Retirement readiness is a fuzzy concept — no matter the size of a nest egg. People face one nagging question: “How do I really know when I’m financially ready to retire?”
It’s tough to answer as there’s no single solution. “I don’t know if there’s a magic bullet answer,” said Judith Ward, a thought leadership director at T. Rowe Price (TROW).
No doubt, figuring out if your money will outlive you is the math problem of the 401(k) age.
Everyone’s computation has different inputs. The equation, for example, is different for a 401(k) supersaver with the house paid off and small monthly costs versus a couple with $2.5 million in 401(k) savings but two unpaid mortgages.
The retirement puzzle is a lot to unpack for working Americans and pre-retirees heading into the homestretch of their working lives. But there are ways to tune predictions.
Knowing You’re Ready To Retire
Monte Carlo simulations — algorithms that run thousands of financial scenarios — can spit out probabilities of success. Financial advisors can run the numbers for you. AI can talk things through with you, too. You can also plug numbers into a retirement calculator to get an idea of whether you have the financial wherewithal to quit working.
Most people, though, have gone through some of these exercises. Yet, the worries remain. The nagging question, “how do I really know if I can retire?” still makes it hard to sleep.
Anxiety about retirement security often has to do with savings shortfalls. In fact, three of five working Americans say they’re behind where they should be with retirement savings, according to a new Bankrate.com survey.
But nest egg angst comes from wild cards, too. The biggest setbacks are losing a job close to retirement or having a health issue that results in having to retire years earlier than your financial plan baked in.
In fact, the median retirement age is 62 (or three years before the traditional retirement age of 65), according to a study of retirees by Transamerica Center for Retirement Studies. Six in 10 retirees retired sooner than planned, the study found.
Find The Signs You Are Ready To Retire
What pre-retirees really want to know is what the all-clear signs are. John Anderson, a certified financial planner with Equitable Advisors, equates not worrying about money in retirement to the freedom of financial independence.
What does that look like?
“It’s the point at which you have enough assets or other income sources outside of your job that will cover your expenses for the rest of your life,” Anderson said. “It’s the day you can proclaim, ‘Hey, working is an option versus something I have to do.'”
Using rules of thumb, such as having 10 times your salary saved by age 67, as Fidelity Investments recommends, or using a magic savings number of $1.8 million that Schwab 401(k) plan participants say they’ll need to retire comfortably, is a good place to start. But they’re imperfect.
Do The Math
Knowing the size of your 401(k) balance, what monthly benefit you’ll get from Social Security, and tallying other income streams you’ll have in retirement isn’t enough.
Why? That information lacks one key input: what you’re spending.
And that is the first step in figuring out if you are financially fit to retire, says Rob Williams, managing director of financial planning for the Schwab Center for Financial Research.
“The dollar amount in your 401(k) is not very relevant unless you know what you’re spending,” said Williams. “What’s your lifestyle? Most people don’t know that. And a surprising number are spending far more than they may realize.”
Overspending can knock a retirement plan off course. It can drain assets faster than expected.
“Think about what you can control,” said Ward. “Spending is key. In many cases, it really is the difference between true retirement security versus it being a little iffy.”
Tally Up Your Spending
Figure out exactly what you’re spending in the years before retirement. And what you expect to spend when you stop working.
The math can be as simple as addition and subtraction. On one side, add up your predictable income streams in retirement: Social Security, retirement savings, annuities, pension and rental income. On the other side, shine on a light on your spending now and how that might change in retirement. And don’t forget about adding in the drag of inflation and taxes.
Plug the numbers into a retirement planning calculator and see what it says. The results can be enlightening and can help identify any adjustments to your plan.
“If you’re not doing that, and you’re not creating a budget so you know what you’re spending, you’re going to be in for a rude awakening,” said Missy Spickler, a financial advisor at Merrill Lynch Wealth Management.
The more specific and honest you are about your spending habits and expenses the better. Ward says that she even calculated the cost of care for her cat and dog.
What you want to see is that your guaranteed sources of income can cover your expenses not just for this year or next, but for all your remaining years as well. If the numbers don’t work, you must determine what nonessential things in your life can be cut back.
Stress Test Your Plan Five Years Before You Retire
There’s an awful lot you can learn from your current finances. Use the five years before you retire to gauge whether your retirement plan and spending is workable.
Think of it as a dress rehearsal. If the numbers aren’t working while you’re still working and getting a paycheck, that’s a sign that the math won’t work in retirement, either.
On the expense side, for example, real estate is a good place to start, as it’s a big expense. A mortgage is often viewed as a nondiscretionary expense because it meets a basic need. But if your monthly mortgage eats up too much cash flow or won’t be paid off for another 20 to 30 years, or you own a second house, real estate could actually be a discretionary expense in need of cutting.
“A home might be an asset, but when does it start to become a ‘liability’?” said Williams. “When real estate starts to become a considerable expense, not just a place to live, that can be a warning sign and something that warrants a closer look.”
Ask yourself: Are you confident that you can sustain that expense when you no longer have income from a job? If the answer is no, you might consider downsizing. “Use the five years before retirement as a reality check,” said Spickler.
Boost Your Odds Of Success By Not Retiring Too Early
The earlier you retire, the more your savings have to do the heavy lifting and the greater the chance you’ll run out of money. Conversely, if you can extend your career to more traditional retirement ages of 65 to 67, you give your assets more time to grow.
“The longer you can wait (to retire), the less drag that will be on your retirement savings because it shortens the number of years you’ll need to rely on your savings,” said Williams.
The sweet spot to retire is between 65 and 67. The reason? Working until age 65 means doing away with the wild card of health insurance costs busting the budget, as Medicare kicks in at 65. And if you work until age 67 (and were born in 1960 or later) you will reach full retirement age for Social Security, meaning you can receive full benefits rather than a smaller check due to early retirement.
This improves your retirement math. A bigger Social Security check means more income and Medicare coverage typically means a lower cost for health insurance. “If you retire earlier, you have to make sure that health care coverage is in your budget,” said Williams.
Prepare For Worst-Case Scenarios If You’re Ready To Retire
If your financial plan can withstand the worst turbulence imaginable, you’re in good shape to stop working, says Merrill’s Spickler.
Spickler, for example, always plans for care in a nursing home or memory care facility just in case. “I’d rather show them the worst-case scenario, and if they still have money left at age 100, then I’m good to go.”
Toward that end, a secure retirement could mean having one to two years of expenses sitting in cash on the sidelines to help ride out any short-term storms, said Spickler.
Ready To Retire? Go With Your Gut
When it comes to money and budgeting, sometimes going with your intuition and instincts can provide clarity that the numbers cannot. If you’re one of those people who just can’t shake the thought of running out of money in retirement, there might be something there.
“If you have that much doubt about it, there’s a reason, right?” said Ward. “So, ask yourself, ‘Why?’ What is holding you back? What is the main concern that’s giving you so much doubt.”
There’s always time to make adjustments, adds Ward.
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