“Do I have enough money to retire?” As the wave of boomers approaches retirement, this is the question on the minds of many. But how do you find an answer to this important and complex question? Will a refrigerator box on a district heating grid 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 yourself?
As I have attempted to address this issue in my own retirement planning, I have identified five steps. Follow these steps and you should have an idea if you have the financial resources to withdraw:
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 ssa.gov/estimator/website.
– Retirement benefits: Pensions are becoming less prevalent these days. If your current employer offers a pension plan, contact your Human Resources Department for an estimate of benefits on your proposed retirement date.
– Savings for retirement: If you have retirement savings in a 401K, IRA, or similar, you’ll need to estimate the balance on your proposed retirement date. Savings forecasting tools are available online.
– Post-retirement income: If you anticipate working in retirement or planning to start a home business, you need to estimate the annual income you can earn from this.
STEP 2: Calculate your expenses in retirement:
– Bills: The general belief is that expenses will decrease in retirement, although this depends on individual spending patterns. Start your anticipated income just before you plan to retire. Calculate your current expenses. If you use personal finance software like Quicken, this should be easy. Then, for each major expense category, like food, housing, taxes, etc., figure out how much they will be in retirement. Some expense categories may increase, such as entertainment and medical care. However, some will go down. For example, you won’t be contributing to a 401K or IRA when you retire. If you don’t work, Social Security or Medicare taxes won’t be taken out of your paycheck. Your state and federal taxes should decrease. If you reduce the size of your residence, your housing expenses, such as utilities and property taxes, should decrease.
– Relocation: If you plan to move to a different city when you retire, the cost of living in the new location may go up or down compared to your current residence. To get an idea of the cost of living in your new location compared to your current residence, go to one of the many online cost of living calculators.
STEP 3: Estimate the unknowns:
– Inflation: Inflation affects your cost of living. We do not know for sure what will be in the future. However, a good bet is to use the long-term average between 3.2% and 4.0%.
– Return on investment: Unless you plan to withdraw your savings in retirement and put them away in a mattress, you should earn a return on the balance. It’s difficult to provide a specific percentage because it will vary with your investment mix. However, you can search the Internet for historical return guidelines for each investment class you own and estimate the returns you can expect.
– Life expectancy: How long will you live in retirement? In other words, how long should your savings last? To get an estimate of your life expectancy, go to http://www.livingto100.com and complete the online questionnaire.
STEP 4: Put all the information you’ve collected together to get an estimate of your financial position for retirement. You’ll usually look for a retirement financial calculator online. Retirement financial calculators are very helpful in assessing your financial readiness. However, the more accurate your assessment of your retirement income, expenses, and unknowns, the more reliable your results will be. Don’t be too optimistic. In this case, hedging your bets (being a bit pessimistic) will probably work better for you. Also remember, as assumptions change, such as when you’d like to retire, your savings balance, your social security benefits, etc. you should reevaluate.
STEP #5: Consider the uncertainties. Many online retirement financial calculators have relatively simple results. You enter 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. More sophisticated financial calculators use a statistical procedure known as “Monte Carlo” to estimate financial readiness for retirement. Monte Carlo changes the question of “how long will my retirement savings last?” to “what is the probability that they will last for various periods of time? For example, what is the probability that your savings will last 20 years or 24 years?” etc.? There are no certainties in the world. This is a much more realistic way to assess your financial health.
Financial planning for retirement can be complex and a bit daunting. However, if you follow the five steps, you should be well on your way to answering the question of your financial readiness for retirement.
