Managing Money in Retirement
Course Section
Sometimes people think so much about how to save for retirement (which is good!) but forget to think about how they will manage their money once they get there. There are lots of things to think about—health, age, hobbies, etc.—when you think about making your money last. And while you may not have enough money to do everything you want to do in retirement, you can make the most of what you have.
Annuities: How to guarantee income
Money Matters
To make your money last in retirement requires some thought and planning. There are things you can do to make your dollars stretch.
People are living longer. According to the 2006 Social Security Trustees Report, in 2006, a 65-year-old man is expected to live to 82.1 years and a 65-year-old woman is expected to live to 84.7 years. The Retirement Confidence Survey (RCS), which is conducted by the Employee Benefit Research Institute (EBRI), found that 6% of workers expect their retirement to last ten years or less. Another 25% believe it will last 10 to 19 years. In reality, a 65-year old man can expect to live to 82. A 65-year old woman is expected to live to 85. An increasing number of Americans are living to be 100.
Plan, plan and plan. First, you need to figure out how much money you will need in retirement. Experts say that retirees typically need at least 70 to 80 percent of their pre-retirement income. Be sure you are on track for a secure retirement with AARP's retirement calculator.
Make your money last. Your money must last as long as you do. You may outlive your money because:
- You didn't save enough
- Your investments don't keep up with inflation
- You withdraw too much
- You don't invest wisely
- You don't have a pension that pays income for life
Financial experts say that you can take out somewhere between 3-6 % (most recommend 4%) of your assets each year in retirement, and not outlast your money. Most caution that if you withdraw more than 5%, the chances of going broke during retirement increase.
While it makes sense to take less investment risks when you reach retirement, some people go too far. With people living longer and longer in retirement, having some investments in stocks along with more stable bonds and cash may help your money last.
You should also think about the order in which you withdraw money from your different accounts. Generally, a good tip is to start taking money from your regular taxable accounts first and let your tax-deferred accounts grow as long as possible. Dip into your Roth IRA last. This may not work best for everyone, so check with a financial professional to be sure.
Health is an unpredictable factor. Even if you're putting much younger people to shame in the workout room, good health comes with no guarantees. Healthcare expenses can alter the amount you'll need in retirement, and medical problems can put a damper on all of your retirement dreams. The health of your spouse or life partner can also change the course of your retirement. Consider getting long-term care insurance.
Social Security choices. Social Security provides a strong base for retirement security. It is the largest source of income for older Americans. For most people, however, Social Security benefits will replace only about 40% of your paycheck. So they—and possibly you too—will need other sources of retirement income.
Deciding when to begin getting your Social Security benefits is important. You can get a reduced benefit beginning at age 62. But if you wait until your full retirement age (sometime between age 65 and 67), you'll get your full benefit. If you can wait even longer, your benefit will be even higher.
There is no clear cut answer on the best course of action. But if you can afford to wait, your benefit amount will be higher.
Consider working. More and more older people are deciding to continue working in retirement. AARP research has found that about 70% of mid-life and older workers expect to continue to work in some way in retirement. While financial need is the major reason, many continue working because they like their work and enjoy being productive.
Many mature workers seek balance in their work and personal life. They want flexibility in the workplace. Options such as flextime, compressed work schedules, compensatory time off, telecommuting, job sharing and phased retirement are becoming more common.
Give a gift. You can give away as much as $12,000 in 2006 to anyone without paying taxes. They don't have to be related to you. The gifts are nontaxable.
Gifts can help you reduce your taxable estate to a level that is free of federal estate taxes. However, don't give away this money if it will leave you short of funds.
Watch the Mission Retirement Video: Living Longer to hear experts talk about the financial implications of living longer in retirement.
Take Action
- What's your life expectancy? Check out the Social Security Administration's life expectancy table.
- See how long your money will last in retirement with Smart Money's interactive worksheet.
- For a detailed calculator for estimating how long you can make your money last during retirement, go to http://fireseeker.com/.
- The Social Security Administration's site can help you:
Learn about and apply for benefits at www.socialsecurity.gov/retire2/near.htm.
Tell you what your full retirement age is.
Learn how much your estimated benefit will be if you retire early or wait until full retirement age.
Find out how working would affect your retirement benefit. - Use these calculators to estimate what your income and expenses will be like in retirement.
- AARP has created a Featured Employers program to help you identify and connect with companies that value mature workers.
AARP Resources
Find out more from the National Endowment for Financial Education about Making Your Money Last Through Retirement.
See if long-term care insurance may be right for you.
Check out these job hunting tips at www.aarp.org/careers.
Order AARP's Job Hunting: Your Guide to Success.
Additional Resources
Read up on turning a hobby into a business:
Women's Institute for Financial Education
Vermont Microbusiness Development Program
Lifestyle Choices
How and where you live can greatly impact your financial security in retirement.
