You know how important it is to plan for your retirement, but where do you begin? Retirement planning is not an exact science. Your specific needs depend on your goals and many other factors. However, by doing a little homework, you could be well on your way to a comfortable retirement.
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 90%, or even more. The problem with this approach is that it doesn't account for your specific situation. It's worth going through all of your current expenses in detail, and really thinking about how those expenses might 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 don't forget that the cost of living may go up over time. The average annual rate of inflation over the past 20 years has been approximately 2.1 percent. (Calculated from consumer price index (CPI-U) data published by the U.S. Department of Labor, January 2018.)
Some expenses, such as health care and insurance, may increase as you age. To help protect against these variables, build a comfortable cushion into your estimates (it's always best to be conservative). Finally, a financial professional can help you make sure your estimates are 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.
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. 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 help guard against that risk, you'll need to estimate your life expectancy. 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 and order a copy of your statement. 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. 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
- Shift your assets to investments that have the potential to outpace inflation (but keep in mind that investments that offer higher potential returns may involve greater risk of loss)
- Lower your expectations for retirement so you may not need as much money
- Work part-time during retirement for extra income
- Consider delaying your retirement for a few years (or longer)
Adam Stone & Jennifer Riedeman
Financial Advisors, RJFS