Drawing on your Social Security

If you are at least age 62, the first source of income you’ll have during retirement is Social Security, the federal government’s social insurance program that includes monthly benefit payments to retirees.

Tapping into other sources

Managing your retirement savings to last the rest of your life is challenging if the only fixed monthly income you have is Social Security. You likely need other sources of income during retirement. The following list highlights possible retirement resources above and beyond Social Security:

• 401(k): As long as you’re working for the employer that sponsors the plan, you generally can’t take money out before you’re 59½ other than for hardship withdrawals. Taking a hardship withdrawal prior to age 59½ means you pay income tax and a 10 percent penalty tax unless the withdrawal is for a reason that is exempt from the penalty tax. (Check Chapter 16 for a list of exempt withdrawals.)

  If your plan permits you to withdraw money after age 59½, you’ll have to pay taxes on the money you take out, but you don’t pay an early withdrawal tax penalty.

  If you leave your job at age 55 or older, you can withdraw the money without any penalty tax, but you still have to pay income tax.

  You can withdraw the money as an income stream provided your 401(k) plan permits installment withdrawals. The amount you withdraw each year will be taxable but without any penalty.

  You can also roll it over into an IRA, but that won’t be a good idea if you want to withdraw money prior to age 59½ because the early withdrawal penalty will apply.

• Other tax-favored retirement accounts: Accounts similar to a 401(k), such as a 403(b) or IRA, have rules similar to those of 401(k)s. Generally, you shouldn’t count on having easy access to your money before age 59½, or possibly age 55. There aren’t any early withdrawal penalties for 457 deferred comp plans.
• Annuity: Consider converting at least 50 percent of your retirement savings (401(k), IRA or other) into a lifetime income stream by purchasing an annuity that provides a guaranteed monthly income. There are many types of annuities on the market, but the only type I recommend is one that provides a monthly income.
• Traditional defined-benefit pension plan: If your employer offers one of these plans, your human resources or benefits representative should be able to tell you what your expected payment will be if you qualify to receive benefits.
• Life insurance: Some people buy a type of life insurance policy that allows them to build up a cash account (a cash value policy) rather than buy term life insurance, which is worth nothing after you stop making payments. If you have a cash value policy (such as whole life or variable life), it should have a cash account that you can tap at retirement.
• Regular taxable savings: A taxable account is any kind of account (such as a bank account, mutual fund account, or stock brokerage account) that doesn’t have special tax advantages.
• Part-time work: No matter when you retire, you may want to take a part-time job that will keep you active and give you extra income.
• Inherited wealth: You shouldn’t count on any inheritance until you actually receive it. But if you do inherit a substantial amount of money, integrate at least part of it into your overall financial plan to give yourself a higher retirement income.

Rental property is another type of investment to consider as you approach your retirement years. My wife and I bought a small farm as an investment property during our late 50s. It has two houses that we rented. The same tenant was in the larger house for 14 years. We remodeled it, sold our other house, and moved three years ago. We have great tenants in the other house and a couple of horses to board that still provide rental income.

You can take the first step toward figuring out when you can feasibly retire by writing down your sources of income and when you can access them.

Living the retirement life

Assume that your retirement begins tomorrow. What will your life be like? This is the necessary question that retirement calculators don’t ask. Most importantly, what will you do six months after the novelty of retirement wears off, when you’re tired of golfing, shopping, traveling, or just being a couch potato? Many people find it difficult to go straight from full-time work to full retirement — particularly when they haven’t developed interests outside of work. A recent RAND corporation survey shows that up to 40 percent of retirees are eventually returning to work full-time or part-time. Seventeen percent of those between 70 and 74 are working at least ten hours per week according to a Stanford University study. Some work because they enjoy it and want to stay involved. Others continue working to keep medical or other benefits. Many continue working because they need the income.

Having an idea of what you’ll do in retirement is important so that you can avoid these common mistakes:

• Retiring too early, realizing that your money isn’t going to last, and being forced to go back to work. In the meantime, you’ve lost out on contributing more to your 401(k) — and possible employer contributions, as well.
• Retiring, becoming totally bored within six months, and begging for your old job back.

