How to Avoid Running Out of Money in Retirement
Dear Rich Lifer,
Over the past year, many Americans have experienced added financial burden as a result of the coronavirus. Many lost jobs, which affected their ability to save or forced some to dip into savings to stay afloat.
The unexpected financial shock of the past year has opened many people’s eyes to the importance of retirement savings, especially in a time when Americans are living longer overall and financial security in retirement is falling short.
If you are worried about running out of money in your retirement or saving enough to retire in the first place, do not fear. Today, we will break down some helpful tips and tricks for saving for retirement so you can enjoy life without the fear of running out of money.
Planning is Key
It’s never too late to start planning for your retirement, and if you haven’t started planning yet, today is the day to start!
Patricia Wenzel, senior financial advisor at Merrill Lynch and president of the National Association of Plan Advisors, advises, “Unfortunately, many people wait until they are almost ready to retire to start planning for retirement. Decades before you retire, you should start evaluating your numbers.”
When making your plan, you need to determine a few things: what age you plan to retire, your estimated expenses, your estimated income to live off of, and how much you already have saved.
Setting up a budget is a great way to track how much you’re spending and find more ways to save. Budgeting can help you determine which of your expenses are essential (like rent) and which are nonessential (like the latest Apple product).
Doing this can help you determine which of your nonessential spending can be reallocated into retirement savings. This brings us to another big tip…
Save, Save, Save
The sooner you start saving, the more your money can grow. The longer you wait to save, the more you will have to put aside.
If you aren’t maxing out your 401(k) or IRA contributions, see if you can boost these accounts with the savings you have identified through planning and budgeting. Remember, once you turn 50, you can contribute $1,000 more to an IRA each year and $6,500 more to a 401k each year in the form of a catch-up provision.
Most experts suggest you should be saving between 10% and 15% of your gross salary, which also includes any contributions made by your employer. Keith Bernhardt, vice president of Retirement Income at Fidelity Investments, says, “No matter your income or savings levels, having a realistic financial plan can help maintain your financial security through all stages of retirement.”
Bottom line, even if you can’t put aside 10%, put aside whatever you can so you can stay on track and develop good saving habits.
The next step is to remember to invest the money that you save, and just like with saving, the earlier you start investing, the more money you can grow.
We briefly mentioned 401(k)s and IRA above, and we want to reiterate that these are the best types of savings accounts for retirement because they come with tax advantages. Health Savings Accounts (HSAs) are another tax-advantaged type of account you should consider contributing to.
Ultimately, Bryan Stiger, a financial planner at Betterment 401(k), notes, “You want to have money in different places to make sure that you don’t run out of money in the end.”
This brings us to a specific type of investment called annuity…
Annuities are investments typically issued by insurance companies that can provide a steady stream of payments that are unaffected by the markets and can last a lifetime.
They were designed to be a reliable means of securing constant cash flow for an individual during their retirement years, which helps ease fears of outliving one’s assets.
There are different types of annuities you can buy to fit your specific needs. Some come with high commissions, annual fees or surrender charges on early withdrawals, so do your research before making a decision.
Traditional annuities, also known as fixed rate annuities, provide a guaranteed interest rate on your money for a set period of time — usually for the rest of your life. Fixed-rate annuities typically have no annual fees and lower commissions than other types, but there are penalties for early withdrawals before retirement of 10%.
Annuities can be a good option for people who are worried about overspending in their retirement or are nervous about playing the stock market.
You shouldn’t put all of your money into an annuity, however, because it’s important to have enough cash on hand in retirement for emergencies.
Maximize Social Security
One of your biggest protections against running out of money is Social Security payments, which are designed to continue your whole life and are adjusted for inflation each year.
Making a smart decision about when to sign up for benefits and when to claim them is very important. Cathy Pareto, a certified financial planner, points out, “Every year that you delay taking Social Security, you get an 8 percent increase in the benefits that you take.”
You can technically claim Social Security benefits as early as age 62, but your benefits will be permanently reduced by up to 30% if you fail to wait until the full retirement age, which is age 66 if you were born between 1943 and 1954.
Experts also agree that Social Security will likely only replace 40% of your income, whereas you should strive to replace at least 80% of your pre-retirement income.
Once you’ve put your money aside into multiple types of savings accounts, you should be smart about making timely withdrawals.
The current IRS penalty for withdrawing funds early from a 401(k) is 10% plus your income tax rate on the amount you withdrew, so it’s very important to hold off on withdrawals until you hit retirement age.
Once you do retire, experts suggest following the 4% rule, which means that you withdraw 4% of your retirement savings each year (adjusted for inflation). This rule comes from the idea that you can usually expect a 4% return on your investments so you won’t run out of money over a 30-year retirement.
However, if you have a larger lump sum saved, you can withdraw at a higher rate, but you should never go over 5%.
Final words of wisdom come from Bo Hanson, a certified financial planner for Preston & Cleveland Wealth Management, who states:
When you get into retirement, if you really want to make sure that you don’t outlive your assets, you need to control your withdrawal rate. Somewhere around a 4 to 5 percent withdrawal rate of your assets is probably the most you can do. If you can make sure your lifestyle stays at or below that number, you are setting yourself up for success.
To a Richer Life (and Retirement),
The Rich Life Roadmap Team