5 key questions to ask yourself about financial preparations for retirement

·6 min read
Millions of Americans have watched their retirement accounts balloon in value in recent years. But if a good chunk of your assets are held in traditional Individual Retirement Accounts or workplace 401(k)-style plans, you eventually will have to pay taxes on the balances. Hence, you&#39;re not as wealthy as you might assume.

Many people head into retirement with unrealistic expectations and assumptions.

Often, it's a matter of budgeting incorrectly or carrying too much debt. Some individuals might miscalculate how soon retirement might be thrust upon them, or they don't have a good mix of assets to help make ends meet.

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When these or other assumptions are off base, it can cause anxiety and lead to serious belt-tightening. Here are some of the key questions to ask yourself about your financial preparations, preferably years before you plan to exit the workforce.

1. Is there enough guaranteed income?

Most Americans receive guaranteed retirement income in the form of their Social Security benefits. But these payments might not be enough to support a comfortable lifestyle. Other sources of guaranteed income, if available, can help fill the gap, including workplace pensions and annuities purchased separately.

Retirees who view themselves as relatively well off typically have multiple sources of guaranteed income, according to a report by financial companies that support retirement research for the nonprofit Employee Benefit Research Institute.

Employers that offer workplace retirement plans might be able to help in this regard, even if they don't offer pensions. For example, they can include more fixed-income options in 401(k)-style plans as well as stable value funds and target-date funds geared to retirement, according to the report. Annuities with very low commissions, offered through 401(k) plans, also could prove helpful.

Read more: Should you downsize your home when you retire? Ask yourself these questions first

Not all income needs to be guaranteed, but retirees would benefit from more than just Social Security. Of concern, nearly the same proportion of current workers expect to receive pensions as retirees currently receive, even though pensions have scaled back. This indicates worker expectations are out of touch with reality, the EBRI said.

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2. Can you handle your debts?

Many people owe significant sums of money heading into retirement. Debt appears to be a key cause of anxiety and reduced standards of living for many people in this group.

Credit card debt generally is starting to rise again, and a 2019 AARP Study found that the amount of student debt held by people 50 and up was six times higher than it had been 15 years earlier, with many older adults incurring their own education debts or co-signing loans for younger relatives.

One way employers might help is by offering debt-management programs for pre-retirees and retirees, too. Many companies have paid more attention to this issue, though the emphasis often is on helping young workers get a handle on their student loans.

Read more: Study reveals that student debt is a potentially crippling liability for college grads

To little surprise, retirees who report financial satisfaction are more likely to have paid down their mortgages and own their homes free and clear.

Addressing debt problems is something you should tackle well before retirement. Once you stop working and have less money coming in, your options are limited.

3. Will you keep working part-time?

Some people who enter retirement with hefty debt loads probably assumed they would have kept working longer, but that's not always possible.

According to a separate Retirement Confidence Survey from the EBRI, people who are still employed expect to retire at age 65 on average, and they anticipate a gradual transition. But among people who are already retired, the average age for leaving the workforce was 62, and it was usually an abrupt stop.

Personal health problems as well as employer changes such as downsizing or layoffs explain why many people retire earlier than expected.

Tax and Social Security policies can play a role, too. For example, for people receiving Social Security, too much other income can make some of those benefits taxable, thereby discouraging workers from staying employed, even part-time.

Also, younger retirees who claim Social Security early and continue to work could lose up to $1 in benefits for every $2 in job income above certain limits, which vary. While Social Security will increase your benefits in later years to adjust for anything withheld earlier, this policy also discourages some retirees from working part-time.

4. Is your spending plan realistic?

It's important for pre-retirees to estimate as best they can how much they will spend in retirement. Some expenses might be lower once you stop working but others — travel and leisure activities, for example — could rise substantially, especially in the early years when people are more active. Long-term care assistance, if needed, also can add up quickly.

In fact, the latest estimate from Fidelity Investments is that a 65-year-old couple, retiring this year, might need $280,000, possibly more, for out-of-pocket health and medical expenses through their retirement years.

Research from the EBRI shows a disconnect between how people think they might live in retirement, and their spending needs, compared to how older retirees actually spend their money and time.

Guaranteed income might play a role here, too. Research cited by the EBRI report shows that people tend to manage their cash flow using money that’s in their checking accounts, preferring not to sell assets such as homes or retirement-account holdings. If regular income is flowing in, people are more comfortable spending it.

5. Do you invest in the right 'buckets'?

It's a good idea to hold investments in different types of accounts, as doing so can help minimize taxes in retirement.

There are several key types of accounts with different tax features, and deciding which assets should go where takes some planning, said Ryan Monette, a certified financial planner at Savant Wealth Management.

Withdrawals from accounts or buckets such as 401(k) plans or traditional Individual Retirement Accounts are taxed at ordinary income rates, which could be fairly high even in retirement.

Conversely, no taxes generally apply on withdrawals made from Roth IRAs, Roth 401(k)s or Health Savings Accounts (if used to pay health-care expenses).

Then there are withdrawals from traditional brokerage accounts; they will be taxed but can qualify for long-term capital-gain rates that run 15% for most people.

As a general rule, if you have multiple account types, you might want to hold lower-returning assets such as bonds in traditional IRAs where ordinary taxes would apply on withdrawals, while holding high-return assets like small stocks or emerging-markets funds in Roth accounts where no withdrawal taxes would apply.

"If you had to pick which type of account you would want to grow most, it would be a Roth," Monette said.

Reach the reporter at russ.wiles@arizonarepublic.com.

This article originally appeared on Arizona Republic: Are you really preparing for retirement? 5 key questions to ask