When to retire?

[dgpcolorado]

"Retirement Planning for Beginners"

I realize that most who are posting here are quite knowledgeable about retirement planning, as the technical discussion of SEPP above shows, but newcomers to the subject of retirement planning, who come across this thread, might find this useful. I wrote this essay two decades ago for a local friend; she was about 40 and still had three kids to put through college. I had spent years figuring this stuff out so that I could retire young — swimming laps gives plenty of time to mull over such things and do financial calculations!

I suppose this will seem simple-minded to the experts here but it was intended to be that way, to get people started on thinking about planning and saving for retirement.

Anyway...

Retirement Planning for Beginners

Introduction:
Many people wonder “how much do I need to retire” but haven’t a clue how to figure it out. If they read
books on the subject, or listen to the “professionals”, they get showered with misinformation, such as “you need
80% of your pre-retirement income in retirement” and similar nonsense. The goal of this essay is to de-mystify
the process of determining how much is enough.

Step 1: The Budget
You can’t know how much it will take to generate the income you need until you know how much you will
be spending. Therefore, you need to create a retirement budget. If you are one of the rare people who already
uses a detailed budget you can adapt it for this purpose by subtracting out the categories that will become
obsolete when you retire. [Plan to pay off your mortgage? Then you don’t need to budget for a mortgage
payment, but you do need to make line items for property taxes and homeowner’s insurance if those are
currently included in your mortgage payment. Do you have children? Your expenses ought to drop when they
are through college and emancipated.]

How do you make a budget? Make a list on a piece of paper, or spreadsheet, of all the things you can
think of that you spend money on. Examples might include “Food and Sundries”, “Gasoline”, “Electricity”,
“Telephone & Internet”, “Water”, “Property Taxes”, “Health Insurance”, “Gifts and Donations”, “Car license”, and
so on. Be sure to include a category called “Miscellaneous” for those things you forgot, like postage or the fee
you pay to renew your Driver’s License. You might want to look at a checkbook register or credit card statement
to get an idea of what you spend money on. Be sure to include a hobby or recreation category; many people will
want to include one called “Travel”.

Now look at the list. Did you remember to include a line for “Car Maintenance” if you plan to keep a car
(and who doesn’t)? How about “Car Replacement”, since you will need to buy a new one someday; this is the
cost of a new (or used) car, less the amount it will be worth (if anything) when you sell it, divided by the number
of years you expect to keep it. Do you have an “Income Taxes” line? You can estimate your future income taxes
by assuming that your entire budget will be your future income. Do you have “House Maintenance”? How about
“Dental” or “Medical Self Insurance”? The latter category covers what you might spend that is not covered by
your health insurance.

Now, fill in the numbers you spend, or expect to spend, each year for each category. [Ignore inflation, all
numbers should be in today’s costs (more on this below).] If you aren’t sure what something will cost, just make
your best guess. Things like health insurance can be looked up on-line (try www.ehealthinsurance.com). You
might want to budget for long term care insurance if you think you might want that. Make a generous estimate
for the “Miscellaneous” category to cover anything you forgot.

Add up those numbers. The total is the amount you need to live on if you were to retire today. That’s
simple enough.

Step 2: How Much?
Now that you know what it takes to fund your lifestyle on an annual basis, how much of a nest egg do you
need to provide the income you need? Let’s start with possible income sources. Do you expect to have a
pension? (Most people will not have one.) Are you eligible for Social Security? If so, you will have received a
form that estimates your benefit when you retire and when you can claim it. [You will also be eligible for
MediCare, such as it is, but will need to budget for “MediGap” insurance and other items not covered.] Social
Security (and pensions, if any) will provide part of your income, the rest will have to come from your savings and
investments. Subtract the estimated Social Security annual total from your annual budget. The remainder will be
how much you will need to fund on your own.

