It can be difficult to determine if you are prepared to permanently exit the work force. You need to save enough to last the rest of your life -- and you'll need to manage that money to beat inflation and minimize taxes. Retirees should also have a plan for remaining connected to others and staying relevant in this new life stage.
Here's how to tell if you are ready to retire:
Establish a retirement budget. Retirees no longer have to pay for professional work clothes or transportation to the office. But unless you enter retirement newly mortgage-free, most of your other expenses are likely to remain the same after you leave your job. "I don't find that people's expenses go down in retirement," says Leisa Brown Aiken, a certified financial planner for Veo Financial Counsel in Chicago. "You're probably going to spend as much or more as you spend now." If you plan to travel or take up new hobbies, your expenses could increase.
Examine your cash flow. Most retirees receive income from several sources, including Social Security, pensions, investments and, increasingly, part-time jobs. You need to make sure you will receive enough income from these and other sources to pay all of your monthly bills. Less-common sources of retirement income include home equity, annuities, insurance, royalties and rental income.
Develop a withdrawal strategy. Retirees need a plan for drawing down their assets. Most financial advisers say that you can safely spend 4% of your nest egg each year. Withdrawals from tax-deferred retirement accounts are required after age 70 1/2. The withdrawal amount is calculated by dividing your IRA and 401k account balances by the Internal Revenue Service's estimate of your life expectancy. The penalty for failing to take out the correct amount is 50% of the amount that should have been withdrawn, in addition to regular income tax.
What's your tax burden?
Minimize taxes. Your entire nest egg isn't available for spending in retirement. When you take money out of tax-deferred 401k's and traditional IRAs in retirement, regular income tax is due on the withdrawals. If your tax bracket fluctuates from year to year, you can time your retirement account withdrawals to minimize taxes. "Do withdrawals or convert to a Roth when you are in a low tax bracket and, if you can, withdraw less when you are in a higher tax bracket," advises Aiken.Maximize Social Security. Retirees can sign up for Social Security beginning three months before their 62nd birthday. But annual payments increase for each year you delay claiming until age 70. Seniors who sign up at age 62 get smaller payments over a longer period of time. But retirees who delay claiming will get higher payments in old age when they are less able to work and more likely to develop health problems.
Get health care coverage. Many people delay retirement until they become eligible for Medicare at age 65. Sign up right after your 65th birthday to avoid a Medicare Part B premium increase of 10% for each 12-month period of delayed enrollment. You'll also need to shop around for the Medicare Part D plan that best meets your prescription drug needs. Those who retire before age 65 need to have a plan to purchase health insurance. Find out if your employer provides health coverage to retirees, if you are eligible for COBRA coverage or if you will need to purchase your own individual policy. You may also find coverage under your spouse's plan. Health insurance exchanges will become operational in 2014.
