Use your current income as a starting point

You have probably read financial press articles that discuss desired annual retirement income as a percentage of your current income. Depending on the article, that percentage could be anywhere from 60 to 90 percent, or even more. The appeal of this approach lies in its simplicity, and the fact that there’s a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you’ll no longer be liable for (e.g., costs associated with working such as lunches out, dry cleaning, commuting, etc.) will, theoretically, allow you to sustain your current lifestyle.

The problem with this approach is that it doesn’t account for your specific situation. If you intend to travel extensively in retirement, for example, you might easily need 100 percent (or more) of your current income to get by. It’s fine 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 you retirement expenses

Your annual income during retirement should be enough (or more than enough) to meet your retirement expenses. That’s why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all of your expenses and projecting how much you’ll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses:

Food
Housing: Rent or mortgage payments, property taxes, homeowners insurance, HOA fees, property upkeep and repairs
Utilities: Gas, electric, water, telephone, cell phone, Internet, cable TV, trash
Transportation: Car purchases or payments, auto insurance, gas, maintenance and repairs, public transportation
Insurance: Medical, Medicare Supplement, dental, life, long-term care
Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs
Care for yourself, your parents, or others: Costs for a nursing home, home health aide, or other type of assisted living
Taxes: Federal and state income tax, capital gains tax, personal property tax
Travel: for fun, to visit family, to go to family events such as weddings and funerals
Clothing
Debts: Personal loans, business loans, credit card payments
Education: Children’s or grandchildren’s college expenses
Gifts: Charitable and personal such as Christmas, birthday, wedding
Recreation: dining out, hobbies, leisure activities, season tickets to sports or entertainment
Miscellaneous: Personal grooming, pets, club memberships, household items

Don’t forget that the cost of living will go up over time. The average annual rate of inflation over the past 20 years has been approximately 2.3 percent. (Source: Consumer price index (CPI-U) data published by the U.S. Department of Labor, January 2015.) And keep in mind that your retirement expenses may change from year to year. For example, you may pay off your home mortgage or your children’s education early in retirement. Other expenses, such as health care and insurance, will increase as you age. To protect against these variables, build a comfortable cushion into your estimates (it’s always best to be conservative). Keep in mind that some expenses have historically gone up at a rate greater than inflation. For example, in our retirement projections we inflate healthcare expenses at a rate of 6%.

Decide when you will retire

To determine your total retirement needs, you can’t just estimate how much annual income you need. You also have to estimate how long you’ll be retired. Why? The longer your retirement, the more years of income you’ll need to fund it. The length of your retirement will depend partly on when you plan to retire. This important decision typically revolves around your personal goals and financial situation. For example, you may see yourself retiring at 50 to get the most out of your retirement. Maybe a booming stock market or a generous early retirement package will make that possible. Although it’s great to have the flexibility to choose when you’ll retire, it’s important to remember that retiring at 50 will end up costing you 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’ll be retired. The other important factor is your lifespan. We all hope to live to an old age, but a longer life means that you’ll have even more years of retirement to fund. You may even run the risk of outliving your savings and other income sources. To guard against that risk, you’ll 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 how long you’ll live. Experts base these estimates on your age, gender, race, health, lifestyle, occupation, and family history. But remember, these are just estimates. There’s no way to predict how long you’ll actually live, but with life expectancies on the rise, it’s probably best to assume you’ll live longer than you expect.

Identify your sources of retirement income

Once you have an idea of your retirement income needs, your next step is to assess how prepared you are to meet those needs. In other words, what sources of retirement income will be available to you? Your employer may offer a traditional pension that will pay you monthly benefits. In addition, you can likely count on Social Security to provide a portion of your retirement income. To get an estimate of your Social Security benefits, visit the Social Security Administration website (www.ssa.gov). Additional sources of retirement income may include a 401(k) or other retirement plan, IRAs, annuities, and other investments. The amount of income you receive from those sources will depend on the amount you invest, the rate of investment return, and other factors. Finally, if you plan to work during retirement, your job earnings will be another source of income.

Make up any income shortfall

If you’re lucky, your expected income sources will be more than enough to fund even a lengthy retirement. But what if it looks like you’ll come up short? Don’t panic–there are probably steps that you can take to bridge the gap. We can help you figure out the best ways to do that, but here are a few suggestions:

Try to cut current expenses now so you’ll have more money to save for retirement
Consider delaying your retirement for a few years (or longer)
Lower your expectations for retirement so you won’t need as much money (no beach house on the Riviera, for example)
Work part-time during retirement for extra income

The best way to determine if you are on track for the retirement you envision, is to get started now on a financial plan. You don’t have to go it alone; you can enlist the help of a professional. Contact us today.

In the St Louis Post Dispatch article “Gallagher: Can You Afford to Retire?” Jim Gallagher discusses a recent report by the Government Accountability Office (GAO) that estimated how much of your pre-retirement income one would need for retirement spending. I shared my experience with helping pre-retirees plan for retirement and how surprised people are by how expensive healthcare can be in retirement. Especially when you look at the impact that inflation has on it over time. I also shared the figures I used when planning for retirees who do not have employer provided retiree healthcare.

Healthcare expenses are a significant portion of retirement spending and can prevent people from being on track for their retirement goals. In order to get on track you usually have to make adjustments such as;

1) increase the amount you are saving toward retirement, or

2) consider a later retirement age, or

3) spending less on other financial goals in retirement

or some combination of those three variables in order to reach your most important financial goals in retirement.

Jim also included information that I shared with him about the most common mistake I see when potential clients come in and would like me to double check their math to see if they can afford to retire. It is that they have added up their sources of income such as portfolio, Social Security, pension, etc. and compared it to their expected expenses their first year of retirement and since the two numbers (income verses expenses) finally match up they think they can afford to retire. I know that that is a dangerous assumption because I have run so many financial plans and I have a lot of experience seeing the impact of inflation therefore I know that in a few years the income sources will not be covering the expenses due to the different inflation assumptions for income sources versus expense items. For example Social Security income we assume will inflate at 2% while healthcare expenses we assume inflate at 6%. The better course of action is to run a Monte Carlo analysis to determine if your money will last a lifetime and if not what changes to the three variables listed above would need to be made.

Some clients that initially hire me discover that they are already on track to make all of their retirement needs, wants, and wishes come true. But for most folks, we must create a plan with action steps to get there. I have noticed that some people who thought they were on track were not, and some people who thought they were not, were. Give yourself enough years before you would like to retire so that you can create the retirement for yourself that you deserve. Especially considering what you now know about healthcare expenses and inflation!