Before You Retire
Jan 24, 2019
By Howard Hook, CPA, CFP
As baby boomers make the shift from employment to retirement, the financial planning decisions they make will have a major effect on their retirement lifestyles.
In talking to clients who are happily retired and by counseling those who are contemplating retirement, we have found that those who have worked through the following three issues prior to leaving their jobs experience the most satisfying retirements.
1. How am I going to pay my bills now that I am no longer receiving a salary?
Before making the decision to retire, you must figure out how much income you will need to supplement your lost wages. This may sound obvious, yet it is often ignored.
- How much money will you need?
Prepare a detailed review of all your expenses to determine how much income will be required to pay bills. Items often forgotten are those your employer either paid or deducted from your paycheck prior to receipt of your wages. One example is income taxes. While working, your employer was responsible for remitting income taxes to the IRS and your resident state on your behalf. Once you retire there still will be taxes to pay, but the responsibility for paying them on a timely basis falls on you. Calculating the amount to pay and when to pay can be tricky, since payments are due at various times throughout the year.
Other expenses to remember include the full cost of medical insurance as well as other expenses that your employer may have paid, such as auto expenses, meals, other insurances, and so on.
- What will your income be?
Some people might be eligible for a pension from their company. If so, certain decisions need to be made: Is a lump sum payment available? Should the pension be paid over your life or the life of your spouse? If you choose the latter, should your spouse receive the same amount or less than the amount you will receive while alive? The option chosen will have a direct impact on the amount of money received.
Social Security income is another source of income. Most people do not realize that a portion of social security is subject to federal income tax. A spouse who is still working can cause up to 85% of the retired spouse’s social security income to be subject to income tax.
Finally, income from retirement, brokerage, and savings accounts can be used to pay for expenses. It is more difficult to calculate how much income can be taken from these investments and how long they will last, since they can end before you die—unlike pension and social security income, which generally you cannot outlive.
- When will you pay the bills?
Most people time the paying of their bills with the receipt of their paycheck. The lack of a regular paycheck can throw off that timing. After retirement, should you continue to pay bills as before? Pension income and social security income are generally received at the beginning of the month. But what if that income is not enough and you need to use your savings or brokerage accounts? We know that transferring money each time that a check is written from a savings or brokerage account is not very practical. However, not doing this may lead to insufficient funds and bounced checks.
Trying to replicate the timing and amount of your paycheck might be one way to alleviate the problem. For example, if your net paycheck was $2,000 twice a month and you received $1,500 a month in social security at the beginning of each month, you might consider setting up an automatic transfer from your savings account of $500 the beginning of each month. In addition, a $2,000 transfer from your brokerage account the middle of each month could be set up as well. This way it will seem as if nothing has changed regarding your cash flow into your checking account to pay bills. When funds run low in the savings account they can be replenished from the brokerage account.
2. How am I going to pay my medical expenses?
Like many employees, you probably had the convenience of your employer preselecting your medical insurance, perhaps offering a choice of several plans. Upon retirement, that responsibility falls squarely on you. Decisions usually need to be made fairly quickly to ensure that any benefits you may be entitled to don’t expire and, equally important, that there is no gap in coverage beyond what the law allows. A break in coverage could result in extended waiting periods for those with certain preexisting conditions and, even worse, major medical bills for services provided during that period where coverage lapsed.
- Determining your medical insurance options
The age at retirement is a crucial factor in determining your options. For the majority of people, eligibility for Medicare comes at age 65. Social Security benefits can be received as early as 62. Not understanding this can result in your declining other available options and possible exposure to medical risk.
So, if Medicare is not available prior to age 65, what are the available options? Typically there may be as many as four, or as few as one. Your employer might offer post-employment medical benefits. Usually offered to employees who meet certain criteria, such as age and years of service, this option often is the best because it can be the most affordable and may be most similar to your previous coverage.
Another option available to the retiree under age 65 is COBRA (Congressional Omnibus Reconciliation Act) coverage. Congress passed COBRA in 1986, requiring most employers who offer group health plans to provide temporary continuation of group health coverage to employees who qualify. However, COBRA can be expensive. Employers can charge the employee up to 102% of the group premium paid by the employer for continued coverage. This usually will be much higher than the amount the employee was paying when employed (when the employer paid at least part of the cost).
COBRA benefits are guaranteed for only 18 months for employees who qualify due to termination of employment. If the company terminates their group plan or goes out of business, COBRA coverage can end sooner. Finally, not all companies are required to offer COBRA, for example, employers with fewer than 20 employees. Employees who are enrolled in COBRA prior to age 65 will have to switch to Medicare once they turn 65.
A retiring employee can choose to be covered under a spouse’s medical plan at his or her place of employment. Obviously, the spouse would have to be working and the employer would have to offer a medical plan for this option to be available.
Finally, the retiree can purchase an individual medical insurance policy. These policies tend to be more expensive than the other options discussed and often the benefits are not as good. Unfortunately, for many employees the purchase of an individual policy may be their only option until they reach age 65 and can enroll in Medicare.
Once eligible for Medicare, the decisions do not become any easier. Medicare used to offer only one type of plan; now it has three different types. Two of these plans are available through private insurance companies, while the third (the original plan) needs no private insurance company to administer it.
Each plan has unique advantages and disadvantages. The cost for each of the plans can vary from nothing to several hundred dollars a month. While some plans include drug coverage, others require the purchase of a supplemental drug plan.
Making matters worse is the threat of financial penalties for not enrolling correctly in these plans. For example, one who enrolls in Medicare must enroll in a prescription drug program unless already covered by a plan. Failure to enroll initially can result in an increase in the premium equal to 1% per month for every month not enrolled. Medicare also imposes waiting periods, so if you choose the wrong plan you may not be able to change plans until the next open enrollment period. Finally, coordinating Medicare benefits with any private insurance from a prior employer or a currently employed spouse’s employer can be confusing as well.
3. How am I going to spend my free time?
After working for 30, 40, or 50 years, chances are your life was fairly well regimented. Your job dictated your amount of free time. Your job may also have influenced the time of year and amount of vacation taken. Now that you are going to retire, you will have all the free time in the world. This changes the parameters of your life and is as important a life change as the more practical financial matters.
Thanks to increased life spans, the average retiree could live upward of 25 years or longer. Keeping busy without a game plan can be difficult and frustrating. More free time can also lead to increased spending. For these reasons, many people go back to work full time or part time after being retired for a short period of time.
Having a plan for keeping busy can help ensure a smooth transition and ease the difficulty of managing large blocks of free time. The idea is not to take out a calendar and fill out each day with a different planned activity. Instead, make a list of the things you would like to do and an approximate time frame for doing them. For example, if you’ve always wanted to travel, make a list of the place you’d most like to visit.
You may want to devote a portion of your time to doing volunteer work. Make a list of your skills and the various organizations that could benefit from your help. You may want to contact those organizations ahead of time, so that once you retire you can hit the ground running as a volunteer. Most people who perform volunteer work find it very rewarding and an excellent use of their free time.
The answers to the above three questions will be different for everybody. And your answers today may be different from your answers 5 or 10 years from now. The key to a successful retirement is to make appropriate decisions now that will allow you the flexibility to adjust those decisions in the future without compromising your lifestyle. The only wrong decision is not addressing these key questions before you hand in those retirement papers.
About the Author(s)
Howard Hook, CPA, CFP, is a retirement distribution planning expert with the wealth management firm Access Wealth Planning LLC, which has offices in Roseland and Princeton, NJ. Contact him at [email protected]