What Belongs on Your Preretirement Radar?

Key Takeaways

• Take the time to write down what you envision your retirement to be. Once you do that, you want to think about the budget or the cash flow.
• You can expect your taxes to go down, but not necessarily.
• If you're retiring before age 65, you are potentially going to be looking for healthcare coverage in the open market if you don't have an employer-sponsored retirement plan package.
• Your allocation for spending should be flexible, and it's important to determine what your spending rates are before retirement.

Christine Benz: Hi, I'm Christine Benz from Morningstar. If you're getting ready to retire, there are a few key items that you should be sure to have on your dashboard. Joining me to discuss them is Maria Bruno. She's head of U.S. wealth planning research for Vanguard.

Maria, thank you so much for being here.

Maria Bruno: Hi, Christine. Good to see you. Thank you.

Preretirement Dashboard

Benz: Good to see you, too, Maria. So, you think at the top of the list, if you're kind of making a dashboard for preretirement should be a look at what you want your retirement to look like, kind of an articulation goals. Can you talk us through that?

Bruno: Absolutely. I always encourage individuals to stop and think about what they envision their retirement to be. We often like, run, run, run and do numbers. But first, you need to think about, well, what exactly do I want to do in retirement? Do I want to travel? Do I want to maybe play golf a few times a week? Do I think I might want to volunteer or do some part-time consulting work? So, really stop and think about what retirement actually means for you. And then, also, if you're married or if you have a partner, it's a really good suggestion to calibrate that with your partner because sometimes goals aren't aligned. You might have one spouse who wants to travel, the other who really wants to stay home and spend time with the grandkids. So, first and foremost, is really to take the time to write down what you envision your retirement to be.

How Will Your Expenses Change in Retirement?

Benz: That's important not just from a quality-of-life standpoint but also from a financial standpoint because the activities that you plan to undertake in retirement will affect your spending. So, you think spending and thinking about your in-retirement budget is another item that you should have front and center on that preretirement dashboard. How should people think about their expenses potentially changing in retirement versus what they were when they were working?

Bruno: Right. So, once you do that, you want to think about the budget or the cash flow. When you think about expenses, so as you shift from your working years into retirement, you want to think about, all right, what's changing, what expenses are going away and what expenses potentially are going to be added? So, think about the work type expenses, whether it's commuting or lunches out or work wardrobes, like, those types of expenses will naturally go away when you're retired. But depending upon what you want to do in retirement--for instance, if you do want to travel or you do have more discretionary type expenses because you have more free time, it's conceivable you want to do things--then you need to think about what those are and what those expenses are and then add those. But I would always encourage individuals to think about discretionary versus nondiscretionary. Nondiscretionary are things like housing, taxes, which become a line item, we can talk a little bit about that, food, insurance. Those types of things are nondiscretionary. Those things that keep the lights running, if you will. And then, the discretionary-type expenses are the things that might be more leisure-type expenses, where you might have more flexibility depending upon what your goals are.

How Are Taxes Going to Affect Your Retirement?

Benz: You referenced taxes, Maria. Should people expect their taxes to go down in retirement? Or is it completely individual dependent?

Bruno: Generally speaking, I think a good baseline would be, yes, you would think that your taxes could go down, but it depends, really. I think the important thing to think about is that in your working years, typically it is you pay your income taxes through payroll deduction. Once you're retired, that goes away, and taxes actually become a line item in the budget. So, you need to think about that, plan for that, and also, depending upon your situation, you might have to make quarterly income tax payments. So, you want to be thoughtful in terms of now taxes are a line item and how you're going to allot for that. Generally speaking, you can expect your taxes to go down, but not necessarily. It depends upon what your spending and then, also, what your income sources are and how those income sources are taxed.

Healthcare in Retirement

Benz: How about healthcare spending? I know that that is something that retirees worry about. Many retirees have seen those big, scary numbers of how much they might expect to spend in retirement. How should people think about how their healthcare spending might change once they eventually retire?

Bruno: You're right, that is at the forefront of many retirees. We actually try to encourage retirees to move away from this big scary number. You often see this big number out there, and it's really hard to plan around to that. Rather, we have actually done research. We've partnered with Mercer, who is an expert in healthcare costs. We've partnered with Mercer to create a model where we can help predict what healthcare expenses can look like in retirement. And that reframes the conversation around the big scary number to an annual cost. So, for instance, in 2020, a 65-year-old woman in moderate health status could expect to spend about $5,100 at retirement in healthcare expenses. That is a much more digestible number than a few hundred thousand dollars.

Benz: Few hundred?

