-age-from-100 strategy. In this one, you simply subtract your age from 100 and use the result to figure the percentage of your savings that should be in the stock market.
For example, if you’re 65 years old, you’d subtract 65 from 100, which equals 35. That means 35% of your long-term savings would go into stocks. The rest you’ll invest in safer assets like bond mutual funds, and savings accounts or CDs.
There’s also a variation on this strategy that suggests subtracting your age from 120 instead of 100. This will result in a higher percentage of your assets going into stocks. So, using 120, a 65-year-old would keep 55% in stocks instead of 35%.
Either way, the idea of subtracting your age from a fixed number is a cool system, because it automatically reduces stock market risk as you get older.
Want to know more? Check out “Build a Successful Retirement Plan With These 5 Steps.”
The bucket system
This investment approach asks you to divide your savings into long-, medium- and short-term buckets. With this strategy, you keep money you won’t need for seven to 10 years in stocks; that will give you long-term growth.
Money you expect to need in three to seven years might be in a mix of stocks and bonds.
And finally, for money you need sooner, you’re going to use a risk-free savings account or money market account.
The advantage of the bucket approach is that it ensures that money you’re going to need in the next few years is out of stocks, and thus out of harm’s way.
The fixed expenses strategy
The final strategy we’ll explore is the fixed expenses strategy. This method ensures you have enough guaranteed income to cover all your necessary expenses. Money left over would be invested in riskier assets like stocks.
Example: Say your nondiscretionary expenses — like rent, mortgage, utilities and food — add up to $4,000 a month. Your total income from pensions and Social Security is $3,000. That means you have a $1,000 gap. To bridge that gap, you’ll use some of your savings to purchase an immediate annuity that would pay $1,000 a month for life.
Not familiar with annuities? They’re not complicated. When you invest in an immediate annuity, you give an insurance company a lump sum of cash and it agrees to give you fixed monthly payments for life. To learn more, check out “Should I Buy an Annuity for Retirement Income?”
Now you’ve got your fixed expenses covered by guaranteed income: $3,000 from Social Security, $1,000 from your annuity. That allows you to invest your remaining savings in higher-risk, higher-return investments like stocks. If those investments perform well, you’ve got more money for fun things like travel. If your stocks don’t do well, you can wait it out since your fixed expenses are covered.
There you have it: three simple approaches to post-retirement investment management. None of these things is set in stone, but at least they’ll give you some ideas.
For most Americans, Social Security is the foundation of retirement income. Unfortunately, however, Social Security isn’t all that simple. For example, you’ve got to decide whether to take it early, late or on time. Mess this up, and you could lose tens of thousands of dollars of income over your lifetime.
When should you start?
Taking your benefits at the earliest possible age, which is generally age 62, will reduce them by up to 30% for life, compared to the amount you’ll get by waiting until your full retirement age, which ranges from 65 to 67, depending on when you were born. Waiting until after your full retirement age to collect increases your monthly check by up to 8% for every year you wait, until you hit 70.
You’re not rewarded to wait
It may seem as if Uncle Sam is paying you to wait, but you’re not actually getting rewarded. In theory, you should get the same amount of money over the course of your retirement no matter when you claim, since you’ll be receiving either a reduced monthly benefit for more years or an increased monthly benefit for fewer years. That being said, however, there are reasons to wait and reasons to grab that check at 62.
Taking it early
Reasons to claim early would include having a short life expectancy, needing the money ASAP, or having minor kids at home who qualify for additional benefits. For more, see “5 Reasons You Should Claim Social Security ASAP.”
Reasons to wait
There are also reasons not to take Social Security early. Obviously, if you like working and expect to live a long time, wait it out and get a bigger monthly benefit. Plus, that higher monthly benefit means a higher cost-of-living adjustment, or COLA, and a bigger survivor benefit for a spouse you leave behind. For more reasons to wait, see “7 Reasons You Should Not Claim Social Security Early.”
Now you can see that knowing when to claim Social Security benefits isn’t as simple as it may first appear. In general, if you’re happy working and expect a long life, waiting’s smart. But if you can’t wait to stop working, don’t expect a long life and/or need the money, there’s nothing wrong with taking it early.
That being said, as I explain in our popular retirement course, Social Security is an awesome foundation for your retirement, so the more you can get, the better.
