As you reach age 50 it is time to get serious about your eventual transition to retirement or semi-retirement. Consider these ten factors to successfully manage your retirement resources. Remember that retirement is a marathon, not a sprint. Proper planning will protect you from running out of money and also from missing out on life's great opportunities by being overly frugal.
1) Set a Withdrawal Strategy for Retirement Portfolios and Stick to It
Committing to a withdrawal strategy is an issue that trips up many retirees. Market volatility leads some retirees to panic and sell assets, thus locking in their losses. Fear of risk also leads some retirees to be overly conservative with their choice of investments. This leads to lower market returns and a portfolio that cannot provide enough retirement income to keep pace with inflation.
A highly recommended withdrawal strategy starts with a portfolio consisting of 60% stocks and 40% bonds. The retiree withdraws 4% of the total balance each year, plus an increase for inflation. For example a retiree with $600,000 in their retirement account will take $24,000 in the first year of retirement. If inflation is 3% they will withdraw $24,720 in year two.
This withdrawal strategy is called the 4% rule. A retiree can take their annual withdrawals monthly, quarterly, or as a single payment at the end of the year. A key component of this strategy is to rebalance your portfolio to the 60% and 40% allocations once a year. Many followers of the 4% rule use their birthday as the date for rebalancing.
2) Track Your Spending
Retirement or semi-retirement means entering a new stage in life, daily routines evolve, providing more unscheduled time. This additional free time influences spending habits, making it critical to track monthly expenditures. Although the average retiree spends 80% of what they did while working, some retirees spend significantly more. Some of this increased spending is due to large purchases such as boats, RVs or new cars. These purchases bring new maintenance costs which can exceed a retiree's budget. In addition, these large purchases can reduce a retiree's future retirement income.
For example, purchasing a $100,000 RV with a withdrawal from a taxable retirement account (like a 401k) will trigger income taxes. You might need to withdrawal $125,000 to pay $25,000 in income taxes to purchase the $100,000 RV. Drawing down $125,000 from a taxable retirement account for your RV would deprive you of $5,000 per year in future retirement income using the 4% rule described above. If you finance such purchases at a low interest rate it may be wiser to finance these purchases instead of paying for them from your retirement account. Properly tracking your monthly spending will keep your retirement finances on course.
3) Seriously Consider Part-Time Work or a Side Hustle
I strongly encourage people to consider the semi-retirement option instead of fully retiring. Working just a few hours a week will keep you physically and mentally active in a way that is beneficial to your long term health. It also keeps your skills and network current. It is much harder to start a job search from a cold start than it is to increase your hours from a part-time status.
Earning just a few hundred dollars a week also has lasting benefits for portfolio preservation. For example, if you earn $20,000 per year from a part-time job this income is equal to the amount you would withdraw from a $500,000 retirement portfolio, using the 4% rule. This part-time job allows you to delay some withdrawals from your retirement account which will preserve these funds for the future.
4) Turn Your Job into a Business
If you want to turbocharge your part-time job look for ways to turn it into a business. If you are consulting, selling crafts, teaching, or offering your professional services formalize this activity into a business. There are two key benefits from starting a business. First, you will become eligible for a range of tax deductions for business expenses which includes deducting equipment or services such as your phone, internet, printer, or a computer. You can also deduct some of your travel expenses related to your work.
Second, if you have a designated work space in your home you are eligible to take advantage of the home office deduction. This is relatively easy to do if you use the "simplified method" deduction which requires multiplying the square footage of your home office (up to a max of 300 square feet) by $5. For example, a 250 square foot home office would provide an annual tax deduction of $1,250.
5) Eliminate Housing Expenses
The average household spends 30% of its income on housing expenses. As you shift to retirement it is highly advantageous to eliminate this major expense. Eliminating your housing expenses frees up income for other more enjoyable expenses such as hobbies or travel. There are several ways to reduce your housing income. The first way is to pay off your mortgage to coincide with your retirement date. This will dramatically reduce your housing expenses, but you will still be responsible for property taxes and insurance.
A second way is to buy a retirement account that generates rental income that covers your housing expenses. This could be done by purchasing a duplex or triplex and renting the other units Another version of this approach is to purchase a property with a guest house or mini-apartment and then renting the space on home sharing sites like AirBnB or VRBO. These rental units will require some time and attention, but will drastically reduce your housing expenses. If you share the burden hiring a property manager for a fee will make managing the properties easier.
The next five factors will be covered in Part 2. For more information on preparing for retirement see the articles under the Ready to Retire? or if you want to develop a comprehensive retirement plan read Become Loaded for Life!