Everyone wants to enjoy a comfortable retirement, but unfortunately, this goal feels out of reach for most people. Individuals approaching retirement can increase their chances of financial stability by working to master practical money skills that will be essential once the working years are in the rearview mirror.
According to a study from early 2021, only 27% of US workers are highly confident they’ll be able to retire comfortably(*). So, it’s natural that now is the best time to prepare for the future, so here are 16 things everyone should know before they retire. People planning on retiring in the next 5-10 years should start mastering these essential money skills now to avoid any regrets when it’s time for retirement.
1. Defining Retirement
Retirement means different things to different people. A helpful first step in the process of preparing for retirement is to define one’s retirement. Here are a few details to consider:
- Does retirement mean no work at all?
- Can retirement involve a part-time job?
- What type of lifestyle does the ideal retirement involve?
- Is traveling important?
- Are living expenses likely to increase or decrease during retirement?
It’s essential to answer these questions and define retirement before making the jump and leaving a career behind. For example, one person may prefer a quiet retirement that involves minimal expenses, while someone else may want to travel and enjoy a more costly lifestyle.
There’s no right or wrong approach, but it’s critical to have a clear picture in mind. For example, those who want to spend more money in retirement may need to be willing to work longer and save more or find a way to generate income in retirement to support their lifestyle.
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2. Determining a Safe Withdrawal Rate
Understanding the concept of a safe withdrawal rate is an essential step in retirement planning. Knowing how much money can be withdrawn each year from retirement savings will help people avoid financial hardship later.
The challenge with determining or calculating a safe withdrawal rate is the fact that there are many unknowns. For example, a standard recommendation is to withdraw no more than 4% of the current value of your investments each year. There’s plenty of math behind this recommendation, but those calculations often assume that a retiree’s financial situation will remain largely the same for years or even decades to come.
To take a more practical, cautious approach and provide some room for error and cushion for something unexpected, some professionals advise a 3% withdrawal rate instead of 4%. A 3-4% withdrawal rate serves as a guide or a starting point, but remember that it’s not a hard and fast rule.
Once the acceptable withdrawal rate is determined, work backward to determine the portfolio needed to support a comfortable retirement. For example, someone who expects to have living costs of $50,000 per year in retirement will require an investment portfolio of $1,250,000, based on a 4% withdrawal rate.
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3. Understanding Social Security Benefits
Social Security benefits are a crucial source of income for most retirees, but there are important details to consider, like the best age to start receiving benefits.
Under the current guidelines, individuals can begin receiving benefits at 62 years old. However, delaying benefits until the full retirement age of 70 will significantly increase the monthly benefit.
There’s no right or wrong approach since each person’s situation is different. However, it’s essential to understand how the benefits work to make the right decision.
Some factors to consider include:
- Employment status – Those who are still working may want to delay the benefits since they currently have another source of income.
- Health insurance – Those who work are likely to have health insurance through an employer-sponsored plan. With health care being a high cost, this can impact a budget and how much income is needed.
- Life expectancy – The longer a retiree lives, the longer they will have to collect Social Security benefits. Life expectancy has a significant impact on determining when to start those benefits.
The Social Security Administration provides helpful guidance for those looking to make this challenging decision.
4. Living on a Budget
Most retirees live on a fixed income. Whether the primary source of income is social security, a pension, retirement accounts, or other investments, there’s usually a need to live on a budget.
Of course, living on a budget requires the ability to create a budget. Think of a budget as the first tool a financial architect would offer. To budget effectively, it’s critical to know how much money is coming in and how much is going out each month.
Creating a budget is only the beginning. Tracking expenses is also necessary to know that the budget is working. Get in the habit of recording every expense. There are several options, including budgeting apps, spreadsheets, or simple pen and paper. Make adjustments to budget categories if needed.
Living on a budget is the most effective way to prevent overspending in retirement. However, it’s not easy to adjust to living on a budget all of a sudden. So, during the years leading up to retirement, get in the habit of budgeting and tracking expenses to develop this practical money skill.
Although it’s critical to control spending and live on a budget, that doesn’t mean all spending is bad. Retirement should be enjoyed, and there’s nothing wrong with retirees spending money that they’ve saved.
It has been said that “You can afford anything, but not everything.”
The key is prioritizing and spending where it matters. Each individual will have their unique priorities, so it’s important to consider this before retirement. For example, travel is a significant part of retirement plans and dreams for many people. Those who manage their money better will have more available for traveling.
Prioritizing involves recognizing the budget categories that aren’t as important and saving in these areas. Cutting back in some budget categories will leave more for the true priorities.
