When Do You Know It’s Time to Retire?

March 14, 2012

With spring right around the corner, it seems employees start to ask themselves if this work stuff is really worth it.  This week alone I have seen an uptick in the number of employees that are contemplating whether or not it is time to take this next step.  Here is just a smattering of the questions we have received via phone calls and emails this week alone:

• Do I have enough money to enjoy the lifestyle I would like to have?
• How do I choose the right pension payout option?
• How do I roll my 401(k) over to an IRA?
• When is the right time to start collecting Social Security?
• What will my tax liability be in retirement?
• How much does my retiree medical plan cost?
• What happens when I become eligible for Medicare?
• How does Medicaid work?
• Does the new health care law change the way I plan for health care in retirement?
• What do I do after I retire?
• How do I maintain a healthy attitude when I leave my work friends behind?

As you can see, some of these questions are financial in nature, some deal with issues concerning health care, and others deal more with the emotional aspect of retirement.  The answer to each question is as unique as the person asking it and unless you can foresee the future, no answer is perfect.  In the next several weeks, I will attempt to offer guidance around what you should consider when answering these questions for yourself.

Let’s start with the financial questions, which are generally the most popular.

Do I have enough money to enjoy the lifestyle I would like to have? – That depends—what kind of lifestyle would you like to have?  We humans have an amazing capacity to adjust our lifestyle to meet our income so a good place to start is asking yourself if you enjoy the lifestyle you are currently living.  If so, plan to replace 70-90% of your current income when you retire.  Why not 100%? Because certain expenses, such as commuting, debt, saving for retirement, and (knock on wood) children, are expected to decrease once you retire. To see what percentage of your income you are currently on track to replace, use a financial calculator such as Financial Finesse’s Retirement Plan Estimator or see my August 10, 2011 post titled Do You Know Your Retirement Number?

How do I choose the right pension payout option? – That depends—how long do you plan to live, how comfortable are you with market risk, and would you like to leave a benefit for someone else? If no one relies on your income and you are looking for the highest monthly income without the possibility of outliving your money, then a single-life annuity may be the most appropriate option. If you have a dependent and you would like him or her to receive a guaranteed monthly income for as long as they live, consider a joint and survivor annuity. If you are comfortable with market risk, and you plan to leave a benefit for heirs, perhaps a lump sum distribution (if available) is most appropriate. For a more thorough analysis of popular pension payout options, see Linda Robertson’s August 30, 2011 blog titled Making the Decision: Which Pension Payout Option is Best?

How do I roll my 401(k) over to an IRA? – Great question! (Aren’t you glad I didn’t say “that depends?”) Rolling a 401(k) over to an IRA is rather quite simple. For starters, if you don’t already have an IRA you need to establish one (see this Forbes.com article for guidance). Next, contact your HR department and request a distribution form. (They may send you to the plan provider, but that’s okay; they can help too.) Finally, fill out the distribution request form with the appropriate information, making sure to have the distribution payable to the IRA and not to you. Some distributions are wired to the account but most are sent to you in the form of a check, which you must then forward on to your IRA custodian. Once the funds are deposited in your IRA, all that’s left is making your investment decisions, which is a conversation for another day.

When is the right time to start collecting Social Security? – Again, it depends on how long you plan to live, and whether you are eligible for spousal benefits. The earliest you may begin receiving benefits is age 62 but at a reduced amount.  You may defer benefits until age 70.  In general, the longer you plan to live, the more beneficial it is to defer collecting your benefit, but there are other reasons to take your benefit earlier, such as needing the funds to achieve your goal of an early retirement. The question is so popular that the Social Security Administration dedicated an entire section of their website to it. The best thing you can do is learn as much as you can about your options and then see how each option fits into your overall retirement plan.

What will my tax liability be in retirement? – Wouldn’t we all like to know? Here’s what I can tell you. Distributions from traditional retirement accounts (e.g. 401(k), IRA), pension benefits, and a certain portion of your Social Security benefit may be taxed as ordinary income. Distributions from Roth accounts are not taxed as long as you have held the account for five years and are at least age 59 ½ when you take it. Selling capital assets, such as stocks, mutual funds, or real estate, are generally taxed at capital gains rates.

Here’s what I can’t tell you. I can’t tell you what tax rates will be in the future. I can’t tell you what the income brackets will look like. I can’t tell you what the exemption and standard deduction amounts will be. In other words, I can’t tell you about things that are subject to change in the future.

That said, you can estimate your potential tax liability by understanding how each income source is taxed, and then using a financial calculator based on current tax law. This is as close as you can get absent a crystal ball.

These are just a few of the financial questions we get regularly. As I said, this decision is not easy, and I think someone put it best when they said “[t]he many decisions that one faces going into retirement are every bit as challenging as decisions being made as a new employee.” The difference may be that new employees still have time to figure it out.

Look ahead for my next blog which will address some of the non-financial related questions listed above.