Now you need to figure out how much of a nest egg will generate that income. I prefer to use a
moderately conservative “real return” of 4% in such estimates. [Important: “real” return means the amount
you earn after adjusting for inflation. This is why your estimated budget and all other calculations can
be done in today’s dollars; your investments will likely keep up with inflation and earn more than 4%.
You are solely concerned with the return above the rate of inflation.] Some people will get even more
aggressive and assume a real return of 5% or even 6% (this is nuts, in my opinion). Others, to be on the safe
side, might use a figure of 3%. This return is generated by the investments, usually a mix of stocks, bonds, and
cash equivalents such as money market funds and CDs. It assumes that the total portfolio generates 4% above
inflation over the long term. Your actual investment performance will fluctuate over time with the vagaries of the
stock market and interest rates but, over time, you ought to be able to make a 4% real return fairly easily and
safely. [How to do this is a subject for another day.]

At 4%, you will need a nest egg 25 times the size of the amount of the budget you need to fund. [100%
divided by 4% equals 25.] So, let’s assume that your budget, less Social Security, is $20,000 per year. To
generate that income you will need a nest egg of $500,000 [$20,000 X 25 = $500,000]. This number is exclusive
of the value of your house; since you will be living in it, the house will not (likely) be generating any income.
However, if you choose to sell your current house and buy a less expensive one elsewhere, the equity you pull
out of the transaction, if any, is part of your investment nest egg. This is a very common strategy used by
retirees to generate a portion of their nest egg.

So, multiply the income you will need by 25 and that is the target you need for your nest egg. If you
choose to use an aggressive 5% real return multiply the income you need by 20. If you choose to use a
conservative 3% multiply the income you need by 33. Yes, it really is that simple.

But, what if you want to retire early, that is before you reach Social Security age? For the time, however
long you want to make it, between your actual retirement age and your Social Security age (generally about age
66 to 67) you will need to fund your living expenses entirely from your nest egg. So long as the savings that
remain by the time you reach Social Security age are enough to fund your retirement income you will be ok.
Therefore, your nest egg needs to be somewhat larger to pay for the extra years of retirement.

For example: your retirement budget is $30,000. Your anticipated Social Security benefit is $10,000 per
year. The difference, $20,000, will need a nest egg of $500,000, as described above. Suppose your Social
Security age is 66 but you want to retire at age 55. You will need to fund your retirement for 11 years before
Social Security kicks in. You will need additional savings to provide for the $10,000 per year for 11 years. The
simplest way to calculate this is to just multiply $10,000 by 11 for a figure of $110,000. That number is actually a
bit of an overestimate because that money will be generating income until it is spent, but this is a good rough
estimate of what you need. So, $500,000 plus $110,000 equals $610,000. That is the nest egg you would need
to retire at 55 at an income of $30,000 per year, inflation adjusted, for the rest of your life, assuming a 4% real
investment return. [Using a 3% real return you would need $666,000 plus $110,000 for a total of $776,000.]

Step 3: Keeping Score
Now you know how much you need. How are you doing? Add up your assets, subtract your liabilities
(debts) and you will get your net worth. Some of that will be your house. Subtract the cost of a house in the area
you expect to be retiring to. The result is the current size of your nest egg. Too small? You have several
options. You can revisit your budget and see if you are willing to live a little more frugally when retired. But most
people will just have to tighten their belts to save more (or get those kids out of the house so that you can really
start to save!). And you can check your mix of investments to see if you can grow the money you already have a
bit faster. At least now you know what target you are aiming for!

To continue to keep track of your progress I suggest that you revisit your retirement budget every few
years and plug in current costs and estimates of what you will need to live, since they will be increasing with
inflation. Then you can generate a new estimate of what your nest egg will need to be. Your savings and
investments should be growing more quickly than the inflated size of the nest egg that you project that you will
need.

Good luck!

Nowadays, I suppose the best resource for health insurance costs would be a state (or federal, for states that don't have their own) Affordable Care Act Marketplace. And Medicare, for after age 65 — talking to neighbors already on Medicare can help with figuring that out.

I must say that the "car maintenance" budget category I mentioned above is somewhat lower with a Tesla, despite my car being way out of warranty. Mostly tires and a few small repairs; that could change if I need to replace the battery. Insurance is higher. My budget line item for "gasoline" has disappeared entirely. This essay was written long before EVs became widely available!

