When you are preparing for retirement there are a ton of financial implications. The biggest one is the amount of money you have available each month to cover your living expenses. Do you need money from savings to supplement that income, and if so, how long will your savings last?
An up to date, active budget that you use on a regular basis is the best tool to help you figure out the answer to these questions. If you don’t have a budget then you need to build one fast. Download your bank statements for the past 3 months and put each expense into a category (food, clothing, housing, auto, entertainment, etc.) Then do the same thing with your credit card statements—download the information and put those expenses into a category. Once you have information from 3 months of spending you can calculate your monthly and yearly living expenses.
While not perfect, this will give you the basics of a budget. However, it is missing any cash spending you did, and cash spending can be the leaking faucet for any budget. Not tracking cash spending means you will never be able to balance your budget so, be sure to include cash spending as you develop your budget.
Analyze your spending to eliminate expenses that stop after you retire, such as the cost of commuting to work, plus tolls and parking fees. Your wardrobe choices may also change and you can eliminate those large dry cleaning bills. Or maybe the amount you spend on lunch decreases.
On the flip side, add expenses that will be new in retirement. For example, you may want to travel when you retire. How much money do you want to allocate to travel each month or over the course of a year? Or your health care costs may increase when you can no longer access an employer-sponsored health care plan.
Once you know what your expenses will be, you have to know where the money is coming from to fund those expenses. Will your income be derived from a 401K, Social Security, IRA, pension, savings or a combination of these?
For example, the expenses in your monthly budget total $3,700. Income from Social Security is $2,700. This means you need an additional $1,000 each month to make ends meet. The $1,000 can come from any source—IRA, 401K, pension or savings and investments.
Hopefully, you have enough money saved to meet your budget shortfall. In the above example, if your savings total of $36,000, you have three years of an additional $1,000 per month income. Then what happens? You will need to find another source of income or cut your budget in order to make ends meet.
The Employee Benefit Research Institute (EBRI), is a research group that focuses on health, savings, and retirement. In an online poll, they found that 81% of those surveyed said that their 401K would be used as income during retirement, which is exactly why you have a 401K.
Of those surveyed, 30% of them have no idea what they’ll do with the money in their 401(k) plan when they retire. Another 25% plan to keep the money in their 401(k). Another 30% plan to roll their 401K into an IRA.
The people who were going to move money out of their 401K could be facing a risky and expensive situation.
Money held in a 401(k) is protected by the Employee Retirement Income Security Act or ERISA. This is a federal law that requires the individuals who manage the plan to act as fiduciaries. A fiduciary must operate in the best interest of the person they are serving. So, they must have your best interests in mind when presenting you with options and helping you make decisions. Further, ERISA protects your 401(k) savings from seizure by creditors.
You don’t have these same protections in IRAs. There is no requirement that investment advisors act as a fiduciary when handling your retirement savings. That means the advisors who roll over your 401K may or may not be working in your best interest. They may recommend investments that are inappropriate for your circumstances or influence you to buy products that are costly or ones that gave them a higher commission.
Additionally, once you withdraw your money from your 401(k), the extent to which your IRA is protected from creditors will vary based on the state in which you reside. And depending on where you move it, there may be tax implications.
If you are thinking about moving your 401K to an IRA, you will probably have access to a broader array of investments in an IRA. Keeping your retirement funds in a 401K means you are limited in your investment choices, based on what your employer offers.
Finally, expenses are worth considering as you decide what to do with your 401K. Typically, financial planners charge approximately 1% to manage your rollover assets, but some small retirement plans have fees as high as 1.19% to 1.95%, which could add up to a lot of money out of your pocket.
As you approach retirement, start analyzing your options well in advance of your retirement date. There are pros and cons to leaving your retirement money in your employer’s plan and also to move it to an IRA.
In preparation for retirement, pay off your debt, including credit cards, consumer loans, car loans, student loans and your mortgage. And have a complete understanding of each and every expense and how they will change in retirement. Knowing how much you spend each month and how much money you have coming in is the only way to survive financially in your “golden years.” Whatever you do, don’t cash out your 401K to take the trip of a lifetime or buy a car. Your 401K should only be used for long-term living expenses.
Planning ahead, calculating income vs expenses and developing a budget will help you be financially stable in retirement.
“Which of you wishing to construct a tower does not first sit down and calculate the cost to see if there is enough for its completion? Otherwise, after laying the foundation and finding himself unable to finish the work the onlookers should laugh at him and say, ‘This one began to build but did not have the resources to finish.’” Luke 14:28-30
The Compass Catholic podcast has more on what to do with your 401K in retirement.