Location is everything. Do you want to stay in your present home for as long as possible or would you be happy somewhere else?
Maybe, it's time for a smaller house. You may get a great tax break if you sell your home. A married couple, filing jointly, can earn up to $500,000 on the sale of their primary dwelling and pay no federal income taxes on the gain ($250,000 for individuals). The great part about this tax break is that you don't have to be 55 or older as was once the case. It's no longer a once-in-a-lifetime tax break and you can take advantage of it every two years.
If you are thinking about moving, consider:
- Cost of living
- Taxes
- Climate
- Family and friend support
- Work opportunities
Cut your spending. People often spend more in retirement than they expected. A miscalculation of 10% is to be expected, because you have:
- More time to spend money and shop;
- More leisure time and will be involved in more activities that cost money;
- More time to travel;
- A greater tendency to splurge.
If you're worried about running out of money, you may need to pull in the reigns with steps like these:
- Luxuries/necessities. Distinguish between items you must buy and things it would be nice to own.
- Stop credit cards. Put away your credit cards to help curb impulse spending. Only carry your credit cards for a planned purchase.
- Avoid ATM withdrawals. Decide how much cash you need and don't spend a penny more.
- Buy right. With the right planning, you can buy most of the things you want at a more reasonable price. Thoroughly investigating each purchase can help you get the best value or you may decide that the purchase isn't worth the money.
- Balance spending. Don't overspend in one budget area without cutting corners in another. If you take an expensive trip, you may want to cut corners by eating out less often or by waiting for movies to come to the bargain theater.
- Downsize. It may be time to move to a smaller house or sell that second car.
- Coordinate. Work with your life partner to keep you spending habits in line. Agree on a budget both of you can live with without feeling deprived. And stick with it!
- Prepare. Leave room in your budget for unexpected expenses. You never know when the furnace will stop or your car will need an expensive repair.
Homemade money. There are ways that your home can help you meet your financial needs in retirement. But be careful, because you don't want to lose your home in the process.
The equity in your home can be a source of cash in retirement.
- Loans. You might refinance your first mortgage and ask for a larger loan. This is called "taking out cash" and it allows you to have cash for any use you wish. If, however, you have a low mortgage rate and don't want to lose it, you could simply get a home equity loan. This is essentially a second mortgage that gives you a lump sum to use.
- Line of credit. You could choose to open a home equity line of
credit. This essentially works like a revolving credit card: You borrow when
you need the money and repay it on your own schedule, as long as you make the
minimum monthly payments.
Some benefits. Borrowing against your home's value has several advantages:- Tax break. The interest you pay may be tax deductible. Ask your tax advisor.
- Low rates. Because the loan is secured by your home, the rate is typically lower than other types of loans.
- Less risk. You can use the loan instead of cashing in stocks at the wrong time or withdrawing from an IRA prematurely. Both of those may trigger income tax payments.
- Reverse mortgages. AARP has an entire section devoted to guiding you through the pros and cons of reverse mortgages. In short, these loans allow you to borrow money and only repay it when you sell the home.
Take Action
- Can you cut spending/change lifestyle during retirement? CNN has a cool calculator that shows you the average spending per category of people in similar situations as you. To try it, go here.
AARP Resources
Learn more about reverse mortgages.
For a complete guide to borrowing against the equity in your home, see the AARP Financing Homes area.
Get some helpful hints on whether to pay off your mortgage early.
Additional Resources
The Federal Trade Commission has information on home equity credit, loans and scams.
Read these tips on tapping your home equity.
Understanding Annuities
Annuities offer a tax-sheltered way to guarantee an income for life, or in the alternative, a set amount of income for a specific number of years. It all depends on what you need. Consider annuities only if you plan on investing for the longer term; otherwise, it might not be worth it.
Annuities can be complicated. Examine fees carefully before making a purchase. Some people sell misleading or outright fraudulent products to unsuspecting people—so be sure that you ask questions and compare options before buying.
An annuity is a contract between you and an insurance company. Based upon the amount you pay in premiums, the company pays you income on an agreed upon schedule. As a general rule, you can't withdraw funds from the account before age 59 1/2. After that, you're only taxed on the earnings withdrawn.
How to make investments. Do you want to pay one lump sum or installments? Be aware that if you pay a lump sum—a "single premium annuity"—and later wish to invest more, you will have to buy another annuity. A "flexible payment annuity" allows you to invest more at any time.
Immediate or later payments. If you want payments to begin immediately, you can get an immediate annuity. Otherwise, you could buy a deferred annuity, which will begin payments at a later date. Even with deferred annuities, you can buy one that matures in just a few years (although the payouts will likely be smaller).
