It's one of the great ironies of financial planning: People save and invest diligently for decades to ensure a comfortable retirement, yet when the time comes, they're reluctant to spend their hard-earned wealth. Some people fear running out of money during retirement or being hit with unforeseen expenses. Others want to preserve wealth for their heirs. And many people simply feel more comfortable knowing they have a big nest egg.
These are legitimate concerns. But they shouldn't stop you from spending money on travel, hobbies and other activities you enjoy. Fortunately, there are some strategies you can employ to get more comfortable with spending some of your retirement savings.
Develop a Plan
Knowledge is power, so the first step is to know where you stand, financially speaking. Take inventory of your assets, income sources (for example, IRAs, pensions and Social Security) and expenses, and do some forecasting. Be sure to account for expected investment returns, taxes, inflation and anticipated changes in medical expenses and spending habits in the coming years and decades. This will help you determine how much of your retirement savings you'll need to tap for basic living expenses and how much you can afford to budget for travel and leisure.
For many people, this exercise offers some comfort that they're unlikely to run out of money during retirement. And for those who discover that their savings may fall short of their needs, it provides an opportunity to make adjustments.
Fill Your Buckets
Fear of running out of money causes many retirees to invest conservatively. But there's a common misconception that "safe" investments, such as savings accounts and money market funds, are risk-free. On the contrary, if you put too much of your savings in these low-interest investments, there's a risk that your overall returns won't keep pace with inflation. This can erode your wealth over time.
A better approach is to divide your savings into three "buckets" with different purposes and risk profiles:
- Bucket 1. This should be for cash and other liquid investments to cover basic expenses over the short term that aren't paid for by pensions, Social Security and other fixed income sources.
- Bucket 2. This one should cover intermediate-term expenses (over the next three to 10 years) with modest-risk investments, such as bonds and bond funds. The objective is to generate sufficient returns that at least keep pace with inflation.
- Bucket 3. This will hold a diversified portfolio of riskier investments, such as stocks and stock funds, that may be volatile over the short term but have the potential for significant growth over the long term (10 years or more). This final bucket should allow your nest egg to grow at a faster rate than inflation and provide income to "refill" buckets one and two.
Consider an Annuity
Annuities can help assuage fears of running out of money in retirement. There are many types, ranging from simple to highly complex. Generally speaking, annuities allow you to exchange a lump sum or annual premiums for tax-deferred growth and a guaranteed income stream for life. This income can start right away (immediate annuities) or at some date in the future (deferred annuities).
Rates of return on annuities are relatively low (and management expenses can be high), so they're no substitute for other retirement savings vehicles. But they can be a powerful weapon in your retirement-planning arsenal, offering the peace of mind that comes with an income source you can't outlive.
Delay Social Security Benefits
You can start taking Social Security benefits as early as age 62 but delaying benefits to age 70 (if you can afford it) is one of the best investments you can make. When you delay benefits beyond full retirement age (usually between the ages of 66 and 67) a couple of things happen. First, your benefits automatically receive annual cost of living adjustments, guaranteeing they'll likely keep pace with inflation. Two, you'll enjoy delayed retirement credits that increase your benefit amount by 8% for each year you wait. That's inflation protection plus a guaranteed 8% annual return. How many investments can you say that about?
You might also want to consider working past retirement age. A part-time job or freelance work can be a great way to keep busy during retirement and make your savings last longer. These days, many jobs can be performed remotely from anywhere. Plus, companies currently are contending with a shortage of skilled workers, so it's a great time to seek part-time opportunities.
Learn More
Forecasting investment returns, expenses, taxes and inflation is a complex undertaking. Your financial advisor can help you get a handle on these factors. Ultimately, the more you know about your retirement resources, the more comfortable you'll be about using some of them.
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Planning for retirement invariably comes down to making sure you save enough during your working years to build up a nest egg to use during your golden years. But what happens beyond retirement?
