Imagine finally breaking free from the daily grind, having all the time in the world to pursue your passions, travel, or simply relax. You spend your days doing what you love without worrying about money, the time of day, or what day of the week it is. This is the retirement dream many of us share. But turning this dream into reality is becoming increasingly challenging as inflation pushes up costs for essentials like gas, groceries, and healthcare. For many retirees, this means financial stress or even returning to work after retirement.
To set yourself up for a long, happy, and financially secure retirement, careful planning is essential. This guide will walk you through six crucial steps to help you take control of your retirement journey—from calculating your expenses and understanding your monthly cash flow to navigating Social Security benefits, health insurance, and estate planning. Let’s dive in and break down these steps into actionable advice.
1. Calculate Your Retirement Expenses
One of the most important yet often overlooked steps in retirement planning is accurately calculating your retirement expenses. Many people assume they’ll automatically adjust their spending after retirement, cutting back on costs as needed. However, this approach can be risky because the lifestyle changes can be more jarring than expected. Think of it like planning a new diet versus actually following it—planning is easier than execution.
According to Fidelity, retirees typically spend between 55% and 80% of their pre-retirement annual income each year. Your actual spending will depend heavily on your lifestyle choices. For example, if you plan to travel extensively during retirement, expect to be on the higher end of that range, possibly even exceeding 80%. Conversely, embracing a frugal lifestyle, such as cooking most meals at home, might bring your expenses down to 55% or less of your current income.
It’s important to remember that Social Security benefits replace only about 40% of pre-retirement income for median earners, so you cannot rely solely on these benefits to cover all your expenses.
To prepare, map out your anticipated monthly expenses in retirement. This can be done with a simple spreadsheet or even on paper. If you plan on adjusting your lifestyle to reduce costs, try living that way months or years before retiring. This “test run” can prevent unpleasant surprises and help you decide whether early retirement is right for you.
2. Understand Your Monthly Cash Flow
Once you know your expected expenses, the next step is figuring out how to cover those costs each month. This is where understanding your monthly cash flow becomes critical. Many people know their total net worth but are unclear on how much cash flow they have on a monthly basis.
For example, you might have a high net worth due to investments in private equity or home equity, but these assets might not provide steady monthly income. A startup investment might increase your net worth, but you won’t receive cash flow until the company has an exit event. Similarly, owning your home outright reduces expenses but doesn’t generate cash flow.
Ideally, you want multiple income streams producing consistent cash flow during retirement. Also, consider inflation, which reduces the purchasing power of your money over time. While the Federal Reserve targets 2% inflation, recent years have seen higher rates—3.3% in the 12 months ending May 2024, for example.
To illustrate, if your annual retirement expenses today are $60,000, with 3% inflation, you would need about $78,600 in 10 years to maintain the same lifestyle and over $108,000 in 20 years. Planning for inflation is crucial because it impacts how much income you’ll need and which investments are best suited to protect your purchasing power. For instance, rental properties allow you to increase rents over time, helping keep pace with inflation. Social Security benefits also adjust annually based on inflation.
Another consideration is whether you plan to work part-time during retirement. Even working 20 hours a week can provide an extra $1,200 or so monthly, significantly easing financial pressure.
Write down your anticipated monthly retirement expenses alongside your projected monthly cash flow. If your expenses exceed your income, you may need to either adjust your spending plans or delay retirement until you build more assets. Always factor inflation into these calculations.
3. Consider Accessibility of Your Retirement Funds
Understanding when and how you can access your retirement funds is vital to avoid penalties and ensure steady income. The IRS has rules about retirement account withdrawals that can impact your planning.
For most retirement accounts like IRAs, 401(k)s, and annuities, early withdrawals before age 59½ typically incur a 10% penalty plus taxes. Roth IRAs require the account to be open for at least 5 years before penalty-free withdrawals. If you plan to retire early—in your 50s, for example—you’ll need alternative income sources to cover expenses until you reach these ages.
Social Security benefits have different rules. You can start claiming as early as age 62, but your benefits will be reduced by 25-30%. Waiting until your full retirement age (usually 66 or 67) allows you to receive full benefits, and delaying further up to age 70 increases your benefits by a certain percentage each month. However, there’s no benefit to delaying beyond 70.
