How to Retire in 2022

Retirement is a major life milestone, and it comes with many changes. Your routine will be different, your finances will change, and the general transition can be mentally and emotionally taxing. If retirement is on your calendar for 2022, it’s time to make or review your plan so the process is as smooth as possible. You might not have anyone teach you how to retire when you leave the workforce, but the steps below can get you started on the right foot.

1. Save the Dates You Don’t Want to Miss

Maximize your benefits, and avoid being penalized by scheduling essential retirement-related milestones on your calendar.

Apply for Social Security 4 Months in Advance

Sign up for Social Security benefits four months before you’d like to start receiving income. It’s the earliest you can apply, it and gives the Social Security Administration time to process your request.

Most people can take Social Security retirement benefits as early as age 62. However, you get a bigger monthly payment if you wait until your full retirement age. Full retirement age is between 66 and 67, depending on what year you were born. If you claim your benefits early, they will be permanently reduced. Plus, if a surviving spouse takes over your benefits, the amount they receive will be based on the reduced amount.

Sign Up for Medicare 3 Months Before Age 65

Most people get Medicare at age 65, and you can sign up for Medicare as early as three months before the month in which you turn 65. 

If you’re still working as you approach age 65, and your job (or your spouse’s job) provides health coverage, ask your benefits department and insurance providers how to handle Medicare. The rules are extremely complicated. You might need to sign up for Medicare even if you have group health coverage. Missing your first enrollment deadline can cause significant problems, such as a gap in coverage and a late enrollment penalty.

If your employer provides retiree health coverage, you most likely need to enroll in Medicare as well. Retiree programs typically complement the benefits you get from Medicare, offering things like prescription drug coverage, for example. However, it’s smart to compare your employer’s retiree benefits against alternatives like Medigap and Medicare Advantage plans.

If You’re 72, Set Up RMDs

If you have money in pre-tax retirement accounts, the Internal Revenue Service requires you to take required minimum distributions (RMDs) from those accounts each year after you turn 72. Examples include:

• Traditional IRAs
• 401(k)—including Roth 401(k), 403(b), and 457(b) plans
• SIMPLE and SEP plans for small businesses
• Other retirement accounts with pre-tax money

If you were born after June 30, 1949, you do not have to take RMDs until you turn 72. Technically, you can wait until April 1 of the year following the year you turn 72 to take your first RMD. That might make sense if you want to hold off as long as possible, but you don’t have to wait that long if you don’t want to. Note that waiting to take the RMD until April 1 of the year following the year you turn 72 will require you to take two RMDs for that year.

When your money is in a workplace retirement plan like a 401(k), you might not need to take RMDs until after you retire (unless you own more than 5% of the employer sponsoring the plan). Retirement plans that are not associated with your current employment at age 72 and older, however, will still be subject to RMDs.

2. Plan for Health Care Expenses

According to Fidelity Investments, a 65-year-old couple should plan to spend $300,000 out of pocket on healthcare expenses during retirement (apart from potential long-term care costs). While that number is staggering, you’ll spread those costs over the rest of your life.

If you’re at least 65 years old, you’ll probably use Medicare for basic services like doctor visits and hospital stays. If you paid Medicare taxes while working, you should ideally pay no premium for Medicare Part A. If you didn’t, you’d pay up to $499 per month in 2022. The standard premium for Medicare Part B is $170.10 in 2022, though it could be higher, depending on your income.

If you retire before age 65, you need to figure out how to stay insured until Medicare kicks in. Options include:

• Continuation of benefits: You might be able to keep your employer’s health plan for up to 18 months with COBRA (or state continuation programs if you work for a small organization). If you go this route, expect to pay a substantial amount. Your former employer typically stops paying for your coverage, so you’re responsible for 100% of the premiums.
• Spouse’s plan: If you have a spouse with employer-provided health insurance, you can potentially switch to that plan. This may be a relatively affordable option if the employer pays a significant portion of monthly premiums.
• Individual policy: You can purchase health insurance directly from an insurance company. Check your state’s healthcare marketplace for more details. Be prepared for sticker shock, because health insurance for older adults may not be cheap.
• Retiree health care from an employer: Some organizations offer post-retirement healthcare coverage. If you’re fortunate enough to have that option, compare the retiree healthcare package to other alternatives. Some employers provide a subsidy to help you pay for retiree coverage, making it easier to afford, but you still might be better off with an individual plan or a spouse’s coverage.

