You know the importance of planning your retirement, but where do you start? One of your first steps should be to estimate how much income you will need to fund your retirement. It’s not that easy at all, because retirement planning is not an exact science. Your specific needs will depend on your goals and many other factors.
Use your current income as a starting point
It is common practice to discuss your desired annual retirement income as a percentage of your current income. Depending on who you’re talking to, this percentage can be anywhere from 60 to 90% or even more. The appeal of this approach lies in its simplicity and the fact that it is based on sound analysis: your current income supports your current lifestyle. So take that income and reduce it by a percentage to reflect the fact that it will be safe expenses for which you are no longer liable (e.g. wage taxes) could theoretically allow you to maintain your current lifestyle. In theory, you can stick with your current lifestyle.
The problem with this approach is that it doesn’t take your particular situation into account. For example, if you plan to travel a lot in retirement, you may easily need 100% (or more) of your current income to make ends meet. It’s okay to use a percentage of your current income as a benchmark, but it’s worth going through all of your current expenses in detail and really thinking about how those expenses will change over time as you transition into retirement.
Project your retirement spending
Your annual retirement income should be enough (or more than enough) to cover your retirement expenses. Because of this, estimating these expenses is a big part of retirement planning – although it can be difficult to pinpoint all of your expenses and predict how much you will spend in each area, especially if retirement is still a long way off.
Frequently considered pension expenses:
- Food and clothes
- Housing: rent or mortgage payments, property taxes, home insurance, property maintenance and repairs, HOA fees, lawn and garden maintenance.
- Connections: gas, electricity, water, telephone, cable TV, internet, mobile phone
- Transportation: car payments, auto insurance, gasoline, maintenance and repairs, public transportation
- Insurance: medicine, tooth, life, disability, long-term care
- Uninsured healthcare costs: deductibles, co-payments, prescription drugs
- Taxes: federal and state income tax, capital gains tax
- Debt: personal loans, business loans, credit card payments
- Education: Study expenses for children or grandchildren
- Gifts: Charitable and Personal
- Saving and Investing: Contributions to IRAs, annuities, and other investment accounts
- Free time: traveling, eating out, hobbies, free time activities
- Take care of yourself, your family or others: costs for a nursing home, home sickness help or another type of assisted living
- Other: personal hygiene, pets, club memberships
Don’t forget that the cost of living will increase over time. And remember that your pension expenses can change from year to year. For example, you can pay off your mortgage on your home or your children’s education early in retirement. But other expenses such as health insurance and insurance can also increase with age. To protect against these variables, incorporate a comfortable cushion in your estimates (it’s always best to be conservative). Finally, get help with your estimates from a financial professional to make sure they are as accurate and realistic as possible.
Decide when to retire
In order to determine your total pension needs, you cannot just estimate how much annual income you need. You also need to estimate how long you will be retired. Why? The longer you retire, the more years of income you will have to finance. The length of your retirement depends in part on when you want to retire. This important decision usually revolves around your personal goals and financial situation. For example, you can envision retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement scheme will make that possible. While having the flexibility to choose to retire is great, it’s important to remember that retiring at 50 ends up costing a lot more than retiring at 65.
Estimate your life expectancy
The age at which you retire isn’t the only factor that determines how long you will retire. The other important factor is your lifespan. We all hope to reach old age, but living longer means you have more years of retirement to finance. You can even run the risk of outlasting your savings and other sources of income.
To avoid this risk, you need to estimate your life expectancy. You can use government statistics, life insurance tables, or a life expectancy calculator to get a reasonable estimate of your life expectancy. Experts base these estimates on your age, gender, race, health, lifestyle, occupation, and family history. But remember, these are only estimates. There is no way to predict how long you will actually live, but given your life expectancy increasing, it’s probably best to assume that you will live longer than you expect.
Identify your sources of income in retirement
Once you have an idea of your retirement income needs, your next step is to assess how well prepared you are to meet those needs. In other words, what sources of income for retirement are available to you? Your employer may offer a traditional pension that pays you monthly benefits. In addition, social security can cover part of your retirement income. For an estimate of your social security benefits, visit the Social Security Administration website (www.ssa.gov).
Additional sources of retirement income can include a 401 (k) or other retirement plan, IRAs, annuities, and other investments. The amount of income you will get from these sources will depend on the amount of your investment, the return on your investment, and other factors. Finally, if you are planning to retire to work, your earned income is another source of income.
Compensating for income gaps
Your expected sources of income may be more than enough to fund even an extended retirement. But what if it looks like you’re falling short? Don’t panic – there are likely steps you can take to fill the void. A wealth management advisor can help you find the best ways, but here are a few suggestions: Can help you find the best ways, but here are a few suggestions:
- Try to cut your running expenses so that you can save more money for retirement
- Shift your wealth into investments that have the potential to significantly outperform inflation (however, keep in mind that investments with higher potential returns can carry a higher risk of loss).
- Consider all of your retirement options so you don’t need as much money (e.g. no beach house on the Riviera) Retirement so you don’t need as much money (e.g. no beach house on the Riviera)
- Part time retirees work for extra income
- Consider putting off your retirement for a few years (or more).
Planning for retirement doesn’t have to feel overwhelming. Meet with an Elevations Wealth Management Advisor from CUSO Financial Services, LP (“CFS *”) to discuss your retirement goals and how you can achieve them.