As retirement approaches and the focus shifts from how to save for retirement to how to use retirement money to pay living expenses, it is wise to put some numbers on paper and develop a spending plan. We all have an idea of the standard of living we would like to maintain during our golden years, but that must be tempered by a realistic look at the retirement assets available and how long they must last. When tapping that nest egg, consideration must be given to factors such as future inflation, life expectancy and health care costs. There is the risk of our retirement funds expiring before we do. Since situations differ, it is not possible to address every possible scenario but there are a few universal concepts that apply to all with respect to how to use retirement funds to effectively manage finances during our retirement years.
Things You'll Need
- Budget worksheets (online or pen and paper)
- Statements for investment and retirement accounts
Develop a viable and realistic spending plan for your retirement funds. Get a grasp on the income you will have and what expenses you will be paying out to help make your retirement money last over the long haul. During the retirement years, resources are finite and there is no real possibility of increasing wealth after we stop working. Set as your goal the efficient management of your retirement assets to help stretch your money over the length of your remaining years. Advances in modern medicine and living healthier have both resulted to significant gains in life expectancy. According to the Society of Actuaries, at age 65, average life expectancy is 17 years for men and 20 years for women. At age 65, men have a 41 percent chance of living to age 85 and a 20 percent chance of living to age 90. A woman attaining age 65 has a 53 percent chance of living to age 85 and a 32 percent chance of living to age 90. For married couples, there is a 72 percent chance that at least one of them will live to age 85 and a 45 percent chance that one will live to age 90. Thus, retirement funds will have to last for decades. Create your retirement spending plan with simple pen and paper or try the helpful online retirement income and retirement expense worksheets offered by The Vanguard Group Inc (see Resources).
Determine how you will fill the gap that you will likely discover during the process of creating your retirement spending plan. After taking stock of the sources of retirement income, such as Social Security benefits and pensions and the expected expenses, most find that a gap exists between projected income and expenses during retirement. Choose a strategy for using personal assets such as taxable investment accounts and individual retirement accounts to bridge the gap. First, determine the current market value of all your investments and estimate expected rates of return. This positions you to make an informed decision about how much you can withdraw annually to help meet your expected expenses during retirement. Evaluate whether you should draw down these assets on the basis of a specific dollar amount or as a percentage of the total. Generally using a percentage method is the best method to guard against the real risk of outliving your retirement assets. As popularized by William P. Bergen, a certified financial planner practicing in California, an accepted annual withdrawal rate froom retirement assets is 4 percent plus annual increases of about 3 percent to compensate for inflation. This is just guideline and you can make adjustments as needed to conform to existing economic circumstances.
Allocate your retirement assets to accomplish the complementary strategies of asset preservation and growth. Both are important in making your retirement funds last. Asset allocation is simply how an investor chooses to distribute his or her investments among various classes of available investments. Especially in light of how the stock market has declined precipitously during the economic downturn beginning in 2008, it is easy to get too conservative. It is tempting to concentrate on putting the bulk of your funds in less risky fixed-income investments over stocks. But consider that on average, fixed investments like bonds return about 6 percent annually while stocks have averaged a 10 percent return since the 1920s. According to the Society of Actuaries, over the period 1980--2007, annual inflation in the United States has averaged 3.5%, so keeping some of your money in stocks is vital if you expect your retirement funds to last by keeping pace with inflation. Make your decision on asset allocation with an eye on asset preservation for the long run, but don't ignore stocks or you will deny yourself the opportunity for growth. Many portfolio models exist for those who choose to make their own individual decisions with respect to asset allocation but many mutual fund companies offer all-in-one, broadly diversified, target retirement funds that can simply things for investors. These funds are designed to automatically adjust the balance between stocks and fixed investments and become more conservative as the retiree ages.
Plan and construct the nuts-and-bolts method you will actually use to tap your nest egg during retirement. One good method is to divide your assets into separate "buckets." Keep money that you will need in the 12 months or less to meet monthly expenses in cash or cash equivalents. Interest bearing checking accounts or money market funds are good choices for the cash bucket. Keep money that you expect to need in two to five years in fixed investments like bonds and certificates of deposit which entail less risk and are likely to preserve your retirement capital. Finally, keep any money that you don't expect to need for 5 to 10 years in equity investments where you will get the growth needed to keep pace with inflation.
Replenish your cash only once each year if possible, and never more than twice. This strategy affords the chance to ride out the short-term fluctuations in the market and allows you to take advantage of compounding with respect to your midterm and long-term investments. Choose the retirement assets that you will draw down first with consideration for tax advantages. Consider withdrawals from taxable accounts first and then tax-deferred accounts such as traditional IRAs, 401(k) plans, 457 plans and the like. Roth IRAs should be drawn down last to allow the tax-free earnings to continue growing as long as possible. Retirement means different things to different people. Perhaps it will be a time for you to just relax and enjoy family and friends or maybe the chance to finally travel around the world. Yet for all, retirement is also a time that demands careful planning for how to use retirement funds. Doing so will help ensure that you don't outlive your retirement assets and will allow you to truly enjoy your golden years.