What Is Retirement Readiness and How Can You Achieve It?

Retirement readiness means having enough financial resources to maintain your desired lifestyle after you stop working. It’s not just about saving but ensuring those savings last through careful planning and strategic decisions. Many people underestimate how much they’ll need, making it essential to assess all aspects of retirement well in advance.

Achieving this requires understanding income sources, managing healthcare costs, and adjusting investments. Proper tax strategies and estate planning can also help maximize what you have.

Income Sources

A secure retirement depends on reliable income streams to cover daily expenses and unexpected costs. Diversifying these sources reduces financial uncertainty and provides long-term stability. Understanding how each option functions, its tax implications, and long-term viability is essential.

Pensions

A pension is a retirement plan typically sponsored by an employer, providing retirees with regular payments based on years of service and salary history. Defined benefit plans guarantee a fixed monthly amount, often calculated using a formula:

Annual Pension = (Years of Service) × (Final Average Salary) × (Accrual Rate)

For example, if a pension plan offers an accrual rate of 1.5%, an employee with 30 years of service and a final average salary of $80,000 would receive:

30 × $80,000 × 1.5% = $36,000 annually

Pension benefits are taxed as ordinary income, and some plans offer cost-of-living adjustments (COLAs) to counteract inflation. Private-sector pensions have declined in favor of defined contribution plans like 401(k)s, but public-sector and unionized workers often still receive them. Checking vesting requirements and payout options—such as lump sums versus annuities—is important when planning withdrawals.

Annuities

An annuity is a contract with an insurance company that provides periodic payments, either immediately or at a future date. They can be structured as fixed, variable, or indexed, each with different risk and return characteristics.

– Fixed annuities guarantee a set payout, offering stability.
– Variable annuities fluctuate based on investment performance.
– Indexed annuities tie returns to a market benchmark, such as the S&P 500.

Annuity earnings grow tax-deferred, but withdrawals are taxed as ordinary income under Internal Revenue Code Section 72. If taken before age 59½, they may incur a 10% early withdrawal penalty. Some annuities offer riders, such as guaranteed lifetime income or long-term care benefits, for an additional cost. Fees, surrender charges, and inflation risks should be carefully assessed before purchasing an annuity.

Investment Dividends

Investing in dividend-paying stocks, mutual funds, or exchange-traded funds (ETFs) can generate passive income. Companies that consistently pay and grow dividends—often referred to as dividend aristocrats—can provide a hedge against inflation.

Dividends are classified as either qualified or ordinary:

– Qualified dividends are taxed at long-term capital gains rates (0%, 15%, or 20% depending on income).
– Ordinary dividends are taxed at standard income rates.

For example, an investor holding $500,000 in a portfolio with a 4% dividend yield would receive $20,000 annually in income. Reinvesting dividends before retirement can accelerate portfolio growth through compounding. Diversification across sectors and evaluating payout ratios—preferably below 60%—can help ensure sustainability.

Balancing these income streams while considering tax efficiency and longevity risk is key to maintaining financial security throughout retirement.

Evaluating Current Savings

Determining whether your savings can support retirement requires assessing both the total amount accumulated and how long it will last. A common guideline is the 4% rule, which suggests withdrawing 4% of retirement assets annually. For instance, a portfolio of $1 million would generate $40,000 per year under this rule. However, this approach assumes historical market returns and may not account for prolonged downturns or rising costs.

Projecting future expenses is as important as calculating withdrawals. Fixed costs such as housing, utilities, and transportation remain relatively stable, while discretionary spending—like travel and entertainment—often fluctuates. Inflation further complicates projections, as a 3% annual increase can significantly erode purchasing power. A retiree needing $50,000 today would require $67,196 in 10 years at that rate.

The composition of retirement funds also affects sustainability. Assets held in tax-advantaged accounts such as 401(k)s and IRAs grow tax-deferred, but withdrawals are taxed as ordinary income. In contrast, Roth IRA distributions are tax-free if the account has been open for at least five years and the owner is over 59½. Maintaining a mix of taxable, tax-deferred, and tax-free accounts allows for greater flexibility in managing income and tax liabilities.

