The decision to retire can be sparked by a number of factors: reaching a specific age, hitting a savings goal, or being laid off in a tumultuous job market. To support yourself without income from a job, you'll have to make a series of choices about Social Security, health coverage, and your investments. Here are 10 of the toughest decisions you will make before you retire.
When to retire. For some people, it's a financial calculation. You know you're financially ready when the combination of your Social Security, traditional pension, and investment income produces enough cash flow to cover all of your anticipated expenses for the rest of your life. "Working two or three more years can make an incredible difference to your long-term plan if you continue to save in your 401(k) or 403(b) and continue to pay into Social Security," says Mary Alpers, a certified financial planner and founder of Alpers and Associates in Colorado Springs, Colo. But retirement also often involves an identity shift from your former job title to a free agent. Sometimes this decision is made for you because of a layoff or buyout. Many people also like to coordinate their retirement with a spouse.
When to claim Social Security. You can sign up for Social Security beginning at age 62, but payouts increase for each year you delay claiming until age 70. "Wait as long as you possibly can, because the additional percentages that are added on are enormous," says Jane Nowak, a certified financial planner for Kring Financial Management in Smyrna, Ga. "Since we are living longer, you certainly want your paycheck from Social Security to be as fat as possible."
Health coverage. It's essential to find affordable health insurance if you want to retire before age 65. "If you are not entitled to retiree medical benefits or if they are deferred to a later date, make absolutely certain you have access to and can qualify for individual coverage," says Robert Henderson, president of Lansdowne Wealth Management in Mystic, Conn. "Also verify the costs. Health insurance can be prohibitively expensive in some cases." Even after you qualify for Medicare, the decisions don't end. You have to choose whether to purchase a supplemental policy and shop around for the Medicare Part D plan that best meets your prescription drug needs each year in retirement.
How much you can safely spend each year. If your nest egg isn't sizeable enough to finance your retirement completely, you'll need to calculate how much you can safely spend each year without depleting your savings too quickly. "Three to 4 percent is my comfort zone, and I hope less," says Alpers. An annual draw-down rate of 4 percent on an investment portfolio with 35 percent in U.S. stocks and 65 percent in corporate bonds has an 89 percent likelihood of lasting 35 years or more, according to Congressional Research Service estimates.
How much investment risk. Retirees need to balance their investment needs for safety and continued growth. "Hold as little equities and higher-risk assets as possible, while still enough to meet your long-term goals," says Henderson. "Most retirees need no more than 50 to 60 percent in equity and equity-like investments." You'll also need an emergency fund and several years' worth of living expenses set aside in a safe place. "Always make sure that you have your first three to five years of withdrawals invested in very conservative investments. Good choices are CDs, money market accounts, short-term treasuries or mutual funds that invest in them, and fixed-immediate annuities," says Henderson. "This way, regardless of what the stock market is doing today, you don't have to worry about withdrawing assets that have dropped in value."
When to pay taxes. After decades of deferring taxes on your retirement savings using 401(k)s and IRAs, the tax bill becomes due upon withdrawal in retirement. The timing of these withdrawals could affect how much you pay in taxes. "Try to balance out your withdrawals from taxable and nontaxable accounts each year so you are not kicking yourself into a higher tax bracket at some point," says Henderson. Taking a large IRA withdrawal in a single year could result in an oversized tax bill. Withdrawals from traditional retirement accounts become required after age 70½.
Where to live. Once you are no longer tethered to a job, you can live anywhere that suits your tastes and budget. Moving to a place that costs less than where you live now can boost your standard of living and help stretch your nest egg. You could also test out a place with better weather, more opportunities for recreation, or move closer to family.
Whether your home should help finance retirement. A paid-off mortgage can help finance your retirement because it eliminates one of your biggest monthly expenses. In some cases, downsizing to a smaller home or moving to a place where the cost of living is significantly lower can even give a significant boost to your nest egg. "Especially if you live on the East or West coast, where housing can be extremely expensive, you may have an opportunity to downsize and realize quite a bit of the appreciation you had in your real estate," says Henderson.
Whether to keep working. A part-time job is increasingly becoming common in the retirement years. Many people downshift to a job with shorter hours and less responsibility before retiring completely, while other people return to work after a break. The income, and sometimes benefits, a part-time job provides allows you to withdraw less of your retirement savings each year. Some people also find jobs they enjoy that allow them to interact with former colleagues, consult on the occasional project, or learn a new skill.
What you will do. Retirement isn't only about quitting your job. It's an opportunity to have complete control over how you spend your time. Make sure you have a few ideas about how you will fill the eight or more hours per day you previously spent working and commuting. Some people miss the sense of purpose and friends that their job provided for them, while others finally have the time for hobbies and projects they have been waiting years to tackle.