Essentially everyone retires sooner or later - by choice, or simply because
they are physically unable to work anymore. The goal for most folks
is that when retirement comes, they will have enough money to support their lifestyle
for the rest of their lives.
The "secret" to retirement is pretty simple - steady investment over a long period of time,
followed by living a retirement lifestyle that matches the savings you accumulate.
In reality, however, most folks get to retirement with some money, but not enough to cover all
the things they'd like to do. So the management of their money - making sure it covers their needs
and that it lasts the rest of their lives - is a key element of their retirement.
The second key element of retirement is happiness. The whole point of retirement by choice is
the ability to live your life doing what you want - when you want. Retirement planning is more
than financial planning. It includes planning activities that you will pursue during retirement -
to maintain your health, to keep your mind active, to reach new accomplishments, to enjoy new experiences,
and simply to enjoy yourself.
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First, let's define retirement as the point at which a person discontinues
employment from their primary occupation, typically one that they've held
for many years (though not necessarily at the same company). Typically this happens
when an individual reaches 65 years of age, although some folks are able and choose
to move into retirement as early as age 55, depending on their ability
to meet their financial obligations and expenses.
The ideal retirement situation is one where the retiree has accumulated enough
money so that at retirement the money will support the retiree's standard of
living indefinitely (or at least to an age that the retiree might be expected
to reach). The choice of leaving money behind for family, or of consuming
all assets by the time of death is one of the decisions a retiree has to make
as part of managing their assets during retirement and can drastically affect
the standard of living that the retiree can enjoy.
Most Americans don't reach retirement under this ideal setting and many find
it necessary to reduce their standard of living, to continue working to provide
income to supplement their savings. This may be part time, or full time,
depending on the particular needs of the retiree.
Nonetheless, we still talk of a person as in 'retirement' once they have
made the transition from a primary occupation, supplemental work not withstanding.
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There are four basic sources of income during retirement:
- Personal Savings
- Company pension plans
- US Government
A majority of families continue depend on Social Security and Medicare
to support them during retirement, although in recent years there have been sharp
increases in the number of people actively saving for retirement and in the number of families
who have access to pension funds. With Social Security payments on the order
of $1K per person, a couple that depends solely on Social Security will barely
be able to make ends meet.
For folks who have managed to generate additional wealth (savings and/or pensions),
the general strategy is to invest their money so that it produces income
throughout retirement. Surprisingly large numbers of people simply park their
money into savings accounts or purchase CD's. The low interest (3%-5%) is offset
by the absolute security of the strategy. However these rates barely keep
up with inflation. Unless the retiree has a fairly large net worth at retirement,
dependence on low interest rates often results in the retiree depleting their
funds well before the end of retirement.
If a family were to need $50K per year during retirement, a net worth of $1M invested
at 5% would provide the required income. However, at only 3% interest even
a $1M would fall short of their needs. It is typical to hear investment planners
suggest a net worth between $1M and $2M as the net worth a family should have
for a comfortable retirement.
However, the majority of Americans retire with much less than this. In such
cases they either match their lifestyle to their income or supplement their
income through part-time work.
A common retirement strategy is to invest personal wealth in areas which can generate
6%-10% returns. These involve risk (much lower returns, or even loss of principal)
but offer the opportunity to provide enough interest income so that the retirees do
not have to consume their principal - providing the possibility of income regardless of
how long they might live. To offset risk, virtually all financial planners recommend
the use of diversification - pursuing several different investments so that if any one goes badly
the retiree's financial status is not wounded beyond recovery.
There are investments which have the potential for higher returns (>10%) but generally
such investments carry proportionately higher risks and are considered inappropriate
for retirees because retirees have little or no opportunity to recover once their
wealth is gone. Returning to the work force permanently is the usual recourse
in such cases but there is usually too little time left for the retiree to rebuild enough
wealth to retire again.
The US government, using money from taxpayers, provides two basic sources of
retirement income for all citizens - Social Security and Medicare.