Additionally, the IRS requires you to take Required Minimum Distributions (RMDs) from certain retirement accounts starting at age 73. These distributions are calculated based on IRS life expectancy tables and can be complicated, so working with a financial advisor is recommended. Failing to take RMDs can result in hefty penalties—up to 50%, though recent changes have reduced this to 25%, and even 10% if corrected within two years.
Action Step: Make a list of all your retirement accounts and income streams. Determine when each will be accessible and whether they align with your planned retirement age. If not, consider alternative income streams or adjust your retirement timeline. Also, plan when to start claiming Social Security benefits strategically.
4. Plan for Health Insurance in Retirement
Healthcare is one of the biggest expenses retirees face, and it tends to increase with age. According to Fidelity’s 2023 estimate, a single 65-year-old may need around $157,500 saved after taxes to cover healthcare costs in retirement, and couples could require double that. These estimates do not include prescription drugs, dental care, or long-term care, all of which add to the cost.
Most people lose employer-sponsored health insurance upon retirement, though about 21% of large companies continue offering retiree health coverage. If you retire after 65, you can transition to Medicare, a federal health insurance program for seniors. But if you retire earlier, you’ll need a plan for coverage until Medicare eligibility.
Options include purchasing insurance through the Health Insurance Marketplace or using Health Savings Accounts (HSAs). Remember to factor these insurance premiums into your retirement budget.
Medicare has several parts:
- Part A: Covers hospital stays and is usually free if you paid Medicare taxes for at least 10 years.
- Part B: Covers doctor’s visits and outpatient care; it has a monthly premium and deductibles.
- Part D: Covers prescription drugs, also with premiums and deductibles.
You may also want supplemental Medicare plans to cover additional services not included in Parts A, B, and D.
Importantly, Medicare does not cover long-term care or most dental expenses. Considering standalone dental insurance and a long-term care plan is wise to protect your savings.
5. Create Your Retirement Vision
Retirement isn’t just about finances—it’s about how you plan to spend your time. Going from a structured 40-hour workweek to having all day free can be liberating but also overwhelming or even boring. Many retirees find themselves unfulfilled without a plan for their time.
To avoid this, develop a detailed retirement vision well before you retire. Think about hobbies you want to revisit or new interests you want to explore. Setting goals—whether it’s reading a book a week, walking daily, or volunteering—can provide a sense of purpose and accomplishment.
Remember the advice of Benjamin Franklin: “If you fail to plan, you are planning to fail.” Also, consider the philosophy of “never retire from something, retire to something.” This mindset shifts focus from what you’re leaving behind to what you’re moving toward.
Staying active and maintaining a sense of purpose has been shown to contribute to a longer, healthier life, so take your retirement vision seriously and put it in writing.
6. Prepare Key Legal Documents
Estate planning is a critical but often uncomfortable part of preparing for retirement. It involves making arrangements for how your assets will be managed and distributed after your death. Having these plans in place is responsible and provides peace of mind to you and your loved ones.
Key legal documents include:
Will
A will specifies how you want your property and assets distributed and can appoint guardians for children, dependents, or pets. It simplifies asset distribution and can reduce family conflicts. Costs can range from a few hundred to several thousand dollars depending on complexity, and you can update your will over time.
Trust
A trust allows you to transfer assets before or after death and can avoid the probate process, speeding up access for beneficiaries. Trusts can also protect assets from creditors and nursing home costs—an important consideration given that assisted living averages $4,500 per month in the U.S. Setting up a trust is more complex and costly than a will, so consulting an estate planner is advisable.
Power of Attorney
This document lets you appoint someone to make medical and financial decisions on your behalf if you become incapacitated. Without it, a court may appoint a guardian, which can be costly and public. The cost to set up power of attorney is similar to a will and is a vital part of your estate plan.
Starting these legal documents can be a great project once you retire, giving you time to find the right professionals and ensure everything is in order.
Conclusion
Retirement planning is a multifaceted process that involves more than just saving money. It requires understanding your expenses, cash flow, access to funds, health insurance, lifestyle goals, and legal protections. By following these six steps, you can build a solid foundation for a secure and fulfilling retirement.
As you navigate this journey, consider working with financial and estate planning professionals to tailor your plan to your unique situation. Being informed and proactive will help you avoid costly mistakes and give you confidence to enjoy your retirement years.
Remember, retirement is not just an end to work—it’s the beginning of a new chapter filled with opportunity and freedom. Plan well, and make the most of it.