 

[DriverOne]

Does the SSA expect me to keep working until 62 to receive benefits starting then? Let's say I stop working at 55... will benefits still be available starting in my 60s?

 

[adiggs]

Does the SSA expect me to keep working until 62 to receive benefits starting then? Let's say I stop working at 55... will benefits still be available starting in my 60s?

Yes - still available starting the regular year and using the regular rules. You won't have contributing years from 55 to 62 (or whenever you want to start). And you'll need to live without SS from 55 to 62.

 

[ArcticStation]

And you'll need to live without SS from 55 to 62.

And don't forget that Medicare doesn't kick in until age 65. Many retirees in their late 50s and early 60s with pre-existing conditions often find themselves paying five figure annual premiums for decent medical insurance.

 

[UnknownSoldier]

Does the SSA expect me to keep working until 62 to receive benefits starting then? Let's say I stop working at 55... will benefits still be available starting in my 60s?

My general theory for retirement has largely been based on the idea of layers of income. Since I want to retire long before 66.5 years of age, my plan is as follows:

Until 55 - Live off of earnings from stock portfolio
55 to 66.5 - Live off earnings from stock portfolio + Roth IRA + 401k (?)
After 66.5 - Life off of earnings from stock portfolio + Roth IRA + 401k + SS + pension

In other words, in theory I only need to support myself using only my portfolio until 55. Then the other stuff starts to kick in, one after another. So I don't need to save quite as much to retire early as many people think, because of the layers of income that will activate as I continue to survive into old age.

Similarly, Medicare kicks in at 65, so I only really need to pay for the entire cost of my health insurance until 65. So I need to make sure I have enough to cover my own health care until then, after that the government steps in to help (a little bit).

 

[dgpcolorado]

Does the SSA expect me to keep working until 62 to receive benefits starting then? Let's say I stop working at 55... will benefits still be available starting in my 60s?

Whether or not you qualify for Social Security depends on how many quarters you have contributed. Full coverage requires 40 quarters (ten years) of credits; the amount of earnings required to qualify for a credit increases gradually over time (but it isn't much). How much you will earn in benefits depends on how much you contributed over the years. However, my experience suggests that earnings early in one's career count for more than later years because they have more years to compound.

I retired at age 45. Even though my earnings weren't all that much — I was way below the earnings cutoff each year — they were decent for the time ($15k a year was a good income in 1978, for example). Despite not contributing to Social Security for the last two plus decades, my benefit will be pretty good when I start taking it at age 70, the age at which Social Security maxes out.

Unless one has no other savings, taking Social Security at age 62 is a mistake, in my view. From age 62 to full retirement age (67 for those born in 1960 or later), benefits increase by 5% a year IIRC. From full retirement age to age 70 benefits increase at 8% a year. That's an 8% inflation adjusted return on what amounts to an annuity. Try to beat that in similarly safe investments!

Some people calculate the crossover age, when taking benefits later yields more money overall than taking them early — somewhere around age 82, give or take a year — and they try to guess whether they will live past that age or not. However, that completely misses the point, in my opinion. Taking SS later, to get the highest benefit you can, is "insurance" against the possibility that you will live to an old age and end up needing the money (for assisted living, for example). And if you end up croaking instead at age 76? So what? You can't take it with you! Is a few more dollars for your heirs more important than insuring against the possibility of living to 90 or 95? [I have an aunt who turned 100 this year and my mother and father are 97 and 94, so it can happen.]

The optimal calculation can vary a lot when factoring in spouses. Often the best approach is for the younger spouse to collect a spousal benefit based on the older spouse's benefit until he/she gets to age 70 and then takes his/her own benefit. Did you know that a divorced person can collect at full retirement age based on the ex-spouse's benefit if the marriage lasted ten or more years? Or that a former spouse can collect a "survivor" benefit from a deceased, divorced spouse? (My sister is doing that until she takes her own benefit at age 70.) The wrinkles are many, except for singles. Singles should just live off of retirement savings until age 70, before taking SS.