Social Security is a payment sent directly to each citizen. It's amount depends
more or less on the amount of taxes that you've paid in during your lifetime.
Most folks can expect to receive a check that ranges from $800 to $1500 per month.
Both husbands and wives receive checks but the amounts may be different depending
on the taxes paid by each person during their working careers.
If a retiree reached age 65 on a wage of only $1500 per month, then Social Security
alone might be enough to maintain the same (low) standard of living. However most
Americans reach retirement having earned much more than that. Retirees with
a pre-retirement salary of $5K-$10K per month will find Social Security to be totally
inadequate to maintain the pre-retirement standard of living and may need several
thousand dollars per month of additional income to sustain an acceptable standard of living.
The Social Security Administration can provide you with an accurate estimate of
the payment that you will receive.
Payments can begin as early as age 62 but choosing to start payments later in life
will result in larger payments. Later in this site we will discuss which option
provides the greater benefit to a retiree. The answer is not the same for all
retirees and depends on the age to which the retiree will live and on the amount
of supplemental income (wages) that the retiree generates.
Medicare is a government-funded medical insurance program. It is available
to Americans at age 65 and is typically the primary source of medical insurance
for retirees (replacing the insurance policies they held will working for
companies during pre-retirement).
Medicare does not cover all possible medical expenses and many retirees find it
appropriate to purchase supplemental insurance which will cover those expenses
not covered by Medicare. Supplemental insurance programs can cost from $100-$500
Persons who retire before Medicare is available (age 65) must locate their own
insurance programs and often pay $500-$1000 per person for coverage.
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During retirement you will continue to have expenses and will need sources of
income to pay those expenses. Yes, there are
many Americans who live on Social Security and Medicare alone, but these
sources of income are inadequate for all but the most meager existence. Some sort of supplemental
income is needed to supplement these government supplied programs.
That is why retirement planning and investing, started at an early age, are recommended by
all financial planners. Retirement planning is all about ensuring that the
income available to you during retirement is adequate for the lifestyle you
plan to live.
You may have heard rules of thumb about how much money is needed during
retirement. Estimates vary, but 75% of pre-retirement income is often
bandied about. While the estimates are useful for talking purposes
a potential retiree cannot use such estimates for accurate retirement
planning. Some folks may be able to retire on a fraction (as little as
50% of their pre-retirement income), but a lot more folks have expenses
which do not change after retirement.
In the cases where post-retirement expenses are less than pre-retirement
expenses, it is usually the case that the retirees have taken some very
specific actions to eliminate expense, such as:
- Paying off debts (mortgage, loans, etc.)
- Moving to states with lower costs of living (no income tax,
reduced food prices, lower property taxes, etc.)
Generally, stopping work does not, all by itself, significantly change
a person's expenses. Yes, there are work expenses which go away, but the
impact is usually not a 25% reduction as might be inferred from the rule of thumb mentioned
above. Major changes in expenses come as a result of an action taken or
culminating by the time that retirement is reached. The rules of thumb
are useful for discussion purposes only and should not be used for
detailed retirement planning.
A retirement expense model is covered in more detail elsewhere
in this site
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So, what do you actually do during retirement? There is no stock answer because the whole
point of retirement is to provide each individual the freedom to do whatever they want -
within the constraints of their finances and health.
However, hardly any retiree does 'nothing'. One of the most common remarks you'll hear from
retirees is that they are very busy and simply don't have the free time available that they
imagined they would have.
While retirees may actually do very little in the early months of retirement - as close
to nothing as they will ever do - most quickly fill up their free time with activities
that they like to do. Surprisingly, retirees often find themselves working or playing at
tasks for which they had absolutely no plans. Other retirees, however, have long since
made lists of the things they want to do and fill their time with pre-determined activities
that they've always wanted to spend more time at.
The common denominator is that retirees usually find themselves with more things to do
than they have time available to cover. As the quote goes 'Only boring people get bored'.