Can I retire yet?

It’s a question many Americans ask themselves regularly, and the answer is often not straightforward. For many, the decision to retire can be an exciting but also stressful process. 

Retirement triggers a significant change in your daily life and introduces a level of uncertainty that comes along with forgoing an earned income. How can you transform that feeling of uncertainty into one of excitement, and what can you do to feel as prepared as possible? As you near retirement age, how do you answer that question: “When can I retire?” How do you know when the time is right?

This is a highly personal decision, but here are some things to consider.

Evaluate both financial and emotional components

First, it’s important to recognize that the decision to retire is not purely financial. The emotional component should not be overlooked. If you are unsure that you’re emotionally ready to retire, it doesn’t hurt to work a little longer as you take the time to decide. You can even consider working part time and easing into retirement. Just because you are financially ready does not mean it is the right time for you to retire.

Two of the most common questions people ask are: “Am I on the right track to retire at my age?” and “Do I have enough money to retire?”

The answer is different for everybody. “Rules of thumb” and “one-size-fits-all” approaches often overlook many personal factors. Each individual must calculate the retirement-readiness equation as it applies to them. There is generally not a binary “yes” or “no” answer. In fact, it usually ranges between the two with varying degrees of certainty.

Solve the “when can I retire?” equation

From a purely financial standpoint, the equation to solve the answer tor the “When can I retire?” question is: What is the probability that your expected retirement income along with your portfolio (and its potential growth) will support the spending needs and desires of you and any dependents? 

To solve most equations, you need to understand and apply the variables correctly, and this equation is no different.

In this case, the variables are your timing (when you are hoping to retire), expected future income (outside of your portfolio), spending desire (required cash flow) and your portfolio characteristics (asset location, allocation and risk tolerance). Not only do these variables form the pillars of your retirement plan, but they are also interdependent upon each other. To further complicate the equation, it is vital to understand the legal and regulatory hurdles that exist along the way.

Ultimately, the decision of when to retire is woven into everything from your risk tolerance to tax and regulatory considerations. Your life expectancy and family history will play important roles, as well. Somebody who does not expect to live quite as long may want to retire a little bit earlier, whereas somebody with a longer life expectancy will potentially need to consider the longer time horizon and potentially work a few years longer than “full retirement age.” It is also a highly emotional decision.

Any of these topics could easily be their own standalone articles, but for now, we are going to address retirement timing quite broadly. Keep in mind these are general guidelines and that you should consider consulting your financial advisor for your specific situation. It is important to have a plan outlining your savings and distribution strategy. Not only will creating and following a plan give you a better chance of reaching your goals in retirement, but it will also help you understand your progress toward achieving those goals.

Understand the variables

When asking yourself when you can retire, it’s important to consider several financial variables:

1. Expected future income

The variables that most often fall into this category can be split between recurring or scheduled payments and one-time income events. Recurring events may include Social Security benefits, pension plans, annuities and rental income, among others. One-time income events may include proceeds from the sale of a property or a downsize, an inheritance payment, a one-time distribution from a pension, or an annuity or cash value from an unneeded life insurance policy.

When to start receiving Social Security benefits is a big decision that will affect your expected future income. You can start receiving Social Security as early as age 62, but if you wait until you reach full retirement age — or even better, until you turn 70 — you’ll receive more money each month.¹ For example, your monthly benefit will be permanently reduced by 25-30% if you start claiming Social Security at age 62 compared to waiting until full retirement age. Benefits rise by 5-8% for each year you delay receiving them.²

You can generate additional income in retirement and stretch your portfolio out further by working part time in retirement if you’re physically able to. This can provide the added benefit of helping you stay active and busy and keeping your mind sharp, as well as providing a social outlet.

Making the correct decisions from a distribution standpoint will have a material effect on the probability that you successfully reach your retirement income goals. For instance, you’ll want to consider when you will have access to these streams of income, when you should start to access them, and how much you can expect to keep after taxes.

