Retirement should be a time of unprecedented freedom when you can enjoy your days indulging hobbies or traveling the world. But that doesn't mean there are no rules to follow.
In fact, there are four key rules that you can't afford to break if you want to have the financial stability to actually enjoy your later years. Here's what they are.
1. Maintain an appropriate asset allocation
As a retiree, it's imperative to do all you can to make sure your investment accounts don't dwindle to a dangerously low level. One of the most important steps to make that happen is to ensure you're invested the right way.
When you're withdrawing regularly from your retirement accounts, you can't afford to have too much exposure to stocks. If you do, you could be forced to sell losing investments during a downturn because you need the money -- rather than being able to wait out a bear market until an inevitable recovery.
On the other hand, while you can't afford to have too much invested in the market, you also can't have too little. Otherwise, your investments may not produce a large enough return to maintain a reasonably sized account balance as you take distributions.
One quick rule of thumb to decide how much of your money should be in the market is to subtract your age from 110 and invest the difference. You may also want to make sure you have enough liquid investments to cover two to five years' worth of living expenses, so you can draw from that pool of money if there's a prolonged downturn and you don't want to sell other assets.
2. Don't withdraw too much too fast
Having the wrong investment mix is one huge risk to your retirement nest egg. Another is withdrawing too much money from your accounts too quickly. If you do that, there won't be enough money left in your account to earn reasonable returns, and you'll eat away at your principal balance and increase the risk of running out of cash.
To make sure that doesn't happen, don't start withdrawing money from your account until you have a strategy for doing so. One traditional rule of thumb said you'd be fairly safe from running out of funds if you limited your withdrawn amount to 4% of your account balance in the first year of retirement and increased withdrawals by inflation going forward.
However, this rule probably doesn't hold up any more with longer life spans and changing market conditions, so instead you may want to follow the recommendations from the Center for Retirement Research and use tables prepared by the IRS to calculate Required Minimum Distributions. Alternatively, you could explore other withdrawal strategies, such as only taking out income your investments produce.
Whatever approach you take, just make sure you have a plan and that you've done the math to make sure it isn't likely to leave you without the money you need late in retirement.
3. Know your state tax rules
Different states tax Social Security and other sources of retirement funds differently. In fact, 37 states don't tax Social Security at all, and some don't tax pension income either. You need to know your state's rules so you can either plan how much income you'll have left after your tax bill or make plans to relocate to an area that has friendly tax rules for retirees.
4. Get the right Medicare coverage
Healthcare is a huge expense for most retirees, but you can defray the costs of care somewhat by getting insurance that's well matched to your needs.
While some retirees assume Medicare will cover everything, that's simply not the case. Look into whether you're better off with a traditional Medicare plan or with Medicare Advantage. And if you opt for traditional Medicare, see if a Medigap plan could help you limit your out-of-pocket costs.
You can only make changes to your Medicare plan during open enrollment, so make sure you review your needs each year and align your coverage to your care requirements.
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