Here’s why I love Social Security:
- It’s at least partially tax-free
- It lasts for life
- It increases with inflation
- Unlike investments like stocks, it can’t decrease in value
- It offers a survivor benefit
- It’s maintenance-free
Those features are hard to beat. And last but not least, for every year you wait after your full retirement age to claim your benefit, your monthly income goes by up to 8% for life. And 8% risk-free is a good return, probably better than most people earn in their savings. That alone is a good reason to put off claiming, at least if you feel you comfortably can.
Confused? Get help
One last suggestion. If you’re confused about when to claim your Social Security, get help. It’s cheap and it’s worth it, especially if you have a spouse.
There are companies that use computer algorithms that promise to maximize your Social Security income. You give them a few simple pieces of information, they send you back a personalized report detailing exactly at what age you and your spouse should file to get the maximum possible benefit over your lifetimes.
Reports like these are especially helpful when two spouses are approaching retirement, since the number of options increases dramatically.
I got one of these reports myself a few years ago and I found it both helpful and interesting. You probably will, too. It’s cheap insurance to make sure you collect every dime you’re entitled to. You can check out our favorite company, Social Security Choices, at this page of our Solutions Center.
Should I pay off my mortgage before retirement?
It’s common knowledge that entering retirement debt-free is the way to go. Obviously, the less money you’re forced to send to creditors, the more money you’re going to have to enjoy life. But that’s not always possible and sometimes not even preferable.
Retiring with a mortgage
Entering retirement with a mortgage isn’t as rare as it used to be. According to a 2014 report from the Consumer Financial Protection Bureau, about 80% of Americans age 65 and older own their home, and the number of seniors with mortgages has been growing for years — which isn’t really all that surprising considering home prices have been rising for years and inflation-adjusted wages haven’t been keeping pace.
The first thing you need to know is that if you have to retire with a mortgage because you have no choice, do it. You’re not the only one.
If you can pay it off, should you?
If retirement approaches and you simply won’t have the money to pay off your mortgage, then the decision is made for you. You’ll retire with a mortgage. But what if you have a choice? What if you have either the savings or the income to pay off your mortgage before you retire? Should you? Let’s look at both the pros and the cons.
Advantages to paying off your mortgage
The primary plus of retiring mortgage-free is increased cash flow. Money you’re no longer putting toward your mortgage can go into something better, like travel. Another advantage is having one less bill to worry about if things should go south. Finally, paying off your mortgage can literally make you richer, if you’re paying more on your mortgage than you’re earning on your savings.
Example: If you’re paying 4% on your mortgage and only earning 2% at the bank, you’re going backward, i.e., getting poorer, by 2% every year. But, if you pay that mortgage off, you’ll be getting richer by that amount.
Disadvantages to paying off your mortgage
What are the disadvantages of paying off a mortgage? Well, one could be turning a liquid asset, i.e., money in the bank, into an illiquid asset — namely, home equity.
Another potential con: one less potential tax deduction.
Finally, paying off your mortgage handicaps opportunities to make money elsewhere. I’ll offer an example from my own life.
About a decade ago, in the depths of the Great Recession, I had a bunch of money in the bank earning next to nothing. I could have used it to pay off my mortgage, but instead I used the cash to buy the house next door at a bargain price. I fixed it up, rented it for a while, then sold it for a big profit a few years later. That was a good trade-off, because what I earned on the investment more than offset the interest I was paying on my mortgage.
In short, having money in the bank can help you make more money. Plus, it obviously feels good to know that if things go south or an opportunity arises, you’ve got the money to deal with it.
What should you do?
Pay off your mortgage if:
- You’ve got your retirement accounts fully funded.
- You’ve got a ton of savings that’s not earning much.
- You’re not getting a tax deduction for mortgage interest.
- You’re not likely to use the cash for a lucrative investment.
- You long for the safety and satisfaction that comes with being debt-free.
Don’t pay off your mortgage if:
- You’re earning more with the money than the mortgage is costing.
- You’re getting a tax deduction for mortgage interest.
- You’re more interested in leveraging opportunities than being debt-free.
- You like the security of having a lot of money in the bank.
A clarification on income taxes and mortgage interest
Despite the fact that I listed mortgage-related tax deductions in the lists above, deductible interest should never be the sole justification for maintaining a mortgage. True, the ability to deduct interest effectively lowers the cost of borrowing. But deductibility alone can never justify debt.
Example: Say I’m in a 30% tax bracket. I pay $100 a year in interest, but that interest is deductible. The $100 I paid saved me $30 in taxes. But the loan still cost me $70, and I’m poorer by that amount.