 

[SageBrush]

Some people calculate the crossover age, when taking benefits later yields more money overall than taking them early — somewhere around age 82, give or take a year — and they try to guess whether they will live past that age or not. However, that completely misses the point, in my opinion. Taking SS later, to get the highest benefit you can, is "insurance" against the possibility that you will live to an old age and end up needing the money (for assisted living, for example).

It's a reasonable POV, particularly if running out of money in retirement is a strong concern. Lately I've been thinking about the likely reality that my desire to spend money will decrease as I age. Definitely a YMMV.

The optimal calculation can vary a lot when factoring in spouses. Often the best approach is for the younger spouse to collect a spousal benefit based on the older spouse's benefit until he/she gets to age 70 and then takes his/her own benefit.

A couple years ago changes were made to the SS rules to prevent couples from gaming the timing and switching rules. I'm not sure about your specific scenario but I would not presume it still works until until an expert says so. By expert I don't mean the folks that work at SS but rather one of the SS benefits analysis softwares available on the web. I've used Maximize my Social Security a couple of times and found it to be exceptional.

 

[dgpcolorado]

It's a reasonable POV, particularly if running out of money in retirement is a strong concern. Lately I've been thinking about the likely reality that my desire to spend money will decrease as I age. Definitely a YMMV.

While I agree that most will spend more money on travel, hobbies and the like, when they are young, my experience in dealing with nonagenarian parents has taught me that the cost of support for very old age can be considerable. Most of us, especially singles with no family, just hope that we croak quickly, rather than linger on with dementia and the like. In our society, however, that's often not how it turns out. I stand by what I said. My father regretted taking SS at 62; doing so limited his and my mother's income considerably over the years.

(Not that I hadn't long ago decided to wait until age 70, because I did my homework — the only way I would have filed earlier would be if I had run out of money and that was very unlikely to happen, barring a medical bankruptcy or similar dire event. Now that I am approaching age 70 all I can say is "so far, so good." I haven't sacrificed a whit by waiting, thanks to being thrifty anyway.)

A couple years ago changes were made to the SS rules to prevent couples from gaming the timing and switching rules. I'm not sure about your specific scenario but I would not presume it still works until until an expert says so. By expert I don't mean the folks that work at SS but rather one of the SS benefits analysis softwares available on the web. I've used Maximize my Social Security a couple of times and found it to be exceptional.

I'm familiar with the changes but that's not the sort of thing I am referring to. Nevertheless, being single, I don't pay much attention to the complexities of spouses and SS and mention it just to remind people to be aware that it's not simple for those who are, or were, married.

 

[ArcticStation]

Often the best approach is for the younger spouse to collect a spousal benefit based on the older spouse's benefit until he/she gets to age 70 and then takes his/her own benefit.

Only if the spouse was born in 1953 or earlier. My spouse was born that year and she plans to use this option. Her sister, born a year later, is ineligible.

Years ago when I started planning my approach to Social Security, individuals could opt to begin taking benefits at age 62 and if they made it to age 70, they could begin receiving payments at the age 70 rate by paying back the total amount they had received in the intervening eight years--interest free! This option is long gone.

Planning for Social Security can be frustrating and the rules often change unexpectedly. Know your options before you flip the switch.

 

[dgpcolorado]

Only if the spouse was born in 1953 or earlier. My spouse was born that year and she plans to use this option. Her sister, born a year later, is ineligible.

Years ago when I started planning my approach to Social Security, individuals could opt to begin taking benefits at age 62 and if they made it to age 70, they could begin receiving payments at the age 70 rate by paying back the total amount they had received in the intervening eight years--interest free! This option is long gone.

Planning for Social Security can be frustrating and the rules often change unexpectedly. Know your options before you flip the switch.

Yes, the payback option is gone. That wasn't the sort of gaming-the-system strategy that I was referring to; I'm glad they got rid of that stuff. Certain file-and-suspend options are still available. I believe that a younger spouse can still collect a spousal benefit at full retirement age (not 62) if the older spouse has already filed. Anyway, as I said above, I mentioned the spousal complexities just to warn people to consider options because some can be obscure and surprising. (Deceased ex-spouse? Can collect full survivor benefit. It was news to me.)