Learning to prioritize is a practical money skill for anyone, but it’s vital for soon-to-be retirees. Without clear priorities, it’s easy to spend money in ways that won’t bring maximum satisfaction or enjoyment of life.
6. Investing for Income
Those who are a few decades away from retirement typically focus on growth with their investments. A longer time frame allows for more ups and downs along the way, with the goal of maximizing long-term results.
In retirement, investments can serve as a source of income. Retirees benefit from investments that pay dividends, providing a source of income without withdrawing from the account and reducing the balance.
During the years leading up to retirement, it’s helpful to shift from growth-oriented investments to investing for income. Of course, it’s not necessary to devote the entire portfolio to this type of investment. However, most retirees will benefit from having some assets that produce income regularly to supplement Social Security, pension payments, or other income sources.
There are many types of income-producing assets, but some options include:
- Rental Properties
- Real Estate Crowdfunding
- Dividend Stocks
- Private Equity
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7. Generating Passive Income
Passive income streams can be another practical source of money for retirees. Of course, the income-generating investments mentioned in the previous point are capable of providing passive income. However, there are also other options for generating passive income aside from investing.
One option is to start a side business that requires little involvement and provides revenue. Some businesses can run primarily hands-off, and others involve work done by employees, freelancers, or contractors. Automatic car washes, laundromats, and vending machines are among the most popular low-maintenance businesses, but there are many other possibilities as well.
Starting an online business also provides the potential for passive income. In most cases, building the business will require much effort upfront, but once it’s set up and running, the income generated by the business does not depend on the number of hours worked.
Popular online business models that can be mostly passive (once established) include:
- YouTube Channels
- Niche Websites
- Self Publishing
8. Preparing yourself for tax Season
Many Americans hire professionals to prepare their tax returns. However, fewer of these have a good understanding of how taxes work, and how to save money on their tax bill. Of course, preparing taxes can be a difficult task, so using a professional tax service is always a good decision. However, preparing yourself before year-end is a practical money skill that can lead to thousands of dollars in savings.
Some practical ways to save money on a tax bill include:
- Increase retirement contributions
- Tax loss selling
- Start or contribute to a Health Savings Account
- Take advantage of tax credits
- Look for deductions
By planning ahead, people like you and I can employ strategies to reduce our tax bill, and keep more of our hard-earned money!
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9. Monetizing Your Hobby
A growing number of retirees are using side hustles to make money without a traditional job. While numerous side hustles exist, one of the best options is to incorporate a hobby. Turning a hobby into a business allows retirees to have a source of income while still spending time on something they enjoy.
Turning a hobby into a source of income may seem unrealistic, but it’s quite possible. Of course, not every hobby offers the same income potential, but there are many hobbies that make money, including:
- Dog Walking
- Restoring Furniture
The benefit of monetizing a hobby during retirement is that it doesn’t need to produce a tremendous amount of money. Instead, anything it generates will help supplement other income streams, so it’s okay if the hobby business only generates a few hundred dollars per month. Reducing the pressure to maximize income also makes it a lot more enjoyable.
10. Expecting the Unexpected
Just about everyone approaching retirement wonders if they have enough money or how long their money will last in retirement. While there are ways to calculate this, unexpected expenses and events can derail plans.
Retirees may have to deal with unexpected things like serious health issues (and related medical bills), family issues and emergencies, home repairs, costs of moving assisted living and nursing care, and more.
When planning for retirement, it’s essential to account for the unexpected. For this practical money skill, don’t plan for an ideal scenario that’s unlikely to play out in reality. Instead, a retirement budget and plan should factor in some money for unexpected events so that they won’t be financially devastating.
Some retirees who are young and healthy enough to work choose to do so and continue to generate income, even if it’s not 100% necessary. That extra income reduces the need to withdraw for savings and investments and essentially provides some breathing room if unexpected expenses arise.
11. Managing Risk vs. Reward
Building wealth is a priority during working years for anyone who wants to have a comfortable retirement. Younger people can invest more aggressively, with plenty of time on their side. However, investing and money management during retirement requires a different approach than any other stage of life. While investments that grow are ideal, it’s equally important to avoid significant losses to the nest egg built with years of disciplined saving and investing.
Preventing these big losses requires a different approach to managing risk and reward. Of course, for this practical money skill, it’s unnecessary to avoid all risks and go 100% conservative. Indeed, there is a delicate balance to find.