Bruno: Right, exactly. So, it's easier to think about that as part of the planning process as you would with any other expense. The other thing you want to think about if you're retiring is, it's not necessarily a net new cost. Many of us who have been with employer-sponsored plans, for instance, might have healthcare plans that have been subsidized. So, the employer might pay a part, we pay a part out of pocket. So, it may not be a net new cost. You do need to think about whether or not you're in a highly subsidized healthcare plan. If so, then your out-of-pocket may be greater. So, those are the things to think about in the context of the healthcare costs, the mechanics of it as well as how you think about healthcare costs, whether if you are Medicare eligible and navigating the Medicare plan choice versus how are you going to pay for healthcare costs if you're retiring before age 65 and then potentially going in the open market and looking for healthcare coverage there if you don't have an employer-sponsored retirement plan package.

Medicare and Healthcare for Retirees

Benz: In that case, your expenses may be high earlier on in retirement, your healthcare-related outlays, but then they might eventually trim down once you're Medicare eligible?

Bruno: It could. The mechanics of it change, right? So, how are you going to pay for it until Medicare? Then, once you are eligible for Medicare – and we've done research on this topic, too, and have the paper to help think about how you navigate this Medicare maze of different types of plans. But then, also, it's important whether you determine a Medicare Advantage plan, or a Medicare supplemental or traditional type plan is more appropriate, and then, also, if you need a supplemental plan, which we would encourage in those situations and Part D. So, there are things that you want to think about with Medicare Plan choice and the corresponding costs there.

What Is the Right Time for Social Security?

Benz: Okay. So, lots to think about in the category of spending and how spending might change in retirement. You think another key item to have on that preretirement dashboard is your nonportfolio sources of income. For many of us, this will be Social Security. For some of us, it will be a pension. So, how should people think about that Social Security claiming decision? If they've got Social Security income on their dashboard as something that's going to provide part of their cash flows in retirement, how should they think about the timing? I know people really struggle with this.

Bruno: This is really one area where you need to do your homework, because you can start taking Social Security benefits as early as age 62. But if you do that, there is a reduction in benefits, and it can be up to a 30% reduction in benefits. And then, you can also defer until age 70, and if you do, then you can enjoy a very rich delayed retirement credit. I think many individuals have this mindset of, well, I paid into Social Security, let me claim as early as possible. Let me start getting those benefits, and that may be feasible. But really, the first thing I would recommend is go to the Social Security website, ssa.gov, look at what your estimates are and then understand what the implications are around the timing, whether it's an early claiming full retirement age, or at age 70, or somewhere in between. Don't jump the gun to just assume that one strategy may be best unless you actually look at what these amounts are. It may be best to work with (technical difficulty) to really understand the implications and the trade-offs of that are. Of course, if you defer Social Security, then the natural question is, well, I need money to live off of, what am I supposed to do? And that's where supplementing potentially with investment income, whether it's dividends and distributions or withdrawals, might be a complement until you begin taking Social Security benefits.

How to Plan for Your Retirement Spending

Benz: If people have gone through the process of looking at their all-in spending and then spent some time looking at those nonportfolio sources of income like Social Security, the next step is to take a look at how much of that spending will be supplied by the portfolio. How should people approach the topic of what is a sustainable amount to take out, because it seems like that's definitely something you'd want to have on the dashboard as well?

Bruno: That's a good one because right now with markets where they are, people are questioning how much can I spend as a sustainable? Flexibility is key regardless of what approach you take. It really is prudent to be flexible. And by that what I mean is in situations where the markets maybe in positive territory, then you want to think about how much you're spending, right? When the markets go down, for instance, and some of the volatility we're experiencing right now, that gives you then the flexibility to have a little bit more bandwidth to be able to spend in those situations. So, flexibility is key. For instance, have a spending target and then, flex around that. Probably the best source to do that would be with any type of discretionary-type spending that you might have. That is probably the first source to surgically go and see where you might need to cut back if you need to.

But there's a few things to keep in mind, too. It's not just the spending rate but also how are you asset allocated? So, you want to make sure you have a globally diversified balanced portfolio for your retirement that will give you growth and income. But depending upon what your goal is for those assets, your allocation should flex with that as well, and then, that will give you a good basis for determining what your spending rates are.

Benz: Those two things work hand in hand. My spending rate, my asset allocation, I'd want to think about those two elements together.

Bruno: Absolutely. But also, within that is--and this is part of what your goals are--is your time horizon. Is it spending for your retirement? Is it a shorter-term goal? Is it I'm thinking about passing assets to my heirs? So, what is this time horizon, and then personalizing that with the asset allocation, your risk tolerance, and then coming up with a prudent spending plan and adapting to that as you go through. It's not once and done.

Benz: Maria, always great food for thought from you. Thank you so much for being here.

Bruno: Thank you. Thanks for having me.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.

Watch "Is the Time Right for Roth Conversions?" and "Retiring in a Down Market? Consider These Strategies" for more from Christine Benz and Maria Bruno.