Archives
Sailboats or Lotto Hopes? Everyone has a Choice in Preparing for the Future.
Last Updated: February 28, 2012
What do you want to do when you retire? Some people want to travel the world. Others want to devote themselves to their favorite hobby. Still others plan to just sit on the front porch and watch the cars drive by. For some, the goal may simply be to reduce their employment to part-time when they retire. Trying to visualize what your retirement lifestyle will look like is the first step to preparing for it.
But there is much more to the process of planning for retirement than just dreaming about how you will fill your time. You must build a plan for how to get to your retirement goals. When you develop your retirement plan, it helps to work backwards, which is why we start with visualizing what your retirement lifestyle looks like to you.
The first calculation that must be done is to determine how much the lifestyle you just pictured will cost in the future. If you have been to the grocery store or the gas station lately, then you know that prices seem to go up over time. How much? Well, it is impossible to say for sure, but historically the price we pay for the goods and services we buy every day, doubles every 20 to 25 years. If you think you could be happy living on $50,000 per year; think again, because that same lifestyle might cost $100,000 by the time you retire.
The next part of the process of building your retirement calculation is to decide how long you will need to maintain that retirement lifestyle you are visualizing. Life expectancies have increased dramatically over the past several generations. Did you know that if a husband and wife both reach age 65, then there is a 50/50 chance that one of them will live to age 90? That is another 25 years of living expenses that must be planned for. Some people will actually spend more years in retirement than they spent in their entire working careers. As you can see, the money that you will need to set aside adds up quickly.
So where will the money come from to meet your retirement income need? One source will likely be Social Security. The amount you can expect from Social Security is different for everyone, because it is based on your personal earnings history. You may have an idea how much you will get based on the estimate you get in the mail every year approximately three months before your birthday. What we do know is that it would be difficult and far from ideal to live solely off of Social Security throughout retirement. For most workers, Social Security will likely replace 30% to 40% of their pre-retirement income. Fortunately, Social Security benefits will already be adjusted for inflation, but you will still need to replace the remaining 60-70% of your income.
That 60-70% will need to be replaced through personal savings. How much personal savings needs to be set aside for retirement is a question that each individual must answer for themselves. Financial professionals will normally recommend that you only withdraw 4- 5% of your retirement savings each year, if you want it to last for the rest of your life. That means that you will need a nest egg of 20 to 25 times the size of the annual retirement income you visualized earlier.
Frequently, the best place to start saving is in your employer’s sponsored retirement plan. There may be tax advantages to using this vehicle and you may also receive some “free money” from an employer’s profit sharing or matching contribution to your account. If you have already begun to save for retirement, you can also subtract your current retirement account balance from the amount you need to save. Furthermore, your current savings should continue to grow between now and your eventual retirement. This growth helps to get you closer to your goal.
Are you there yet? If the amount you expect from Social Security and the amount of income you can withdraw from your retirement account are not enough to meet that retirement lifestyle we talked about earlier, you have some more work to do. The extent of the shortfall will determine your personal calculation. How many more years until you retire? What is a reasonable growth rate for your account based on how it is invested? With these two pieces of data you can once again work backwards to determine how much must be withheld from each paycheck from now until retirement to cover the shortfall.
Remember: being short of your retirement goal is not an excuse to give up planning and saving for retirement; the key is to know how short you are, so you can make a plan to meet your ultimate goal. Another key is to monitor your progress along the way. If you make a calculation based on retiring twenty years in the future, about the only thing you know for sure is that it will not happen exactly as you calculate today. Because of all of the moving variables like the rate of inflation, your asset allocation, stock market rates of return and how long you plan to work, your calculations will most likely be either too high or too low, but the closer you get to your magic date, the more accurate these estimates will become.
If it looks like you are already saving enough out of each paycheck to get to your retirement goal-congratulations! Keep doing what you are doing until you get there. Some of you may not like the numbers you are seeing, but there are things you can do. Although not always easy, we all have choices: you may have to adjust your expected income in retirement; perhaps, you will need to work an extra year or two. Maybe you could reduce your lifestyle today, so that you can defer more money to savings. Keep in mind that the sooner you make some changes, the longer those changes will have to work for you, and the rosier your retirement picture could become.
PCI’s archived blog entries are dated, the rules and statutes referenced may have changed. The analysis or guidance within these blog entries may have become stale, dated, or no longer accurate. PCI will not update or change these entries to reflect the latest analysis or development.
