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Are you ready to retire?

How to decide when to retire in 5 steps

The bottom line

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How to Decide When to Retire In Five Easy Steps

How to Decide When to Retire In Five Easy Steps

Oct 14, 2022


7 min read

The time to retire depends on the person, with proper planning you can align health needs and lifestyle with adequate financial support. Here's what you need to know.

Retirement is a monumental life change, and deciding when to take the plunge is not always an easy call. Truth be told, there is no one-size-fits-all answer. But there are common factors any individual may want to weigh before making this big decision. 

Are you ready to retire?

It may seem simple, but first, do a gut-check: Do you really want to retire? 

Some can’t wait to give up the daily grind, the tiresome commute, the work stress. They might want to retire as early as possible if it makes financial sense. Others find fulfillment, camaraderie, and responsibility at work. Early retirement might bring about boredom, anxiety, or a lack of purpose. The key to knowing when you’re ready is knowing your needs. When deciding if you’re ready to retire, consider your expected health and lifestyle desires, and then evaluate if your finances can support them. 

When it comes to evaluating health, ask yourself how many years of good health you realistically expect. Retiring early can maximize years of relative good health. When contemplating retirement, imagine the lifestyle you want. Do you expect to live in luxury, take lots of vacations, eat out and socialize a lot? Those activities cost money and require a significant nest egg. But maybe you expect to slow down, downsize, and live comfortably but more frugally. In this case, a smaller nest egg might be enough to support the anticipated lifestyle. 

Age benchmarks when considering retirement

Early retirement age is considered any age before 62, the minimum to qualify for Social Security benefits. Retirees younger than that will need other sources of income. Early withdrawals from retirement plans and individual retirement accounts (IRA) could be an option, but there are restrictions, and violating them can result in hefty penalties. If someone retires before age 59 ½ and takes an early withdrawal from a tax-deferred account like a traditional IRA, 401(k), or 403(b), they are subject to a 10% penalty. There are some qualified exceptions to the early withdrawal penalty. 

When considering the right age to retire, there are important age benchmarks to keep in mind: 

  • Age 62

    . This is the earliest age at which a person could start taking Social Security benefits. But the payment amount if taken at this age will be lower than if benefits are taken later, and the lesser amount will last for the rest of their life. 

  • Age 65

    .  Age 65 is when one will qualify for Medicare coverage. The initial enrollment period lasts for seven months: starting three months before turning 65, lasting until three months after the month you turn 65. It’s important to apply for Medicare before the initial enrollment period expires; delaying could mean paying more for Medicare Part B coverage and prescription drug coverage (Part D).

  • Age 66

    . The Social Security Administration considers age 66 the full retirement age for people born between 1943 and 1954. Those born between 1954 and 1960 reach full retirement age at 66 plus some months.  

  • Age 67

    . People born after 1960 will reach full retirement age at 67 and be eligible for the full Social Security benefit. 

  • Age 67 to 70

    . Those who wait until after full retirement age are eligible for Social Security delayed retirement credits that increase their monthly benefits. The benefit increase cuts off at age 70. 

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How to decide when to retire in 5 steps

Identifying the best time to retire is a process. Here are four broad steps to help decide when it’s time. 

  1. Estimate your total annual spending

Spending patterns can change drastically in retirement. Try to predict both essential and non-essential costs in retirement, based on lifestyle values. These are some costs to factor in:

  • Essential monthly costs

    . This includes housing (mortgage or rent), utilities, food, transportation, phone and internet, regular doctor appointments, home maintenance, and repairs, and other essential things. 

  • The fun stuff

    . Travel expenses, movies, shows, concerts, restaurants, bars, festivals, and other entertainment. Because retirees have more time on their hands, there’s a good chance that spending could go up, especially in the early years of retirement.

  • Debts

    . It’s hard enough to face retirement on a reduced income. Lingering debts—such as mortgages, home equity loans, car loans, credit card debt—will make it that much more difficult. For homeowners, even if the mortgage is paid off, remember to budget for necessary home maintenance and repairs (as much as 1% of the house price annually), property taxes, and insurance.

  • Inflation

    . Many financial advisors suggest that a retiree will need at least 70% of pre-retirement income to cover annual expenses in retirement. Don’t forget to project for inflation, too. The spike in inflation in 2022 is a reminder that today’s budget might not be enough to pay tomorrow’s prices, and Social Security cost of living adjustments (COLA) may not be enough to keep pace.

  1. Add up potential sources of income in retirement

Total up all expected sources of retirement income, which for many people tends to be significantly less than during one’s working years. Retirement income strategies include Social Security benefits, a pension, retirement plans, IRA distributions, or even supplemental income like part time work. Remember, however, that income taxes will need to be paid on retirement plan withdrawals and IRA distributions (except for Roth retirement account distributions, which are tax free).

  1. Develop a strategy for retirement account withdrawals

One approach to managing retirement account withdrawals is to preserve capital for as long as possible. That requires keeping an eye on the size of the portfolio, its anticipated average annual return, and the consumption rate (rate of withdrawals). A financial planner can help to determine whether the portfolio is big enough to support an investor’s retirement timeline, how much it is likely to grow after retiring, and what the optimum withdrawal rate should be. 

A common rule of thumb known as the 4% rule holds that in their first year of retirement, a retiree in their mid-60s shouldn’t withdraw more than 4% of the total of investments, Social Security, distributions, and pension payments. 

Ultimately, deciding whether expected retirement income is enough to align with lifestyle and health needs is a balancing act. 

  1. Decide the best age to take Social Security

At this point in the decision process, an investor may consider what the optimal age to be claiming Social Security benefits would be. Benefits can start as early as at age 62, or one can wait until later. The monthly benefit amount would be much higher the longer one waits, reaching the maximum at age 70.

Taking benefits before full retirement age (65 to 67, depending on birth year) means one won’t get the full monthly benefit amount calculated based on earnings history, because the recipient will be collecting benefits for a longer period of time. On the other hand, waiting as much as five years to take the retirement benefit also means foregoing five years of benefits. 

  1. Plan for increasing healthcare costs

Healthcare is the proverbial elephant in the room when it comes to retirement costs. A much bigger chunk of the annual retirement budget will go toward healthcare than many realize. There’s a good chance that it will actually be the single biggest item in the retirement budget. Healthcare costs include health insurance, supplemental insurance, prescription drugs, copays, and potential long-term care. 

Those who retire before age 65 won’t be eligible for Medicare yet. They will need to bridge the distance from their employer health or individual coverage to Medicare with some form of private health insurance, which can get expensive. Even after enrolling in Medicare, there will be costs (such as long-term care) that insurance won’t cover. Retirement savings may be needed to plug the gaps. 

The bottom line

The best time to retire varies with each individual. With proper planning, one can arrive at a likely best time to retire by aligning health needs and lifestyle preferences with adequate financial support. The process to decide when to return involves evaluating a retirement budget and how closely it matches the available income and savings. 

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