Friday, May 27, 2011

How Much You Make in Retirement versus Working

  Income in retirement and income while working are entirely different things.

One problem that most of us have when working versus retirement is our attitude toward income.

When you are working, you want to make as much as you can - the more you make, the better.

But when you are retired, how much you make is a matter of choice, for the 401(k) generation.  How much you "make" is determined by how much you withdraw from your tax-deferred savings plan.  This is a whole different head, and something that takes most of us some time to get our heads around.

The goal in retirement is to spend less - if you can, and within reason.  Since you don't know how long you are going to live or what unexpected expenses you are going to incur, you can't afford to spend it all now, lest you end up broke later on.

As I noted before, my fear about the 401(k) generation is that there will be a small percentage of us who, upon reaching age 59-1/2 (the age you can withdraw your money without the 10% tax penalty) will basically take all their money out and spend it within a year or two.  New cars, new boats, vacations, drugs, clothes - you-name-it and they will blow their money on it.

How do I know this?  Well, already we are seeing people take money out of their 401(k) and IRA plans prior to retirement and paying the 10% penalty and spending it all to pay off credit card debts or car loans, or whatever.  Which is the same as just blowing it all on crack cocaine.

A still larger percentage will take money out not all at once, but at a rate faster than they should, and end up pumping the well dry long before they die.  This is, of course, the tricky part.  In an optimal world, you'd want to spend your last penny with your last breath, but many of course will die early and leave money behind, which is bad.  But many more will spend it too fast and end up trying to get by on Social Security, which is worse.

Getting into the mindset of making less money - of making your income variable and optional - is the key, and it does take a mental gear change.

And it means that you have to look at spending differently and more closely.  Sure, it would be nice to have a new "smart phone" with a texting plan and spend all day downloading "apps" for it.  Handy, convenient, and totally unnecessary for daily living - but it comes with a $100 a month price tag - if not more.

Subscription services like that are a constant drain on your finances, and for many of us middle-class folks, we have to ask ourselves whether we really "need" electronic toys and the like, or whether it is a better idea to have money in the bank to rely on later in life.

When you are working, it seems these sorts of "time-saving" toys (although the jury is still out on that one, in my mind) are not that expensive, and besides, we "make good money".

But as I illustrated before, even if you save $1,000,000 in your 401(k) plan chances are, this means an effective income of maybe $40,000 a year plus your Social Security.   That ain't a lot of money for a lot of us, used to making $100,000 a year or more, even throwing in another $36,000 of Social Security money.

But once you are retired, hopefully you can also be debt-free.  And if you set this up right, your need for money should drop dramatically.  Since you won't have a mortgage payment, credit card payments, and car payments, you no longer need to keep the money train running at full speed.

But that takes some foresight, and as I noted, some folks are retiring these days (or trying to) with a mountain of debt over their heads.

If you stop working, you may also find you spend a lot less.  As I noted in a previous post, many middle-class people spend an hour's income on lunch every day - and perhaps another hour's income on commuting.  Office clothes, dry cleaning, and other work-related expenses do add up.  And since you are making a "lot of money" you end up in a higher tax bracket, which means for every dollar earned, you bring home less.

Most financial advisers posit their retirement scenarios based on the retiree making about 2/3 of their working income.  The savings in not working can account for a lot of this decrease, as well as the elimination of debt.

When you retire, you may be able to structure your life to stay in the 15% bracket while still maintaining a nice lifestyle.  With no onerous debts to pay, you don't need to bring home the bacon.

Of course, you can get a head-start on retirement by getting out of debt NOW - or creating a concrete plan to be debt-free over a number of years.  I call it practice for retirement, and it is helpful to understand exactly how much you are spending, and on what, and how much you will need to retire.

You'd be surprised how many people have no idea what their household expenses are - their food clothing and other budgets.  Most folks just spend and spend, and if they run out of money, put it on a credit card.  A lot of people do that - did that - in the last two decades.  And the chickens have come home to roost, as our generation nears retirement.

The happy news is, learning to live on less is not as onerous as it might seem.  In retrospect, spending a lot of money was rarely a happy or fun thing.  You realized, deep down, that you were squandering cash, and oftentimes, it ended up casting a pall over the fun you were having.  Having a good time and spending money are not the same thing.   In fact, sometimes it is more fun to spend less.

The best things in life are free - or at least inexpensive.