There are two stages in our life with regard to money: the accumulation phase, from the time we start working until retirement. In the beginning, we focus on the accumulation phase: the time sacrifice now for a great life later. During the accumulation stage, which may stretch forty years or so, we diligently put away money in our pension plan, IRA, Roth or other vehicles that help us to accumulate principal which later will be used to generate income for our golden years (with the price of gold these days, perhaps we should coin another phrase?). While we are saving, it should be more than just about shoving money monthly into some investment account: it should take planning and constant review. The big question though, is what do we review? Let’s take a look at some of the major factors that will govern how and if our plan will get us to retirement.
The net expense variable: In other words, what will it cost you to live in your retirement years? At this point in time, you’ve raised your standard of living to wherever you choose it to be. In retirement though, it is destined to change: things like travel and business expense will drop off, mortgages and car loans or personal loans may be paid off, you will stop helping the kids with their debts (the four hardest words parents can’t seem to say to their kids…”we can’t afford it), etc. Alternatively, there will be new expenses added on: tee times, hobbies, travel and vacations, more time to shop, finally buying that collector car, etc. Will you stay in the same residence, or relocate to a less expensive area of the country- we all must be crazy to live in this area, one of the top 3 most expensive places to live in the US- but hey, that’s just my opinion. Where would you like to spend the rest of your life?
Health Care Expenses: If you think that once you reach the age of 65, Medicare will kick in and you’ll be off the hook for health insurance, think again- it’s not quite like that. Healthcare costs in retirement are more than TWICE the general rate of inflation. According to an article in USNews and World Report on 5/23/2012, healthcare increases since 2002 have averaged 6% annually, while the Social Security cost of living raise for 2013 was 1.7%- not exactly keeping up with the Jonses. While Medicare part A will cover hospitalization, let’s not forget (don’t get a calculator- I’ll add it up for you) Medicare Part B for 2013 at an average of $104.90. Now add in Part D for prescriptions, and we add $31.17 to the stack. Most have a Medigap policy to cover those things not covered by Medicare at an average of $175.00, round it out by deductibles, co-pays, dental, vision, hearing and other vast sundry unscheduled medical expenses, and here you are at about $500.00 per month. Maybe not as much as you pay now, but it’s not chicken feed- especially on a reduced income.
Income taxes: That proverbial hand in your pocket. The tax rules and rates are always subject to change, and usually in an upward direction. Tax rate increases create the need for more income in order to pay more taxes. If your income is fixed and you pay more taxes, it leads to a swifter drawdown of your principal to cover the gap. Less principal leads to less income if you are depending on the principal to generate income at a fixed, determined rate. Increasing medical costs result in more taxation because we must hope to generate more income to pay for the additional expenses. I don’t know about you, but at this time I envision a mouse running on a wheel…
The real rate of inflation: Regardless of what you see on TV or read in the local paper, the real rate of inflation is different for all of us. Much has to do with where you live and how you live. Your standard of living must be included, as well as things like how often you buy a car, where you shop, and what you buy. Not everything goes up based on the Fed’s rate of inflation: it’s all different. What’s your real rate of inflation? It’s seriously different for all of us.
The tax consequences of withdrawals: As you know, when you take money out of your 401(k) or IRA, it’s fully taxable. The taxes payable on your Social Security depend on a number of variables. If you saved in a Roth IRA, there are no taxes. Planning for retirement should include projecting where your income will come from, and balancing the tax liabilities to give you the most after tax income annually.
There are other factors involved, and are different for everyone. Be sure to consult your Certified Financial Planner™ to discuss the above issues so when you get to that magic time to have the rest of your life to yourselves and your family, you are financially ready: hoping for the best rarely works out.