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Generally, one of the primary focuses before retirement is saving money. The hope is to build your retirement savings to help you live a comfortable lifestyle during your golden years.
As you get closer to retiring, planning how you'll turn your savings into income is an important step. You'll likely want to take all your potential sources of income into consideration as you make a plan.
Here are some details you may want to think through as you start your retirement income planning.
Estimate Your Retirement Years
Today, as people retire earlier and live longer, it's not uncommon for retirement to last 20 or even 30 years in some circumstances.
While it's impossible to predict the future, having an estimate of how long you'll need your retirement savings to last can help you plan. Part of that will depend on factors such as your age and health.
A retirement calculator can help you see if you're on track with your savings depending on how long you think you'll be retired.
Understand Your Sources & Options for Retirement Income
You might want to begin looking at each of your potential sources of retirement income and how much money they will provide. That way, you can see if there are any gaps that exist between your expected retirement income and expenses.
Here are some of the common sources of income for retirees:
For some retirees, Social Security is an essential part of their retirement income. Once you decide to claim your Social Security benefits, the government will send you money every month that you can rely on as income.
However, before you retire, it's important to think about ways to maximize your Social Security benefits. That might include claiming it later or pushing your retirement back a few years.
If you have a pension through your employer, that's another source of income for your retirement. Depending on how your pension is set up, you might get a fixed amount each month. In some cases, the amount can fluctuate. Regardless of the amount, a pension is typically intended to last for the rest of your life.
Another way to receive income in retirement is an annuity. There are different types of annuities, and you purchase one by either making a lump-sum premium payment or a series of payments to an insurance company. In exchange, the company will provide you payments that start on a specific date and last for a certain amount of time.
Just because you're retired doesn't mean that you have to give up working altogether. Some people enjoy working part time to get out of the house and stay active during their retirement years.
Any money from a part-time job should likely also be included in your retirement income planning. It's also important to keep in mind that having a part-time job — especially one that brings in a substantial income — can affect your taxes and savings contribution limits. You can discuss this with a financial professional for a better understanding of how it might affect you.
Of course, the savings you've set aside for your retirement can serve as a potential source of income as well. Many people build their savings through individual Retirement Plans (IRAs) or employer-sponsored 401(k)s.
If you're over age 50, one way to help maximize your savings is to take advantage of catch-up contributions. The Internal Revenue Service (IRS) allows you to contribute additional funds to IRAs and most 401(k)s.
As you approach your retirement, you may want to look at your savings closely and develop a withdrawal strategy that fits your needs.
Other Sources of Income
There are many other potential sources of income you can have in retirement that you may also want to take into account as you plan for the future. For instance, another source of income might include rental fees from a vacation home or investment property.
Know Your Expenses
As you prepare for retirement, it's important to understand your monthly expenses. For those who will spend their retirement years on a fixed income, making arrangements to avoid overspending is helpful.
For example, it may be a good idea to build a retirement budget that can help you track your expenses and plan for the future. You might want to set aside time to take a good look at your current expenses and see what might change in retirement. For example, your transportation costs could lower, or you might finish paying off your mortgage in the next few years.
Any expenses you can cut before you hit retirement may also help your savings last longer. Reducing your expenses, especially early on in retirement, may help you maximize your savings for later on in life. When it comes to budgeting for your future, it's never too late to start.
Prepare for Unexpected Costs
It's not uncommon to get hit with some unexpected costs during retirement, so preparing for the unexpected can be helpful. There are a variety of potential unexpected costs, such as general home repairs or helping a family member through a rough financial period.
While you can't guarantee you won't face these costs, you can potentially help to reduce the risk. Effective retirement planning can mean having an emergency savings or rainy day fund set aside to help take care of smaller immediate issues.
Some of the unexpected costs you could face may also come from health care. As people age, health care costs often become a more significant expense. This is especially true if you become ill or need long-term care. Preparing for the costs of health care in retirement can be helpful. Part of that may be building up your savings, but you might also consider long-term care insurance or a health savings account (HSA).
Consider the Taxes You'll Pay
It's important to consider your taxes in retirement, too. Just because you're not receiving your income from a job doesn't mean you no longer have to worry about taxes.
Depending on the type of account you opened for your retirement savings, you may be taxed on what you've saved. For example, with a traditional IRA, you will have to pay taxes at your current tax rate upon withdrawal. To help reduce those costs, many people look to options that have tax-free withdrawals. For instance, qualified withdrawals from a Roth IRA are tax-free because you already paid taxes on your contributions. For a withdrawal to be qualified, it must be taken after you reach age 59 1/2, and after the five-year period beginning with the first taxable year that a contribution was made to the Roth IRA.
In addition to a Roth IRA, there are a few other financial tools that may give you tax advantages. An HSA is one option to consider before retirement. Depending on your health insurance plan, you may be eligible to put pre-tax money into an HSA. The money in an HSA grows tax-deferred, and you can use it tax-free to pay for qualified health care costs.
Finally, remember that early withdrawals from your retirement savings may be subject to additional tax penalties.
Plan Now & Enjoy Your Retirement Later
You've worked hard over the years to save for your retirement. As you approach your golden years, you'll likely want to have a plan to maximize your retirement savings. Having a solid retirement income plan in place can help you enjoy your retirement more comfortably. For more information, consider speaking with a financial representative.