Obviously, the less debt you have, the better, especially as you approach retirement. So, even if you can’t pay off your mortgage entirely, unless you’re earning more than you’re paying in interest or may need a wad of cash in foreseeable future, try to pay off as much as you can.
What is an annuity and should I buy one?
Back in the day, workers could count on a pension from their employers that would take care of them for life. These days, not so much.
Social Security is one source of income you can’t outlive, but for most, it’s not going to be enough. So, today’s seniors are looking for additional sources for safe monthly income.
That’s where annuities come in.
What’s an annuity?
Annuities are simply investments offered by insurance companies. Why look to insurance companies for investments? Well, they offer two benefits over banks, stock brokerages or other investment providers. First, investments offered by insurance companies can be tax-deferred. They also can bypass probate court.
What’s tax deferral? Well, if you’ve got a traditional individual retirement account (IRA) or 401(k), you know you don’t pay income taxes on the earnings until you take them out. That’s tax deferral.
Also, like your IRA or 401(k), when you set up an annuity, you name a beneficiary. That means if you die, that beneficiary is going to get the money without the hassle and expense of having to go through probate court.
So, here are two reasons annuities are popular: They let you postpone a tax bill, and they allow you to leave money directly to your heirs. Now, let’s explore various types of annuities.
The 3 types of annuities
The three basic types of annuities are:
- Fixed annuities: Basically like bank certificates of deposit
- Variable annuities: Basically like mutual funds
- Immediate annuities: A source of monthly income
When you’re planning for retirement income, you’ll be looking for an immediate annuity. You’ll give the insurance company a lump sum of cash, and they’ll start paying you a guaranteed monthly income.
Your income stream could last for a fixed number of years. Or, it could last for the rest of your life. Or, it could last for the rest of your life, then your surviving spouse’s life. Or, it could also last for life, but for a minimum of 10 years guaranteed. In short, there are lots of ways to set up one of these contracts.
Obviously, the amount you’re going to get every month is going to depend on how much you deposit with the insurance company, as well as of length of time you expect to receive payments. But if you’re looking for a predictable income in your retirement years — in other words, a substitute for a pension — this is where you might find it.
Let’s look at an example. Before I wrote this, I went online and got a quote for an immediate annuity for a 65-year-old male. Result? If I give the insurance company $100,000, they’ll guarantee me $525 every month for life.
Not all that much, right? And that’s one drawback of annuities: To generate a decent monthly income, you’ll have to invest a lot.
Other potential annuity drawbacks
The amount of income you’ll get from an immediate annuity depends on several things.
When interest rates are low, like they are as I write this, your guaranteed monthly income will also be lower. And that monthly income is locked in for life. Should rates later rise, too bad; your income won’t increase.
Which leads me to the next fly in the ointment: Once you purchase an immediate annuity, your money’s tied up. There’s no getting out of it, even if a crisis creates a need for cash.
A final potential problem with all kinds of annuities is excessive fees, which will reduce the monthly payout. As with mutual funds, these costs often are not apparent, making them difficult to assess.
Should you invest in an annuity?
An annuity could be an appropriate investment for those approaching retirement. As with any investment, however, comparison shopping is a must. If you’re looking for an immediate annuity, you’ll shop by comparing the amount of monthly income and the quality of the insurance company providing it.
One thing important to remember: Guarantees here are only as solid as the company making them. No Federal Deposit Insurance Corp. (FDIC) or other government entity guarantees with these things.
Who to buy from?
You can also go directly to insurance companies to shop for annuities, as well as to most insurance agents and investment advisers. But be careful and remember this rule of thumb: The more a salesperson is trying to jam something down your throat, the more cautious you should be. If possible, avoid commission-based financial advisers.
Another rule of thumb: If you’re not paying by the hour, you’re probably paying a commission. Always ask how your adviser is getting paid.
Bottom line? Annuities can be useful to provide monthly income during retirement. Just make sure to take your time and get the right one.
That concludes today’s answers. But I know you’ve got additional questions. You’ve got to be wondering about things like: How am I going to pay for health care? Should I retire early? How much do I pay in taxes when I retire? Should I take my pension as an annuity or a lump sum? What am I going to do with myself in retirement?
If you want answers to these questions and lots, lots more, then invest in your future by taking a look at our full retirement course. It’s a simple guide that has everything you need to plan a worry-free retirement full of freedom, purpose and enjoyment.