Greetings! I trust this will find you well and enjoying life.
I am aware that this week’s topic is somewhat lengthy. However I find more and more retirees and persons approaching retirement being challenged to examine a retirement with an income shortfall. The experience can be radical unless you plan for it or adjust to it. Even if you feel confident that you have accumulated all that you will ever need to manage your retirement expenses, I think you will find tips in this week’s retirement discussion to add value in your retirement plan.
When you determine your retirement income needs, you make your projections based on the type of lifestyle you plan to have and the desired timing of your retirement. However you may find that reality is not in sync with your projections and it looks like your retirement income will be insufficient for the rate you plan to spend it. This is called a projected income shortfall. If you find yourself in such a situation finding the best solution will depend on several factors including the following:
- The severity of your projected shortfall
- The length of time remaining before retirement
- How long you need your retirement income to last
One way of dealing with a projected income shortfall is to stay in the workforce longer than you had planned. This will allow you to continue supporting yourself with a salary rather than dipping into your retirement savings. Delaying your retirement could mean that you continue to work longer than you had originally planned. Or it might mean finding a new full or part time job and living off the income from this job. By doing so, you can delay taking Social Security benefits or distributions from retirement accounts. The longer you delay tapping into these sources the longer the money will last when you do begin taking it. While you might hesitate to start on a new career path late in life there may actually be certain unique opportunities that would not have been available earlier in life. For example you might consider entering the consulting field, based on the expertise you have gained through a lifetime of employment.
The Social Security Administration has set a “normal retirement age” which varies between 65 and 67, depending on your date of birth. You can elect to receive Social Security retirement benefits as early as age 62, but if you begin receiving benefits before your normal retirement age, your benefits will be decreased. Conversely if you elect to delay retirement, you can increase your annual Social Security benefit. There are two reasons for this. First, each additional year that you work adds an additional year of earnings to your Social Security record, resulting in potentially higher retirement benefits. Second, the Social Security Administration gives you a credit for each month you delay retirement, up to age 70.
The longer you delay retirement, the longer you can contribute to your IRA or employer-sponsored retirement plan. However if you have a traditional IRA, you must start taking required minimum distributions (and stop contributing) when you reach age 70½. If you fail to take the minimum distribution, you will be subject to a 50 percent penalty on the amount that should have been distributed. If you have a Roth IRA, you are not required to take any distributions while you are alive and you can continue to make contributions after age 70½ if you are still working. Minimum distribution rules do not apply to money in qualified retirement plans until you reach age 70½ or retire (whichever occurs later), unless you own 5 percent or more of your employer.
Under the federal Age Discrimination in Employment Act, individuals 40 years of age or older are protected against employment discrimination based on age. However employers may have legitimate concerns about hiring an individual of retirement age. Prospective employers may believe older employees will have greater health-care needs, require more sick leave and tend to be short-term employees. You should be aware of these concerns and have a strategy for dealing with them if you plan to seek new employment after you have reached retirement age.
You may be able to deal with projected retirement income shortfalls by adjusting your spending habits, thus allowing you to save more money for retirement. Depending on how many years you have before retirement, you may be able to get by with only minor changes to your spending habits. However if retirement is fast approaching, drastic changes may be needed. Saving even a little money can really add up if you do it consistently and earn a reasonable rate of return. Make permanent changes to your spending habits and you’ll find your savings lasting even longer.
If you expect to fall far short of your retirement income needs or if retirement is only a few years away, you may need to change your spending patterns drastically to save enough to cover the shortfall. You should create a written budget so you can easily see where your money goes and where you can reduce your spending. The following are some suggested changes you may choose to implement:
- Consolidate your loans to reduce your interest rate and/or monthly payment. Consider using home equity financing for this purpose.
- Refinance your home mortgage if interest rates have dropped since you took the loan.
- Reduce your housing expenses by moving to a less expensive home or apartment.