The level of acceptable risk will be different for each person. There’s no right or wrong approach, but it’s essential for those retiring in the next few years to consider how much risk they are willing to accept and how a changing appetite for risk will impact their investment strategy.
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12. Debt Payoff
Avoiding and eliminating debt is a worthy goal at any stage of life, but it’s imperative during retirement or leading up to retirement. Living on a fixed income is much more challenging if the budget includes money for monthly debt payments.
Most financial experts recommend paying off a mortgage before retirement, although this may not be realistic for everyone. Living with a mortgage in retirement is feasible with an adequate income or nest egg, but avoiding other types of debt like credit cards, car loans, and personal loans is critical.
Those planning for retirement should evaluate their current debt and what they need to pay off that debt before retiring. Two practical money skills to pay off debt include the debt snowball and debt avalanche methods. Indeed, these are two different methods that are both highly effective for eliminating debt as fast as possible. Further, the debt avalanche is generally better for numbers-oriented people who want to pay as little interest as possible. The debt snowball is better for those who are looking for a psychological boost to help with motivation.
13. Understanding the Difference Between Liquid Net Worth and Net Worth
Net worth is one of the most common metrics used to measure wealth. Yet, while net worth does matter, it doesn’t necessarily indicate current financial health or the ability to withstand unexpected events.
All assets are counted the same in a net worth calculation. However, liquid net worth considers only the assets that can be quickly liquidated and converted to cash. Why is this helpful? Because liquid assets are more valuable and useful in emergencies compared to illiquid assets.
In an emergency, having $10,000 in cash is more valuable than a piece of jewelry that’s worth $10,000. Of course, both would be of equal value in a net worth calculation, but only the cash adds to liquid net worth.
Retirees need to have assets that are liquid in case money is needed with short notice. Therefore, for this practical money skill, calculating liquid net worth is a worthwhile endeavor because it provides a helpful look at someone’s ability to deal with some financial turbulence.
14. Monitoring Progress
Being proactive with finances is essential at any age, but retirees and those hoping to retire soon have an even more vital need to monitor progress.
Someone planning to retire in five years should have a financial goal based on the investment portfolio needed for a comfortable retirement. It’s critical to track and monitor the progress toward that goal regularly.
Online software like Personal Capital can be a helpful tool for automatically calculating and tracking net worth. The software also provides detailed reports on investments, so it’s easy to get a big picture view at any time. Indeed, mastering financial apps is a practical money skill that anyone can benefit from.
Many people prefer to ignore finances because they’re afraid of what they’ll see. However, avoiding problems does not fix them. Instead, anyone looking to retire should be proactively monitoring their finances and adjusting their approach as needed. A proactive approach encourages sound financial habits and decisions, which go a long way towards a comfortable retirement.
15. Prioritizing Health
Health care costs are a significant concern for many retirees and those who would like to retire but fear they can’t afford it. The best approach is to prioritize health and take preventative measures that will minimize the costs long term.
Eating well and getting exercise is standard advice, but it’s just as crucial for financial purposes as it is for health reasons. Many retirees depend on Medicare for covering health costs, but Medicare won’t cover everything. So it’s best to maintain a healthy lifestyle and keep health care and medical expenses to a minimum.
Developing healthy habits is just like building good financial habits – now is the best time to start. Waiting until retirement to prioritize health is not a good idea, so it’s critical to begin as soon as possible.
Being healthy is also crucial for being able to enjoy retirement. Travel, hobbies, and spending time with family are all more practical for retirees in good physical condition.
16. Estate Planning
As retirement gets closer, it’s essential to start thinking about estate planning. Ideally, every adult with kids should have a will in place, but estate planning involves much more than simply drafting a will. It’s an important subject, so hiring a professional is the best way to ensure that nothing critical is overlooked.
Your estate planning process might include things like:
- Listing assets and accounts
- Listing debts
- Reviewing retirement accounts
- Adding or updating beneficiaries on all accounts
- Establishing a power of attorney
- Designating an estate administrator
- Drafting or updating a will
Estate planning is vital because it provides the opportunity to control how assets are handled at the end of one’s life. Proper estate planning saves loved ones from difficult decisions and countless hours of paperwork and frustrations. It also ensures that assets will be accessible to loved ones and not held up in an unnecessary legal process.
Many attorneys and estate planners offer free consultations, so it’s easy to get input from a few different professionals before hiring anyone.
Retirement is an important financial goal, but it’s essential to prepare adequately. The practical money skills covered here are helpful for those who are planning for retirement or looking to retire in the next few years. Mastering the skills now will help provide the best chance for a comfortable and enjoyable stage of life.