“Do I have enough money to retire?” As the wave of boomers approach retirement, this is the question on the minds of many. But, how do you find an answer to this most important, but complex of questions? Will a refrigerator crate over an urban heating grate be your version of “condo living” in retirement or will you thrive? There is a lot written on this topic, but how do you put the pieces together to get an answer for you?
As I have attempted to come to grips with this issue in my own retirement planning, I have identified five steps. Follow these steps and you should have a sense of whether you have the financial resources to retire:
STEP #1: Determine your retirement income:
– Social Security: The Social Security Administration can provide an estimate of your retirement benefits. Get an estimate of your benefits at the ssa.gov/estimator/ website.
– Pension Benefits: Pensions are becoming less frequent these days. If your current employer offers a pension plan, contact your Human Resources Department for an estimate of benefits at your proposed retirement date.
– Retirement Savings: If you have retirement savings in a 401K, IRA or the like you will need to estimate the balance at your proposed retirement date. Savings forecasting tools are available on-line.
– Post-Retirement Income: If you are anticipating working in retirement or plan to start a home-based business, you should estimate the annual income you may derive from this.
STEP #2: Estimate your expenses in retirement:
– Expenses: The general belief is that expenses will decrease in retirement, although this is dependent on individual spending patterns. Start with your anticipated income just before you plan to retire. Estimate your current expenses. If you use personal finance software such as Quicken, this should be easy. Then for each major spending category such as food, housing, taxes, etc., estimate what they will be in retirement. Some categories of spending may go up, such as entertainment and healthcare. However, some will go down. For example, you will not be contributing to a 401K or IRA when you retire. You will not have Social Security or Medicare taxes coming out of your check if you don’t work. Your state and federal taxes should decrease. If you downsize your residence, your housing expenses such as utilities and property taxes should decline.
– Relocation: If you are planning to relocate to a different city when you retire, the cost-of-living in the new location may increase or decrease compared to your current residence. To get a handle on the cost-of-living in your new location compared to your current residence, go to one of the many on-line cost-of-living calculators.
STEP #3: Estimate the unknowns:
– Inflation: Inflation affects your cost-of-living. We don’t know with any certainty what it will be in the future. However, one good bet is to use the long-term average between 3.2%-4.0%.
– Investment Returns: Unless you plan to draw out your savings in retirement and stuff it in a mattress, you should earn a return on the balance. It is difficult to provide a specific percentage because it will vary with your mix of investments. However, you can research the internet for guidelines on the historic returns for each investment class you own and do an estimate of the returns you can expect.
– Lifespan: How long will you live in retirement? In other words, how long must your savings last? For an estimate of your expected lifespan, go to http://www.livingto100.com and complete the on-line questionnaire.
STEP #4: Bring all of the information you have gathered together to get an estimate of how well you are financially positioned for retirement. Typically, you will search out an on-line retirement financial calculator. Retirement financial calculators are very useful for assessing your financial readiness. However, the more accurate your assessment of your retirement income, expenses, and the unknowns, the more reliable the results. Don’t be overly optimistic. In this case, hedging your bets (being a little pessimistic) will probably work better for you. Also remember, as the assumptions change such as when you would like to retire, your savings balance, your social security benefits, etc. you should reassess.
STEP #5: Consider the uncertainties. Many on-line retirement financial calculators have relatively simple outputs. You put in your numbers and they come back with a specific number of years your savings will last. However, the reality is that given the uncertainties a specific number is likely to be inaccurate. The more sophisticated financial calculators use a statistical procedure known as “Monte Carlo” to estimate retirement financial readiness. Monte Carlo changes the question from “how long will my retirement savings last” to “what is the probability that it will last for various time periods. For example, what is the probability that your savings will last for 20 years, or 24 years, etc.? There are no certainties in the world. This is a much more realistic way of assessing your financial health.
Retirement financial planning can be complex and a little daunting. However, if you follow the five steps, you should be on better footing to answer the question of your retirement financial readiness.