Healthcare Funding

Medical expenses are among the most unpredictable costs in retirement, with long-term care, prescription drugs, and insurance premiums consuming a significant portion of a retiree’s budget. Healthcare costs tend to rise faster than general inflation, often increasing by 5% or more annually.

Medicare serves as the primary health insurance for retirees 65 and older but does not cover everything. While Part A is typically premium-free for those who paid Medicare taxes for at least 10 years, it still has deductibles and coinsurance costs. Part B, which covers outpatient care, requires a monthly premium that adjusts based on income. In 2024, individuals earning above $103,000 (or couples above $206,000) pay higher premiums under Income-Related Monthly Adjustment Amounts (IRMAA).

Long-term care is another financial challenge, as Medicare provides limited coverage for nursing homes or in-home assistance. Private long-term care insurance can help, but premiums rise with age, making early enrollment more cost-effective. Some policies offer hybrid options, combining life insurance with long-term care benefits. For those without private coverage, Medicaid may cover long-term care, but eligibility requires meeting strict asset and income limits.

Health Savings Accounts (HSAs) offer a tax-efficient way to prepare for medical costs. Contributions are tax-deductible, growth is tax-free, and withdrawals remain untaxed if used for qualified expenses. Unlike Flexible Spending Accounts (FSAs), HSAs do not have a “use-it-or-lose-it” rule. However, only individuals enrolled in a high-deductible health plan (HDHP) can contribute. Those who max out contributions—$4,150 for individuals and $8,300 for families in 2024, with a $1,000 catch-up for those 55+—can build a substantial healthcare reserve.

Portfolio Adjustments

As retirement approaches, shifting investment strategies becomes necessary to preserve wealth while still generating returns. Reducing exposure to highly volatile assets mitigates risk, but maintaining some level of growth is essential to outpace inflation. A common approach is transitioning from an aggressive allocation, such as 80% equities and 20% fixed income, to a more balanced mix, like 50% equities, 40% bonds, and 10% cash equivalents.

Fixed-income investments, particularly Treasury Inflation-Protected Securities (TIPS) and municipal bonds, provide stability and predictable income. TIPS adjust with inflation, safeguarding purchasing power, while municipal bonds offer tax-free interest at the federal level and potentially at the state level if purchased in-state.

Dividend-paying stocks and low-volatility ETFs allow for continued market participation without excessive risk. Additionally, allocating a portion of assets to alternative investments, such as real estate investment trusts (REITs) or private credit funds, can provide diversification and non-correlated returns.

Estate Arrangements

Planning how assets will be distributed after death ensures financial security for heirs while minimizing legal complications and tax burdens. Without a structured plan, estates may go through probate, a court-supervised process that can be time-consuming and costly. Establishing a will specifies asset distribution and appoints an executor. However, wills do not bypass probate, making revocable living trusts a popular alternative.

Beyond asset distribution, designating beneficiaries on retirement accounts, life insurance policies, and payable-on-death (POD) bank accounts ensures funds pass directly to named individuals. Additionally, establishing powers of attorney for financial and healthcare decisions allows trusted individuals to manage affairs if incapacitated.

Tax-Efficient Withdrawals

Withdrawing retirement funds strategically reduces tax liabilities and extends portfolio longevity. A common approach is withdrawing from taxable accounts first, allowing tax-deferred investments to continue compounding. Roth IRAs provide flexibility, as qualified withdrawals are tax-free and do not require required minimum distributions (RMDs).

Leveraging qualified charitable distributions (QCDs) allows individuals 70½ and older to donate up to $100,000 annually directly from an IRA, satisfying RMD requirements while avoiding taxable income. Careful planning around withdrawal sequencing and tax brackets ensures retirees retain more of their savings.