Author: Kristi Krepel, Senior Advisor, Private Client Services
Retirement should be a time to relax and enjoy life after years of working hard. However, a recent study conducted by the Consumer Financial Protection Bureau (CFPB) finds that many retirees lack the income to live their retirement dream. In fact, nearly half of retirees are forced to reduce their level of spending in order to make ends meet.
The study findings suggest that Americans are not properly preparing for retirement and need to take a closer look at a number of factors before leaving the workforce.
The CFPB study found that a retiree’s spending capacity during the first five years of retirement was a harbinger of things to come. In fact, those retirees who were unable to maintain a consistent level of spending during this initial phase were at a higher risk of being forced to make severe spending reductions of 50 percent or more over time.
While the study didn’t look in depth into why some retirees are unable to support a consistent lifestyle, we know from our work with clients that many factors contribute to an individual’s success during retirement. Often, the ability to maintain pre-retirement levels of spending into post-work life is heavily impacted by the financial decisions made during the working years, particularly the timeframe directly leading up to leaving the workforce.
For example, 55 percent of individuals who entered retirement still paying a mortgage were unable to maintain spending levels for the first five years. Meanwhile, 61 percent who were mortgage free had sufficient income to continue spending at the same rate.
Additional debts also play a part. According to the study, only 42 percent of individuals who were paying student loans, auto loans, credit cards or other debts were able to maintain spending levels for those initial five years. Conversely, 55 percent of debt-free individuals met pre-retirement spending levels during the same time period.
However, just as often, it’s a simple matter of underbudgeting daily living expenses or failing to account for unexpected expenses, such as the need to make a major home repair, in your retirement plan.
Healthcare costs during retirement are another expense that can catch retirees by surprise. Many people don’t realize that Medicare doesn’t offer the same coverage benefits as their employer-paid healthcare plan and are caught off guard by out-of-pocket medical expenses.
Taxation can also hit retirees hard. Most employer sponsored retirement accounts have required minimum distributions that a retiree must begin taking when they turn 72. Since these funds were put away using pre-tax dollars, you’ll need to pay taxes when you receive a distribution. Unfortunately, this isn’t always accounted for correctly in retirement planning.
It’s also key to think about how you’re going to spend your free time. If you pick up a new hobby or even commit more time to enjoying an old one, you could easily increase your spending. And what about home improvement projects? With more free time, sprucing up the residence is a common pastime for retirees. Expenses like these add up quickly and can easily outpace retirement budgets without care.
The good news is that most of these unexpected financial shocks don’t need to be unexpected at all. A qualified financial advisor can help you identify your expenses and understand your budget, so you can make the best decision about when to retire.
When planning for retirement, it’s important to remember that any changes to your spending can impact how your plan plays out. That’s why it’s essential to understand your spending habits and ensure you’re investing your savings in a way that can support your lifestyle, as well as any one-off expenditures, before you leave your job.
For instance, are you anticipating any upcoming large costs, such as a child’s wedding, home repairs, medical bills or the possibility that you might need to care for an aging parent? If so, you’ll need to account for those expenses when planning your retirement budget.
You should also plan for the possibility of a sudden financial shock, such as an unexpected home repair. Make sure you’ve set aside enough money in an emergency savings fund to cover unexpected expenses.
It’s also a good idea to look at your healthcare benefits. Compare the coverage offered through your current employer-sponsored plan to Medicare benefits and think about any coverage you will need to add. In general, you should plan for your retirement costs to add up to 75-85 percent of your pre-retirement income, but healthcare costs can easily account for 15 percent of your budget.
If you’re counting on Social Security payments to play a part in your retirement income, like most things when it comes to retiring, timing is everything. While you are eligible to start drawing from social security at age 62, you won’t receive 100 percent of your benefit until you reach your full retirement age.
Your full retirement age will differ depending on when you were born, but your financial advisor can help you decide how social security fits into your overall plan and when it is best to start taking your earnings.
Above all, remember that it’s never too early to start planning for your retirement. For instance, if your employer-sponsored plan offers to match your investment, you should try to invest at least that much. Otherwise, you’re leaving free money on the table that could compound over the years and eventually form a large portion of your retirement savings.
And remember, as you age, it’s a good time to consider trimming back your investment exposure. However, changes like this could make a difference in the success of your retirement plan, so it’s important to work with your financial advisor when making these decisions.
It is possible to maintain your current lifestyle during your retirement years, but you’ll need to have a firm idea of where you are going and how you will get there. It’s never too early to find a trusted financial advisor and start planning for your future.
About the Author:
Kristi is a Senior Advisor in Private Client Services at First National Bank Wealth Management. She strives to build lasting relationships with her clients so they feel comfortable trusting us to help them reach their financial goals no matter what stage of life they’re in. Kristi focuses on financial and estate planning as well as administration of Trusts, IRAs, Investment Management Accounts, Agencies, Foundations and Endowments.