- Sell your second car especially if it is only used occasionally.
Minor changes can also make a difference. You’d be surprised how quickly your savings add up when you implement several small changes to your spending patterns. If your expected shortfall is minor or if you have many years before you plan to retire, making such small changes to your spending habits may be enough to correct this problem. The following are several areas you might consider when adjusting your spending patterns:
- Buy only the insurance you really need. For example consider canceling collision insurance on an older vehicle.
- Shop for the best interest rate whenever you need a loan.
- Switch to a lower interest credit card. Transfer your balances from higher interest cards and then cancel the old accounts.
- Eat dinner at home and carry “brown-bag” lunches instead of eating out for lunch.
- Consider buying a well-maintained used car instead of a new car.
- Subscribe to the magazines and newspapers you read instead of paying full price at the newsstand.
- Cut down on utility costs and other household expenses.
- Get books and movies from your local library instead of buying or renting them.
- Plan your expenditures and avoid impulse buying.
Keep in mind that the money you save should be earmarked for your retirement. It should not be frittered away on minor expenditures and impulse purchases. The point of reducing your spending is to overcome projected income shortfalls, not to indulge yourself at end-of-season clearance sales. The money you save should be put away immediately. If you can take advantage of an IRA or other similar retirement plan, consider doing so. Any growth such a plan may experience will occur on a tax-deferred basis.
Continue saving during your retirement
Don’t think of your retirement date as your deadline for saving. Instead, continue to save money throughout your retirement years. Saving may become more difficult after retirement as a result of reduced income and potentially increased medical expenses. But you can work part-time during retirement and take other steps to keep saving. Putting away just a little each month can make a significant difference in how long your money will last.
If you are facing a projected income shortfall, you may want to revisit your investment choices, particularly if you’re still at least 10-15 years from retirement. If you’re willing to accept more risk, you may be able to increase your potential return. However there are no guarantees; as you take on more risk your potential for loss grows as well.
It’s not uncommon for individuals to make the mistake of investing too conservatively for their retirement goals. For example if a large portion of your retirement dollars is in low interest earning fixed-income investments, be aware that the return on such investments may not outpace the rate of inflation. By contrast, equity investments (i.e., stocks and stock mutual funds) generally expose you to greater investment risk, but have the potential to provide greater returns.
If your projected income shortfall is severe enough or if time is too tight, you may realize that no matter what measures you take you will not be able to afford the lifestyle you want during your retirement years. You may simply have to accept the fact that your retirement will not be the jet-setting, luxurious, permanent vacation you had envisioned. In other words you will have to lower your expectations and accept a more realistic standard of living. Recognize the difference between the things you want and the things you need and you’ll have an easier time deciding where you can make adjustments. Here are a few suggestions.
- Perhaps you’ve always planned to live in a luxury condominium community in Palm Beach when you retire. Realize that this goal may not be realistic. If you are facing a severe income shortfall, you might have to shop around for a more affordable housing option in a less exclusive location.
- Maybe you’d always planned an extended tour of Europe or a cruise around the world to celebrate your retirement. You may have to downgrade these plans to a driving trip to visit relatives or a train trip across the Rockies. Simple trips can be just as much fun as extravagant vacations and they don’t put as big a dent in your retirement funds.
- You may dream of driving a shiny new Cadillac off the dealer’s lot right after your retirement, but shiny new Cadillacs come with big, thick payment books. Consider purchasing a used car of the type you want. If you must have a new car think about buying a less expensive model.
There are numerous ways to decrease your everyday expenses. You might find that simply cutting back on your spending will help stretch your retirement dollar. For instance you could eat out less often or set your home thermostats slightly lower in the winter.
There is a great deal you can accomplish to manage the impact of an income shortfall in retirement, if you will put your mind to it.
If you have any questions or feel that we can help in any way with retirement finances or retirement planning, don’t hesitate to contact us.
Jeff Christian CFP, CRPC