You’ve worked 40 years, and finally, you’re preparing for retirement. Unfortunately, many retirees are downright confused about the key elements of retirement, such as their pension benefits and how they work. This lack of insight can lead to poor decisions.
For example, some people are confused about the difference between a pension and a retirement savings account, such as a 401(k) or 403(b). A client of mine, who had a 403(b) plan, thought her pension and her 403(b) were the same thing. After I explained that they were two separate items, she did some checking and discovered that she had close to $1.5 million in assets that she was unaware of. She thought she had to work another year or two before retiring, but, of course, this discovery changed her schedule.
Now, don’t expect too much. Not everyone will discover $1.5 million in benefits they previously didn’t know existed. But everyone can make better retirement decisions if they understand all of the terms and factors involved.
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The path to preparing for retirement includes:
Retreats. Fewer people have pensions today than a few decades ago, but if you do, it’s important to understand how it works and what options are available to you. A pension provides a monthly check upon retirement, usually for life. But sometimes you can take a lump sum instead of the monthly check. It is worth exploring as the lump sum allows you to invest and manage your asset as you see fit. For example, you could buy an annuity to establish an income stream while investing some of the money for growth.
It also provides you with money to draw on in an emergency and gives you control over how your money will go to your beneficiaries when you die.
Beyond the lump sum, another pension option to consider is whether you can take a smaller monthly payment and, in exchange, provide a lifetime check for your spouse after your death. A finance professional can help you weigh the pros and cons of your options to determine what’s best for you.
Retirement savings plans. Depending on where you work, you may have a 401(k) plan, a 457 plan, or another retirement savings plan. But do you have a good understanding of how your plan works? Is it a tax deferred plan or maybe a Roth plan?
If it’s tax-deferred, you get a tax benefit now, but you’ll pay taxes on withdrawals in retirement. If it’s a Roth, there’s no immediate tax benefit, but the money grows tax-free and withdrawals aren’t taxed. It’s important to know whether your plan is tax-deferred or tax-exempt, because when you reach retirement, it will make a significant difference in how much of your money is available to you – and how much is available for retirement. ‘Uncle Sam.
Taxes. Speaking of Uncle Sam and his share of your money, it’s no secret that the tax code is constantly changing. Right now we are still taking advantage of the 2017 tax cuts (opens in a new tab), but these are expected to expire at the end of 2025 and return to previous higher rates. And it’s possible they could go even higher in the future.
Financial professionals like to say that, right now, taxes are on sale, making it an opportune time to convert tax-deferred assets into a Roth IRA. You will pay taxes when you convert, but you will do so at today’s lower rate rather than at a potentially higher future rate. Understanding the tax ramifications – and taking action on them – can make a big difference in how much money you have in retirement.
Health care. Medical costs can add up quickly as you age, so having a good health insurance plan in retirement is a must – and understanding what’s covered. Where will your medical benefits come from after you turn 65? Can you keep the insurance from your current job, or does it disappear, forcing you to switch to Medicare?
Medicare itself has different options, so you want to understand those and what your medical costs might be each time you see a doctor. As people live longer, you want to make sure you’re making informed health insurance decisions.
Inflation. People talk a lot about inflation, but they don’t always think about what it means, especially in the long term. Too often, retirees don’t take inflation into account when making their retirement plans.
For example, you might think that you need $5,000 a month to live on, and you make a plan to meet that need. But $5,000 today almost certainly buys more than $5,000 in 10 or 20 years. Those dollars start to erode over time, so your plan needs to account for inflation, lest your money disappear faster than expected.
Spending habits. Imagine that you arrive at retirement with a substantial nest egg. Based on these savings, you and your financial professional develop a plan that allows you to age comfortably to 100.
But then life happens – with the temptations to spend. Your daughter wants an expensive wedding, so you dip into retirement savings to pay for it. Your son needs help with the down payment on a house, so the savings take a hit.
Before you know it, your nest egg evaporates and nothing comes to help you replenish it. Beware of large items or helping family members and friends in ways beyond your means. If you have a plan, stick to it.
Preparing for retirement covers a vast territory and can seem overwhelming. But it doesn’t have to. If you find a fiduciary advisor to work with, that person can make sure you consider factors you may have overlooked and can help navigate you through the process.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a public relations program. The columnist received help from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger was not compensated in any way.
This article was written by and presents the views of our contributing advisor, not Kiplinger’s editorial staff. You can check advisor records with the SEC (opens in a new tab) or with FINRA (opens in a new tab).
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