3 Things You Need To Know Before You Retire From Washington State
Retirement can be a life-changing milestone, especially for Washington State employees who’ve worked hard and are now looking forward to enjoying their golden years. But before you take that leap, it’s essential to understand how retirement works and how it impacts your financial future. Let’s break down the three key things every state employee needs to know before retiring. We’ll cover taxes on your retirement income, the importance of creating a spending plan, and the reality of healthcare costs in retirement.
Understanding Taxes on Your Retirement Income
Your Retirement Income Is Not Tax-Free
One of the most significant misconceptions people have when they retire is thinking their pension and Social Security income are tax-free. That’s not the case. In fact, your pension, Social Security, and any distributions from retirement accounts like your Deferred Compensation Program (DCP) are subject to taxes unless you’ve specifically requested to have taxes withheld.
For example, let’s say your monthly pension is $2,000, and you also receive $2,000 from Social Security. You may assume you have $4,000 a month to live on, but that’s before taxes. If you don’t have enough tax withheld, you could end up owing a significant amount at the end of the year.
Be Proactive About Withholding Taxes
Unlike when you were working, taxes aren’t automatically withheld from your pension or Social Security. It’s up to you to file the proper paperwork and determine how much should be withheld. This is crucial because tax laws change, and you need to adjust accordingly.
If you don’t adjust your withholding when tax rates go up, you might find yourself owing more than you expected at tax time. Let’s say your pre-tax retirement income is $5,000 per month, and you’re withholding 20%. That means you’re taking home $4,000. But if tax rates rise to 25%, your take-home pay drops to $3,750—a $250 monthly reduction in your spending power. Over time, this adds up, and it can significantly affect your budget.
Tax Increases and Inflation
Taxes aren’t the only thing that can shrink your income. Inflation and rising costs of living will erode your spending power, too. As prices go up, your retirement income may not stretch as far as it once did. This is why it’s so critical to save more than what you think you’ll need—having a buffer can help protect against rising taxes and increasing living expenses.
Prioritizing Your Retirement Savings
You Need a Solid Plan for Your Savings
Saving for retirement is one thing. Knowing how to spend it is another. Too many retirees end up blowing through their savings because they don’t have a plan in place.
The goal of retirement savings is simple: create a big enough nest egg so that you can live off the interest. For example, if you have $1 million saved and withdraw 4% per year, you’ll have $40,000 a year to spend. But if you spend too much, you’ll dip into the principal, and your money won’t last as long as you need it to.
Don’t Overspend in Retirement
Many people make the mistake of spending too much too early in retirement. Whether it’s because of poor planning, emotions, or the desire to get rid of debt, overspending can quickly deplete your retirement funds.
Here’s an example: A retired custodian I worked with had $200,000 saved for retirement. He bought a new truck for $40,000 and paid for it in cash from his retirement savings. He also paid $10,000 in taxes for the withdrawal. In less than a year, he had spent 25% of his savings. What’s worse, the truck would depreciate over time, and the money spent was no longer generating any income.
To avoid this, you need a clear spending plan that accounts for your lifestyle, bills, and unexpected expenses. Focus on managing your money wisely, not just paying off debt or buying things you don’t necessarily need.
Behavior Matters More Than the Market
Most people think that the stock market is the biggest risk to their retirement savings, but the reality is that your behavior plays a larger role. Overspending, pulling money out to pay off low-interest debt, or making emotional decisions can drain your savings faster than any market downturn.
For instance, another retiree I helped pulled $135,000 out of her Plan Three retirement account to pay off her mortgage, resulting in a $30,000 tax bill. She effectively wiped out 80% of her savings in one year. In her case, the behavior of wanting to be debt-free ended up costing her more than she could have imagined.
Have a Spending Plan in Place
The takeaway here is that having a solid spending plan can make or break your retirement. Work with an advisor or financial planner who can help guide you through making smart decisions with your money, ensuring it lasts as long as you do.
Understanding Healthcare Costs in Retirement
Healthcare Costs Will Increase
When you’re working, healthcare costs are usually low because your employer covers a significant portion of your medical expenses. But once you retire, things change drastically. Healthcare costs become one of the biggest expenses retirees face.
For instance, if you’re on the Public Employees Benefits Board (PEBB) system and want to keep the Uniform Medical Plan (UMP) for you and your spouse in retirement, it could cost you around $1,800 per month after taxes. That’s about $2,000 pre-tax—a huge chunk of your monthly income if you’re relying solely on your pension.
Include Medical Costs in Your Budget
One of the most common mistakes retirees make is forgetting to budget for medical expenses. While you might be used to covering things like your mortgage, food, and other daily expenses, healthcare costs can easily be overlooked—and they’re often much higher than people expect. And don’t forget, these costs will likely continue to rise as you age, especially as healthcare needs increase.
Beware of Low-Cost Insurance Plans
While it might be tempting to go with the cheapest insurance plan to save money, that’s often not the best choice. In fact, medical debt is the leading cause of bankruptcy in the United States. Opting for a low-cost plan might leave you vulnerable to high out-of-pocket expenses if an emergency or serious health issue arises.
Remember, if you’re pulling money from your retirement accounts to cover unexpected medical costs, you’ll also be paying taxes on that withdrawal. If you pull $10,000 to cover a hospital bill, it might actually cost you $12,000 when you factor in taxes. That, in turn, could push you into a higher tax bracket or increase your Medicare premiums for the following year.
Plan for Medicare and Supplemental Insurance
After you turn 65, Medicare will kick in, which will help reduce some of your healthcare costs. But keep in mind that Medicare doesn’t cover everything, and you’ll still need to budget for things like premiums, copays, and other out-of-pocket expenses. Some retirees also opt for supplemental insurance to help cover costs not included in Medicare.
Conclusion
Retiring as a Washington State employee comes with many benefits, but there are also challenges you need to be aware of. Taxes, spending, and healthcare costs are three of the most critical factors that can make or break your retirement.
Start by understanding how your retirement income is taxed, creating a detailed spending plan that ensures your money lasts, and budgeting for the often-overlooked cost of healthcare in retirement. These steps will help you avoid financial pitfalls and allow you to enjoy your retirement years stress-free.
If you’re unsure where to start, or if you’d like some personalized advice tailored to your situation, I’m here to help.
Ready to start taking control of your future? Schedule a meeting with us here: https://www.watrspers.com/personal-help/.
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FAQs
What happens if I don’t withhold enough taxes from my pension?
If you don’t withhold enough taxes, you may face a large tax bill at the end of the year. It’s important to review your tax withholding regularly and adjust it as needed to avoid surprises.
How much should I save for healthcare costs in retirement?
Healthcare costs can be one of the largest expenses in retirement. It’s a good idea to budget at least $1,500-$2,000 per month per person for healthcare, depending on your plan and coverage.
Is it better to pay off my mortgage before retiring?
It depends on your financial situation. Paying off your mortgage can give you peace of mind, but it might not be the best decision if it means draining your retirement savings or triggering a large tax bill.
What are the benefits of having a spending plan in retirement?
A spending plan helps ensure you don’t overspend early in retirement, reducing the risk of outliving your savings. It also provides a framework to manage your money wisely and allocate resources for future needs.
P.S. Join our free community and gain exclusive access to expert financial insights, personalized tools, and step-by-step guidance tailored for Washington State employees. Whether you’re just starting out or nearing retirement, our community offers the resources you need to confidently plan your financial future. Connect with like-minded individuals, ask questions, and stay informed about the latest strategies to maximize your retirement benefits. Start your journey today and take control of your financial goals—it’s completely free!
