Retirement: the word carries a mix of excitement, anticipation, and perhaps a touch of uncertainty. It’s a major life milestone that many of us eagerly await, but it also brings forth questions and doubts. Are you truly ready to retire? Or will you regret your decision once you take that leap of faith?
Before you retire, you must familiarize yourself with important finance topics. Making informed financial decisions can enable you to retire early and enjoy your golden years. Here are some need-to-knows before you give your pink slip and take off to retirement bliss.
#1 Healthcare Costs:
Many individuals overlook healthcare costs when planning for retirement, which can lead to financial difficulties. Failing to plan for these expenses can be disastrous. On average, a 65-year-old couple retiring in the current year can expect to spend around $315,000 out-of-pocket on healthcare during retirement, excluding Medicare and long-term care costs. By saving approximately $3,100 annually in a Health Savings Account (HSA) for 30 years and earning a 7% average annual return, a 35-year-old couple can accumulate that amount.
To minimize healthcare costs, prioritize maintaining good health, undergo preventive screenings, and seek regular medical care. Flexible Spending Accounts (FSAs) allow you to set aside pre-tax funds, up to $3,050 in 2024 ($2,850 in 2024), for qualified healthcare expenses like dental care, eyeglasses, medications, and doctor visits. However, be aware that most funds in an FSA must be used within a specific period, or they are forfeited.
Health Savings Accounts (HSAs) are even more advantageous because unused contributions are not lost. In retirement, they can be invested and withdrawn penalty-free for any purpose, though they will be subject to taxation as income. The HSA contribution limit in 2024 is $3,850 for individuals ($3,650 in 2024) and $7,750 for families ($7,300 in 2024), with an additional $1,000 catch-up contribution allowed for individuals aged 55 and older. To participate in an HSA, you must have a qualifying high-deductible health insurance plan. Having a thorough understanding of Medicare is also crucial, as it offers extensive coverage starting at age 65. Remember to sign up on time to avoid lifelong extra charges.
#2 Inflation:
When planning for retirement, inflation must be taken into account since your savings’ purchasing power will decrease over time. On average, inflation has been around 3% annually, although it can vary significantly. Over the course of 25 years, inflation can reduce the value of your money by approximately half.
To factor inflation into your planning, you can use the following approach: Suppose you are currently 20 years away from retirement and aim to have an income equivalent to $50,000 in retirement. By raising 1.03 to the 20th power (1.03^20) through calculations, you get 1.81. Multiply this figure by $50,000 to find that you would need an income of $90,306 in 2043 to maintain purchasing power, similar to $50,000 in 2024.
Investing in dividend-paying stocks can help combat the effects of inflation. Dividends tend to increase over time, helping to keep pace with inflation. Additionally, the stock prices of these companies may rise, further preserving your purchasing power. For instance, if you have $100,000 invested in dividend-paying stocks with an average yield of 3%, you would receive $3,000 in dividend income in the first year. Assuming a 5% annual average growth rate, the dividend income would grow to approximately $4,900 annually in 10 years. Other options to mitigate inflation include investing in Treasury Inflation-Protected Securities (TIPS) bonds, which adjust their interest rates to account for inflation, and purchasing annuities with built-in inflation-adjustment features.
#3 Social Security:
Understanding the expected income from Social Security is crucial, as it typically constitutes a significant portion of retirement income for most individuals. In January 2024, the average monthly Social Security retirement benefit check will be around $1,827, equivalent to just under $22,000 per year. However, this amount may not be sufficient for most people, emphasizing the importance of early planning, saving, and investing. In recent years, the maximum benefit for those retiring at their full retirement age was around $3,627, or approximately $43,524 annually. Social Security benefits are adjusted regularly to account for inflation.
For a precise calculation of your benefits, it is recommended to register for a “my Social Security” account; you can do this by visiting the Social Security Administration (SSA) website. This account allows you to view your earnings history year by year and provides estimates of your future Social Security benefits based on different claiming ages. The number of benefits differs depending on whether you claim them at 62 or 70.
Starting benefits at age 62 results in smaller checks but more of them over time, while delaying benefits increases the monthly amount. It’s important not to be late in signing up for Social Security, as delaying could result in permanent reductions in benefits.
If you are unsatisfied with the estimated amounts, there are several ways to increase your Social Security benefits. The formula used to determine benefits considers your 35 highest-earning years. If you have worked fewer than 35 years, the formula includes zeros for the remaining years, reducing your benefits. Working a few additional years can replace low-income years with higher-income ones, resulting in larger benefit checks. Coordinating with your spouse, if married, can also help maximize the total benefits received from Social Security.
#4 Annuities:
Annuities are worth considering for retirement planning. While purchasing annuities means sacrificing the funds used to buy them, they provide regular income for life.
Fixed annuities, in particular, are recommended over variable or indexed annuities due to their more favorable terms and potential benefits. They can start paying immediately or be deferred to a future date specified by you, offering a reliable income stream that helps guard against running out of money later in life.
For example, a 65-year-old man could spend $100,000 on a deferred annuity that starts paying him in 10 years, providing $1,138 monthly for life. Since interest rates influence annuity payouts, a ” laddering ” strategy can be employed during low-interest rates. With this approach, you purchase annuities gradually, spending only a portion of your total annuity budget initially, and then invest the remainder in the coming years when interest rates are expected to be higher.
While most individuals have not saved enough for retirement, a group of people has aggressively saved and invested, accumulating a sizable nest egg. These individuals may have the opportunity to retire early. If you fall into this category but haven’t considered early retirement, it’s worth exploring the possibility. Life is unpredictable, and you never know how long your life will be. By planning ahead, you may be able to retire earlier. Early retirees often enjoy better health, enabling them to engage in various activities like travel, gardening, golf, tennis, and more.
If you are relatively young, accelerating your saving and investing efforts can help you reach your retirement goals sooner. Being proactive and well-informed can increase the likelihood of achieving early retirement.