Retirement Puzzle Piece #2
Proper Income Planning for Retirement
Learning Video: Proper Income Planning for Retirement Part 1
Retirement Income Planning is a holistic planning process that tries to understand what you are hoping for in your retirement and then making sure that from a financial perspective you achieve what you’re hoping for.
Understanding how to navigate through retirement is a completely different skill set than navigating through your accumulation years. When you get to retirement, not only do you have to replace the income that your employer was paying you but you have to make major new decisions about how you’re going to handle issues such as health care, long-term custodial care, frailty, incompetence, longevity and inflation. Financial risks also change after retirement. And, you have an unknown end date that you’re moving toward. That uncertainty has some pretty significant impacts in terms of how you approach the income planning process.
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To safely prepare for retirement, it’s critical that you first prepare a well thought out budget and cash flow. That is, determine what your spending needs will be over the life of your retirement.
First, make a list of the essential expenses such as housing, food, utilities and health care. And then, in order to enjoy retirement, you must also account for the discretionary expenses such as entertainment, travel, hobbies and charitable giving. Also, remember to factor into your budget large and infrequent expenditures, such as a new roof, a new car, property taxes or a special vacation.
As a final step in your budget preparation, be sure to add a 10% cushion to cover the items you have overlooked that could come up unexpectedly. And finally, be sure to properly account for inflation and longevity.
Many individuals that retire early fail to consider how seriously inflation can impact their lives during a long retirement period. People in or near retirement could still have several decades of need for inflation-protected income.
Most experts agree you should plan on approximately 3% inflation every year. In some cases, we have seen as much as 10% inflation in one year. This can have a dramatic impact on how far your retirement dollars can go.
For example, if you need $50,000 a year for current living expenses. Then in just 24 years at 3% inflation, you’ll need $100,000 a year just to have the same standard of living.
In the past 100 years, we have made great strides in improving human health and increasing life expectancy. Back in the year 1900, the average American lived just past at 40. Today, according to the Centers for Disease Control, average life expectancy in the U.S. has increased to 78.2 years.
Since 1940, we have gained one year of life expectancy every five years. If we keep this pace, by the end of this century, the average American will live to be close to 100 years of age. For couples in their 60s today, there is a 50% chance that one partner will live to the age of 94, and one out of 10 couples will have a partner that lives to be 100 or older.
It’s important to factor life expectancy into your budget. I like to recommend that since science, medicine and technology could work in your favor, you should plan to live into your 90s and budget assets to last to age 100.
Planning for Social Security
Retiring early can have a significant impact on how much money you are able to collect from Social Security for the rest of your life. Too many Americans begin collecting Social Security benefits as soon as they turn age 62 even though they are penalized severely for not waiting until they reach their full retirement age. Between the age of 62 and 70, workers can boost their Social Security checks by 7 to 8 % for each year they delay signing up for benefits.
So, if you can afford to live on income from other sources, then waiting to collect Social Security is something you should strongly consider.
Health Care Costs
It’s not news that health care costs are increasing. Yet several recent studies show that few people factor those rising costs into their retirement plans.
Consider the annual report from Fidelity Investments. For a 65-year-old couple retiring this year, the cost of health care in retirement will be $220,000 not counting what Medicare will cover or the high costs of long-term custodial care.
So I suggest you set aside 5 percent of your annual budget for health-related costs and deductibles. If you don’t spend it, you can always use the money to do something healthy.
Long-Term Care Costs
- Chance of needing Long-Term Care after age 65: 70%.
- Most people believe Medicare pays for long-term care. It does not!
- The average stay in a nursing home is 2½ years.
- About one-half of people entering nursing homes will spend their entire net worth before death.
- 70% of married couples now 65 will have at least one of the spouses entering a nursing home.
According to the 2014 Cost of Care Survey by Genworth Financial
- Cost of Non-Skilled Health Care (5 hours/day, 5 days/week): National average rate = $26,000/year
- Cost of Assisted Living – One Bedroom Unit – Single Occupancy: National average rate = $42,000/year
- Cost of a Nursing Home (semiprivate room): National average rate = $77,400/year
- Cost for Nursing Home Care in 18 years at 4.0% inflation: $155,000/year
The question is: Are you going to pay for long-term custodial care out of your current assets or are you going to look at alternatives for covering these potentially catastrophic costs?
Matching Guaranteed Lifetime Income to Lifetime Living Expenses
Once the retirement budget and cash is complete, the second step is to match your spending needs with anticipated sources of retirement income that are guaranteed for your lifetime. There are three sources: Pension (if any), Social Security benefits and lifetime income from Annuities.