When I tell people that I have taken charge of my calendar, in other words, I have retired, a surprisingly common response is, “I don’t know if I can afford to do that,” or even more troubling is the statement that they don’t think “they will ever be able to afford to retire.” The reality is that most of us will stop working before we stop living. Many of us do voluntarily, and some of us do unexpectedly and often suddenly because of health or a loss of employment.
We are told to save for our future. The tax code offers incentives in the form of Individual Retirement Accounts (IRAs), 401(k) plans, and Roth IRAs. The investment industry offers a lot of advice on how to save and invest for later life. I will leave investment advice to the experts. The missing part for many people is figuring out if they can live comfortably on the income available when they retire or significantly cut back on work.
Figuring out if you can afford to retire is a two-step process: projecting income and estimating the cost of living. Accountants and financial analysts call this budgeting. For most of us, “budget” is a nasty word, bringing as much joy as being placed on a diet. Once most people start to earn enough to live comfortably, they never want to think about a household budget again. As long as what comes in and covers what goes out, most families don’t think about what living costs. In determining when you can retire, think of it the same way; think of the process as developing a spending and income plan.
A good starting point is projecting available income when we are no longer paid for our work. Lawyers tend to earn higher wages and are often near the top of the benefits payout for Social Security. Social Security sends out earnings and benefits statements showing projected benefits based on age. Discounted Social Security retirement benefits can start as young as 62, the full retirement age is 67, and benefits continue to increase if you delay starting benefits up to age 70. There are multiple models and experts to offer advice on what age to start retirement benefits. If your budget is tight, waiting may make a difference. Social Security will provide personalized benefits estimates. Create a “My Social Security” profile to see the most personalized of estimates. Even if you are not ready to retire, go ahead and set up an online account with Social Security, it is how you enroll in Medicare at age 65, and claim retirement benefits. There are several steps, and it takes a couple of weeks to get full access to your personal profile. Do it before you need it.
Access to affordable health insurance is a critical factor in timing of retirement or cutting back on work. Except for people eligible for Social Security Disability Benefits, the starting age for Medicare is 65. Medicare is critical for many adults unless other insurance is available, such as through an employer pension. Private health insurance can be extremely expensive for an adult in their 60s or older who Medicare does not cover.
Defined benefit pensions are traditional plans that pay a guaranteed retirement benefit based on the income the person earned, the number of years of service, and age at the time benefits start. The terms of the plan define how the benefit is calculated. If you are vested in a traditional pension, the plan trustee will provide an estimated benefits amount. Often these are sent out annually, or can be requested online or over the phone with the trustee. Even if you have not worked for the employer in decades, many of us are vested in pensions from decades ago. I have a small pension from my first job after law school.
For most of us defined benefit pensions have been replaced by defined contribution plans, most commonly known as IRAs, 401(k) or 403(b) plans. These plans have a cash value. Traditional IRAs, 401(k), and 403(b) plans are tax-deferred, meaning that the contributions were not taxed when put into the plan and are subject to income tax when withdrawn. Consult a trusted investment advisor (or two or three of them) on what is best for you in structuring the investments and how much income you can expect to draw from those plans. Many advisors use a 4% rule, that if properly invested, you can draw 4% of the balance each year and have the money last through retirement. Some will recommend drawing less, some will urge drawing more. The right answer depends on you, your long-term goals, and the amount of risk that is acceptable to you. Seek advice from trusted professionals to help you understand what works for you.
Other savings and investments can be evaluated the same way. Financial advisors can help you determine how much income you can generate and whether the savings will meet your life goals.
Add this up, and you have a projected income. For most higher-income earners, there will be some income tax liability; the more you draw on tax-deferred accounts and traditional pensions, the greater the tax. Talk to financial planners and tax experts for estimates on what tax to expect.
This is not a budget or diet; it is calculating how much you want to spend to live the way you want to live in retirement. Some of the numbers you will know, some you can find by looking at the year or two of expenditures, and some numbers will be a guess.
Sit down and make a list of what you expect to spend. The best guide to this that I have read is in Finding Your Landing Zone - Life Beyond the Bar by Kevin McGoff. I recommend studying chapters 9 and 10 and appendices A and B.
Here is a rough list as a starting point list:
When you finish the estimates, if the income is equal or greater than the projected costs, being able to afford retirement is easy to see. If the costs are greater than the income - you have more work to do.
Start by looking at the expenses. Can costs be reduced? Reducing or eliminating debt services, such as mortgage and car payments, is a huge first step. For many the largest recurring expense is housing. Would a less expensive home meet your needs? If you own a vacation or second home, can it be rented when you are not using it? Do you really need to keep it? We eliminated the second home and paid off all mortgages before retiring. Cars are fun but expensive. Do you own more than you really need to own? We went down from three cars to two when getting ready to retire. This does not need to mean parting with fun. I kept the impractical older convertible and parted with the sensible second car. When we replace our primary family car, we will move to a less expensive car with lower annual service costs, and I can see us going down to one car in a few years. Look at phone and utility costs. You may be able to reduce expenses by a couple of hundred dollars a month. Many find that they spend less on clothing and food in retirement. We are no longer dressing for the office. With time to shop and cook at home, the cost of eating well may go down.
Continuing income in “retirement” is also an option. Many of us supplement with part-time or consulting work, either in our areas of expertise or doing something totally unrelated. My sister works part time as a docent at a local zoo to supplement her retirement income. Work that brings her joy and a modest income to make her income higher than her expenses without dipping into savings.
The idea of walking away from a regular income can be terrifying. Taking time to estimate income and expenses is an essential step in taming the fear. As Kevin McGoff says in his book Find Your Landing Zone, “You have to have a plan.” Looking at the numbers is an important part of planning.
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