How much do we need? A very common question we receive from aspiring retirees as they are deciding when to stop working and start the next chapter of their lives. As you can imagine, that number can be very different from person to person depending on a variety of factors.
First, your plan needs to encompass your own particular vision. What are your goals, and what resources will you need to meet them? Here are three basic questions we ask clients as we begin the planning process:
1. How much will you need to spend to achieve your goals?
2. How much do you expect to earn from a savings, Social Security and other potential sources of income?
3. What will you do if your savings fall short?
In regards to spending, one school of thought says you’ll need 75% to 80% of your current income in order to maintain your present standard of living. That’s because some costs—such as mortgage payments or work-related expenses like clothing and commuting—are expected to decrease or go away altogether.
However, while some costs may be reduced, others—such as travel, entertainment and health care—may increase. Therefore, it might be safer to assume you will need roughly the same level of annual income that you earn now, minus other potential sources of income, such as savings and Social Security.
Another approach is to create a detailed budget by breaking anticipated expenses into two groups:
- Essential expenses, or those you can’t live without, such as food, health care and housing.
- Discretionary expenses, or those that are nice to have, not need to have, like entertainment, restaurants, and travel.
If you own your home, you should also budget for expenses like major appliance replacements and other improvements and repairs that may be required during your retirement. You might also include possible one-time expenses, such as relocation or that dream trip you’ve been putting off.
When it comes to spending, you can begin to calculate whether you’ll have the resources to meet that threshold.
First, tally up any earnings you expect to receive from pensions, Social Security and any other sources of income—other than that from your savings. Then subtract that amount from your estimated expenses to determine how much of your income will need to come from your portfolio.
For example, let’s say you’re aiming for $90,000 in annual spending. Assuming your non-portfolio income amounts to $30,000 a year, you will need $60,000 a year from your portfolio.
What if your savings fall short? While some investors will find themselves on target, others will discover that their current vision is out of step with their savings. If you experience the latter, here are several ways to bring your savings and aspirations in line:
Step up your savings
- Contribute the maximum to your 401(k).
- Contribute to an individual retirement account (IRA).
- Contribute to a SEP-IRA if you’re self-employed.
- Make additional catch-up contributions if you’re over 50.
- Earmark bonuses, raises and tax refunds for retirement.
- Work longer to help preserve your savings.
- Work until you’re eligible for Medicare to avoid potentially pricy private coverage.
- Wait to collect Social Security. You can begin collecting benefits as early as age 62, though it will be reduced by about 30% compared with your so-called full retirement age (currently 66 but rising to 67 for those born in 1960 or later). Once you attain full retirement age, every year you wait up to age 70 increases your benefit by 8%.
- Reduce discretionary spending by separating “nice to haves” from “need to haves.”
- Cover “need to haves” with proceeds from pensions, Social Security and other relatively reliable sources of income whenever possible.
It’s important to remember that retirement-income planning isn’t a “set it and forget it” exercise. Rather, your retirement plan should be a working document that is reevaluated at least annually to account for any changes to inflation, investment returns, life expectancy, spending, and taxes.
This may all sound like a lot of work. But by planning today, you can confidently count on going the distance tomorrow. As always, remember to consult a financial professional before making any major decisions.