- Payment schedule. You can select from a variety of payout options: monthly, quarterly, or annual payments starting immediately or starting some time in the future. Annuities are tax-deferred, not tax-deductible. Your money earns interest without your having to pay taxes. However, when you do start drawing from the annuity, you will pay taxes on the interest so consider the tax implications of your payout choice. For example if you are under 59 1/2 and make a withdrawal, you will pay a 10% penalty.
- Length of time. You'll need to determine if you want payments for as long as you live, for as long as both you and a survivor live, or for a fixed time. You will probably hear these options referred to as a "life annuity," "joint and survivor annuity," or a "period certain annuity." The longer the time the insurance company must make payments, the less each payment will be.
Fixed or variable. These are the two main categories of annuities.
- Fixed. If you want pure predictability, buy a fixed annuity. It lets you set a guaranteed schedule of payments for a fixed period of time. Consider products that include cost of living adjustments (COLAs), as a way to keep up with inflation. Be aware that there may be fees, such as mortality and expense charges, deducted. Study so-called "bonus" offers on fixed annuities that make it look like you're getting a higher than usual interest rate. The bonus rate may only be good for a limited time—like a teaser rate on a credit card, the good terms that attracted you to the annuity may expire and you may end up with worse terms.
- Variable. If you're willing to take some risk in exchange for
the opportunity to increase your future income, you can buy a variable annuity.
You control how the money is invested from among a variety of mutual funds.
Your income, therefore, will be variable, subject to the success of the mutual
funds that are in your annuity. There may be a guaranteed minimum you will
earn, with an unlimited upside; but there may be no minimum guarantee at
all.
Variable annuities are generally not for those already retired or near retirement, because their purpose is to grow retirement savings tax-deferred over an extended period of time. Furthermore, the minimum rate guarantee may be as low or close to as low as what you could earn with a CD—but you'd be paying much higher fees for the annuity.
Pay attention to fees. Before buying an annuity, be sure you know how much you will be paying for the annuity. Here are some things to look for:
- Surrender charge. There's a charge if you want to cash out of the annuity. The amount is clearly stated in the annuity contract and differs from company to company. Usually, the surrender charge will go down each year until it completely disappears. Pay close attention to surrender charges; they can have a big impact on the value of your annuity.
- Withdrawals. Annuities have different withdrawal rules. Try to find a contract that allows for partial withdrawals. This would allow you a one-time right to take out up to 10% of the accumulated cash value without a fee or penalty (imposed by the contract, not the early withdrawal penalty imposed by the government, explained below). This can be useful if you need to tap the annuity during the years the surrender charge is in effect. In addition to the penalties imposed by the contract, taking money from an annuity may result in taxation and penalties.
As a general rule, if you withdraw money from an annuity prior to age 59 1/2, you'll pay a 10% early withdrawal tax penalty. This applies to earnings, not the amount you deposited. The IRS thinks of your withdrawals as automatically taking your earnings first and the amount you invested last. So if you withdraw money before you reach the contractual date for receiving income payments, it's likely that the entire amount withdrawn will be taxable. However, once your stream of income begins, the IRS will view each payment as a mix of earnings and the amount you invested. Only the earnings are taxable.
Safety. There are independent rating services that examine the financial health of insurance companies, such as A.M. Best, Weiss Research, and others. An annuity bought at a bank is not FDIC insured.
Watch out for fraud. There are many reputable companies selling annuities. But annuities are a fertile area for fraud. One of the most common techniques is the switching, exchange or replacement of one variable annuity for another. A switch to an inappropriate variable annuity can cost you a great deal of money, but gives the salesperson a windfall. Be on the lookout if the proposal to replace the annuity comes from the salesperson, not from your own initiative.
Annuities sales people make very high commissions so there's pressure for them to sometimes force a sale. Be sure the agent is focused on your needs and doesn't simply come in and offer you a particular product without getting to know your situation first. Even so, don't trust too easily; sales training in annuities is intense, and the sales approaches can be tricky.
Take Action
- Here are questions to ask before buying an annuity, from the SEC.
- To get a basic sense of what an annuity might provide in income, try this calculator.
- You can file a complaint about an annuity at Annuity Truth.
AARP Resources
Examine the pros and cons of using a charitable gift annuity.
This telephone survey of 800 retirees
examines issues of money management in retirement.
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Because your Money Matters, get more tips and action steps on Managing Your Money - PDF file |
Additional Resources
The Securities and Exchange Commission has a general brochure on annuities, www.sec.gov/answers/annuity.htm, and a brochure on variable annuities, www.sec.gov/investor/pubs/varannty.htm.
This column is meant to provide general financial information; it is not meant to substitute for, or to supersede, professional or legal advice.
Note: The content areas in this material are believed to be current as of this printing, but, over time, legislative and regulatory changes, as well as new developments, may date this material.