Once you’ve estimated how much healthcare coverage will cost, be sure to include it when determining your overall need for income. 

3. Know Your Income Needs

One essential part of a successful plan is determining how much money you need on an annual basis. Having a target helps you know whether you’re on track or whether you need to make adjustments. Ask yourself how much you plan to spend each month and what additional expenses might come up each year. There are at least two ways to estimate your spending in retirement.

Income-Replacement Ratio

You might assume that you’ll spend at a similar level in retirement, with a slight reduction. For example, you'll no longer need to pay payroll taxes or save money for retirement. Plus, any expenses related to work, like commuting and clothing, may be significantly reduced.

An income-replacement ratio can help you estimate how much of your current income you will need. According to the U.S. Government Accountability Office, target income-replacement rates typically range between 70% and 85% of pre-retirement income. Fidelity found rates to be somewhat lower—between 55% and 80%. For example, if you currently earn $100,000 per year, based on an 80% replacement ratio, your target becomes replacing $80,000 of annual income.

Detailed Monthly Budget

A more granular approach would be to make a list of your expenses, similar to a monthly budget. This method allows for the most control and insight into your spending. You can remove expenses that are temporary (if you’ll pay off your mortgage after eight years in retirement, for example) and budget for periodic items, like a big vacation every three years. 

To create a detailed spending plan, start by tracking your current spending over several months. Then, add irregular costs (quarterly or annual payments, such as insurance premiums or property taxes), plus the estimate of healthcare costs calculated above. Finally, don’t forget to add any other costs you anticipate during retirement.

Set a spending goal, no matter what method you use. With a spending plan in place, you can better avoid unpleasant surprises and improve your chances of having the resources you need available.

4. Inventory Your Income and Assets

Social Security benefits and any pensions from an employer are two common types of income and are considered “guaranteed.” Those payments are likely to last for your entire life and don’t depend on how your investments perform.

Your ultimate goal is to figure out how to retire comfortably with that income base plus supplemental withdrawals from your retirement savings accounts.

Social Security

Nine out of 10 people age 65 and over receive Social Security benefits. The average retirement payment was $1,555 per month in 2021. Depending on your earnings history and when you claim benefits, your monthly benefit might be higher or lower. Review your Social Security statement to understand how much you can expect to receive at different ages.

Unfortunately, the calculations that determine your monthly Social Security payment are getting less generous, especially after 2021. The penalty for claiming early (before full retirement age) is not new, but as the full retirement age rises—from 66 to 67, depending on when you were born—your benefits are reduced more now than they used to be.

Pension Income

If you’ll receive pension income from an employer, you can include that income in your “guaranteed” base, but you need to find out whether your pension will interfere with Social Security retirement benefits. For example, some people have worked for both private organizations that pay into Social Security and government organizations that do not. When that’s the case, you might see your Social Security benefits reduced or eliminated altogether. Ask your employer and the Social Security Administration whether you need to worry about the Windfall Elimination Provision or Government Pension Offset.

Retirement and Savings Accounts

Guaranteed sources of income might not meet your spending needs. If that’s the case, you’ll need to withdraw from your accounts to supplement your base income. 

Your retirement assets are most likely in an employer-provided retirement plan like a 401(k), 403(b), or 457. You also might have savings in IRAs, annuities, high-yield savings, or taxable accounts. Take stock of where all of your money is and how it is invested. As you near retirement, you need a plan for managing and drawing on those assets. 

5. Review Your Investment Risk

Your first few years in retirement are critical for your investments. Market losses in those years can have a surprisingly large impact on your chances of success, and they can increase your odds of running out of money.