Imagining your retired life can be both fun and motivating.

Testing the waters in your gene pool

When you think about your retirement age and how long you’ll need to finance your retirement, keep your genes in mind. If your family has a history of longevity, you should plan financially to live until 100. (If you’re the cautious type, you may want to do this anyway, even if you don’t think there’s a chance you’ll live that long.)

Cutting down on your expenses

I realize that many workers barely earn enough to pay for basic necessities and can’t eke out anything extra for a 401(k) plan or IRA contribution. But it’s important to try. Or you may be in your 40s and want to save more to catch up, but you can’t figure out where to find the money. You may be surprised at some of the places you can save money. Often, a few minor spending adjustments can free up money for savings.

Like most everything, it all boils down to making choices. Table 11-4 lists suggestions for cutting your spending. None of the expenses listed are necessities — and cutting out one or two, or reducing the cost of a few, can help begin your savings program.

You’re probably wondering whether all this nickel-and-diming is really worth it, but it can add up. I’m not suggesting that you give up everything on the list — only that you look at what you spend to see if you can cut some costs without feeling too much pain. Giving up a few nonessential items today is far better than struggling without necessities during your retirement years.

I’ve never met a 401(k) participant who claimed to have saved too much. I’ve never heard participants say that they wished they’d spent more money earlier. Instead, what many older participants tell me is that they wish they had started saving sooner.

This may be difficult to believe, but the important thing about money is not how much you earn. It’s how you manage what you have. Spenders will always spend what they have or more, regardless of how much they earn. Spenders who get a substantial increase in income will adjust their spending habits to the new level within a very short period of time.

If you have a tendency to spend, automatically take a portion of any pay increase and put it into a 401(k) or similar forced savings vehicle before you get used to having it in your hot little hands. Otherwise, you may never break your spending cycle.

Picturing your progress

After you start saving, you have to keep checking to make sure that you’re on track. Benchmarks can generally help you gauge where you should be.

The savings goals in this section are designed for 25-year-olds just starting their savings programs. If you’re over age 25, these benchmarks can still tell you if you’re on target with your retirement planning. If you’re significantly behind these benchmarks, you’re certainly not alone.

Remember that these are ideals; they’re not here to make anyone feel defeated. Instead, the intention is to motivate you to sit down and develop a workable plan for catching up. This may mean that you have to work longer than you’d like or substantially increase your savings rate. If you feel depressed looking at these, just be glad you’re starting now. If you’d waited, imagine how much more catching up you would have to do!

If you don’t have a 401(k) or other employer-sponsored retirement savings plan, use an IRA to hit the numbers I use in the examples in the following sections.

Counting on compounding

The purpose of the sample plans in the preceding sections is to show you how a specific plan gives you a tangible way to measure your progress each year. It’s helpful for you to know some assumptions in the previous savings goal examples:

• Money is saved for retirement every year. You should even add to your retirement savings during periods that you’re not eligible to contribute to a 401(k) using an IRA and other investments if necessary.
• All the money is left in the plan until retirement. None of the money is withdrawn for other purposes.
• The assumed return requires at least 60 to 70 percent in stock investments (mutual funds or a diversified mix of individual stocks) up to age 55. After age 55, the stock holdings drop to the 50 to 60 percent range. (I talk more about investment strategy in Chapter 13.)

Your retirement nest egg comes from your own contributions and your employer’s contributions, and the investment return that’s earned on these contributions. Table 11-9 shows this final breakdown among the three sources, using the example of savings progress at age 60 from the previous section.

You’ve probably heard about the magic of compounded growth — a term used to explain how money can grow over time.

Figure 11-1 looks at the cost of waiting to save $1,000 a year. See how much more the person who starts at age 25 ends up with than the one who waits until age 35.

The benefit of compounded growth is very real, but this magic is significant only over long periods of time — 20 to 30 years or longer. This is why starting to save at an early age and sticking with your program is so important. If you wait 10 years before you start, you’ll substantially reduce your investment return. The difference can be made up only by a much larger savings rate or by working and saving longer.