You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you'll need to fund your retirement. That's not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.
Use your current income as a starting point
It's common to discuss desired annual retirement income as a percentage of your current income. Depending on whom you're talking to, that percentage could be anywhere from 60% to 100%, 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., certain payroll taxes, retirement funding) should, theoretically, allow you to sustain your current lifestyle.
The problem with this approach is that it doesn't account for your situation and how it may change. If you intend to increase your travel in retirement, you might easily need 100% (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 your 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 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, review your current lifestyle expenses (things such as housing, utilities, food, etc.) that will remain during your retirement. Then add the cost of things you want to do—winter somewhere warmer, travel more, etc.
What many people find is that their expenses do not go down. In fact, expenses may just shift from one category to another. You won’t be putting money into a retirement account, but your health care needs will likely increase over time, so savings turns to another expense. Many find that the portion of their monthly income that goes towards health care (including long-term care) increases dramatically.
Don't forget that the cost of living will go up over time. 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 child's education early in retirement. Other expenses, such as health care and insurance, may increase as you age. To protect against these variables, build a comfortable cushion into your estimates (it's always best to be conservative). Finally, have a financial professional help you with your estimates to make sure they're as accurate and realistic as possible.
Decide when you'll 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. 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. 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. You won’t be eligible for Medicare until age 65, so your out of pocket for health care coverage will likely go up.
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 want to avoid 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 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 some level of 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 withdrawals from your 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. It’s best not to plan on some sort of part-time work during retirement—it may not happen for health or employment opportunity reasons.
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 may be steps that you can take to bridge the gap. A financial professional can help you figure out the best ways to do that, but here are a few suggestions:
- Try to cut current expenses so you'll have more money to save for retirement. This will help set a lower target for lifestyle expenses during retirement as well.
- Re-evaluate your investment allocation. Moving some of your long-term funds to investments that have the potential to outpace inflation may give your returns a boost (keep in mind that investments offering higher potential returns may involve greater risk of loss)
- Lower your expectations for retirement (no beach house, for example)
- Consider delaying your retirement for a few years
At Busey Wealth Management, our team can help you build a roadmap for retirement, balancing today’s needs with your goals for the future. To learn more about our services or find an advisor near you, visit busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.
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