Completely eliminating risk (keeping everything in cash) leaves you vulnerable to inflation: You might find it hard to keep up with rising prices and pay for the things you need over several decades, but taking too much risk can backfire. Finding the right risk level is challenging, because you need to make assumptions about the future and weigh the pros and cons of different portfolios. A financial planner can help you allocate risk across the investments in your portfolio in a way that reflects your income needs and risk-tolerance level.

6. Make a Withdrawal Plan

The best way to plan your retirement is to estimate year-by-year cash flows from your savings. But if you just want a high-level strategy, two popular approaches can help you understand how to manage withdrawals in retirement. 

The amount you withdraw should be able to fill the gap between your guaranteed income sources and the amount you need to spend. Ideally, you can withdraw what you need without depleting your assets. The strategies below might help you accomplish that. 

If you’re facing a shortfall and won’t have enough assets to fill the gap adequately, you may need to make some changes. Two potential (but probably unwelcome) solutions are delaying retirement or spending less each year.

The 4% Rule

Retirees often wonder how much they can withdraw from their accounts. The answer depends on several factors, and there’s no way to know in advance exactly how much you’ll earn (or lose) on those accounts. The 4% rule might help with initial estimates.

The 4% rule says that you can:

• Withdraw 4% of your retirement account each year
• Increase withdrawals with inflation
• Expect the funds to last for 30 years

The 4% rule assumes that you invest 50% of your money in stocks and 50% in bonds. When taking income, you would likely sell a portion of your stocks and a portion of your bonds to keep the target allocation at 50/50. Keep in mind that this is only a rule of thumb, and some variation is acceptable.

Bucketing Strategy

A bucketing strategy involves planning your withdrawals with different time segments, or “buckets.” For example, you might imagine the withdrawals you need to take and put them into three buckets:

1. The next four years (your first few years of retirement, 2021 through 2025)
2. The subsequent six years (2026 through 2031)
3. The remaining years of your retirement (2032 and beyond)

For your first bucket, use safe investments, such as cash in government-guaranteed bank and credit union accounts. You won’t need to worry about what financial markets do—that money is safe, and you can spend according to your plan in the first few years. The second bucket might invest in a relatively low-risk mix of investments, such as a portfolio of mutual funds with 30% in stocks and 70% in fixed income. Over time, you replenish the first bucket from this portfolio. 

The third bucket, which holds funds you probably won’t touch for at least 10 years, could go into higher-risk investments. For example, you might build a portfolio of mutual funds with at least 70% of your money in a broadly diversified stock portfolio. The goal for that bucket is to pursue long-term growth, but that doesn’t mean you need to take excessive risks. Over time, refill the second bucket with some of the money in your third bucket.

7. Don’t Forget About Taxes

Taxes leave you with less spending money each year, so you need to include them in your income plan. These are some of the biggest issues for retirees:

• Funds you withdraw from pretax accounts, like 401(k) and 403(b) plans, are subject to income tax, plus an additional 10% tax for early withdrawals (typically withdrawals made before reaching age 59 1/2). 
• Pension income is usually taxable, so you can’t necessarily spend every penny of the income you receive. 
• If your total income (including distributions from pretax retirement accounts) is high enough, your Social Security benefits might be partially taxed. For single filers, taxation on your Social Security starts when you reach $25,000 of income. For married couples filing jointly, the lowest threshold is $32,000 of annual income.
• A high income in retirement can result in increased Medicare premiums.

Before you retire, review how your taxes will affect your available income and Medicare premiums and what percentage of your Social Security benefits will be taxed. And don’t forget to account for taxation on RMDs. It may be possible to reduce future taxes by selectively paying taxes in your early years of retirement.

Partial Roth conversions can help smooth out your taxable income and prepay taxes at today’s rates. That might make sense if you will have several years of relatively low income (before RMDs kick in, for instance) or if your investments decline in value.

8. Enjoy Your Retirement

With the steps discussed, you can address some of the most critical financial aspects of a successful retirement transition. Planning helps you improve the chances of having the income you need for the rest of your life (and of dodging some of the biggest retirement pitfalls).

With these steps covered, you’re in a good position to focus on the most important things—like your relationships and spending your retirement years in a meaningful way.