Many public pension and retirement plans will also affect how much Social Security you are entitled to. Additionally, at a certain point, required minimum distributions (RMDs) will begin to occur. It is important to plan around these as they not only can provide a source of income but may affect your tax situation.

2. Spending needs and desires in retirement

Once you’ve determined what level of income you can reasonably count on, it is important to understand what your spending will look like in retirement. Your current budget may provide a good estimate, but it should not be the final figure. Taking some time to consider what costs may change in retirement is a valuable exercise.

One strategy is to place all of your expenses in one of three buckets: must-haves, nice-to-haves and contingencies. Must-haves are non-discretionary recurring costs that will persist indefinitely. Common examples include your mortgage or rent, property tax, homeowner’s insurance, utilities, transportation, food and groceries, and basic home maintenance.

An additional must-have expense that many employed individuals don’t always consider is healthcare and the rules and regulations surrounding it. You’ll need to consider if you’ll be eligible for Medicare health insurance when you retire, or if you might need to shop the private market until you become eligible. Some people approaching retirement may also want to consider the future cost of long-term care if you need assistance in your later years.

Beyond those must-have costs are nice-to-have or discretionary expenses: entertainment, eating out, travel, nice clothing, housekeeping and other home services, upgraded home furnishings, and private club (like country club) memberships. Keep in mind that you might even spend more on nice-to-haves like travel and entertainment with the extra free time that comes with retirement.

The final bucket is contingencies, or unexpected expenses. This includes things like home and car repairs and unplanned medical expenses and copays that aren’t covered by insurance or Medicare. While these costs likely won’t occur every year, it is important to plan for them by maintaining an emergency savings fund with coverage that’s right for your monthly expenses and potential healthcare costs.

You should also factor inflation into your retirement budget. Over time, inflation erodes the purchasing power of your retirement savings. For example, if inflation averages 3% per year, prices will double over the next 24 years. Keep in mind that healthcare expenses tend to rise even faster than the consumer price index (CPI) upon which the inflation rate is based.³

3. Investment portfolio

After you’ve estimated your expected income and spending in retirement, you’ll have a better understanding of the probable discrepancy between your income and spending expectations. This gap represents the annual cash flow that your portfolio needs to generate. This cash flow — considered alongside your current portfolio, planned future contributions, time horizon and inflation — will dictate your “required rate of return.” This can be generated not only with traditional sources of income like interest and dividends, but also with the growth of principle, also known as capital gains.

If your required rate of return is likely not attainable at a level of risk you are comfortable with, you will need to adjust your retirement plan. You may need to save more, work a few years longer, or adjust your standard of living expectations before and/or during retirement.

Finally, it is important to consider the structure and location of the assets in your portfolio. This is especially important from a regulatory and tax standpoint. Not only are the sources of income generally taxed at different rates, but so too are the different retirement savings accounts that you use to invest.

Roth IRAs and Traditional IRAs are both tax-advantaged, but distributions from a Traditional IRA are generally taxed at your ordinary income rate when you take the distribution. Qualified distributions from Roth IRAs are generally tax-free. From a regulatory standpoint, you will need to be aware of the potential penalties associated with accessing your assets. For example, if you decide to retire at age 50 and the majority of your assets are in tax-advantaged retirement accounts, you may have to pay taxes and a penalty to access those funds. Such penalties can potentially cut into your portfolio’s ability to meet your goals.

The short answer to the “when can I retire?” question

If your required rate of return is attainable at a risk level that you’re comfortable with and you feel emotionally prepared, you could be ready for retirement. To make this decision and determine whether your required rate of return is realistic for you, you will need to carefully examine your time horizon, expected income, desired spending, portfolio characteristics, and regulatory and tax considerations.

Our take

Your decision to retire should not be spontaneous. There are many pieces of the puzzle to consider, and it may be challenging or overwhelming to navigate on your own. We believe your approach to your financial health should be like your approach to your physical health. You should develop a plan with a qualified professional and monitor that plan on a regular basis, occasionally employing the use of a specialist when it makes sense.