The decision to retire will have a profound effect on how you spend your time and on where your money comes from. Before you give up a paycheck, make sure you're in a good place financially and won't end up regretting your decision to retire.
Taking these four steps can help you confirm you're prepared and can give you a good idea of what life will actually look like for you as a retiree.
1. Decide on a safe withdrawal rate
Deciding on a safe withdrawal rate is one of the most crucial pre-retirement steps. Your withdrawal rate determines how much income your savings will provide -- and whether you're likely to run out of money during retirement.
Traditionally, many retirees followed the 4% rule. This allowed for a withdrawal of 4% of your account balance in the first year. Each year, you'd adjust the amount up based on inflation. Unfortunately, this strategy may now put you at risk of running short of money, as lifespans have gotten longer and projections for future returns have changed.
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There are a number of other approaches, including using Required Minimum Distribution tables prepared by the IRS to set a withdrawal rate. Choose one before retiring and estimate the amount of income your nest egg will provide so you can make sure it's enough.
2. Set a budget
It's not only important to know how much income you'll have as a retiree, but also how much spending you'll do.
When you're close to retirement, make a sample budget that takes all of your fixed and discretionary costs into account. Don't forget things like travel if you plan to enjoy retirement by seeing the world.
Compare your budgeted expenses to the amount of income you'll have from your nest egg and from Social Security. If you'll fall short, you may want to make some modifications before retiring, or you may need to work longer to save more and enable a delayed Social Security benefits claim to earn larger monthly checks.
3. Research tax rules
It's crucial to understand how your retirement income will be taxed -- including your Social Security benefits, pension income, and distributions from your retirement accounts.
The rules differ depending on your state, but the federal government begins taxing Social Security benefits once provisional income hits $25,000 for single filers or $32,000 for married joint filers. Provisional income is half your Social Security checks plus all taxable and some non-taxable income.
Make sure you check your state's tax rules as well as the IRS requirements so you're prepared for what your pre-tax income will look like as a retiree.
4. Check your insurance coverage
Finally, you'll need to make a plan for getting comprehensive insurance coverage, especially as healthcare is one of the largest expenses retirees face.
This is especially important if you'll be retiring before Medicare kicks in at 65, as you may need to stay on an employer's plan through COBRA or shop for independent insurance. But even if you're already Medicare eligible, you may want a Medigap or Medicare Advantage plan to provide broader coverage. You'll want to know how much this is likely to cost and what your out-of-pocket care expenses could be.
By setting a budget, assessing your income sources, and determining the effect of taxes and healthcare on your retirement income, you can make a fully informed decision as to whether or not you're really in a financial position to support yourself without a job for the rest of your life.
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