The majority of Americans have no idea how much they need to save for retirement. Most of us just guess an arbitrary round number, such as $1 million. And while having a random savings goal is obviously better than none at all, finding a more accurate retirement number doesn't have to be too complicated. Here are three steps to determine yours.
First, figure out how much income you'll need after retirement.
Experts generally suggest you'll need about 80% of your pre-retirement income to maintain the same lifestyle in retirement. This figure accounts for certain expenses you probably won't have to pay anymore. As an obvious example, you'll no longer have a need to set some of your paycheck aside to save for retirement. You will likely pay less in income taxes too, and you will pay no Social Security or Medicare taxes anymore.
However, some fool will give you back 40 hours per week to do anything you want to do – and that will likely be more expensive than driving to work used to be! Visiting kids and grandkids, playing more golf, or visiting some far flung Pacific Islands will likely take a hunk out of your budget – and you deserve these pleasures after working so long!
Naturally, this 80% rule of thumb isn't perfect. If you're more of a thrifty person and save more of your income than most people, you can probably maintain your lifestyle with less than 80% of your income. Conversely, if your current lifestyle consumes pretty much all of your income, your retirement income needs may be closer to 100% of your current income.
My cousin makes it easy. He says, “My number is three million bucks. I can pay myself 4% per year, and will spend $120,000 per year through my retirement years!”
But is it right? Is planning your retirement as easy as pulling funds from an account, or is it more difficult – perhaps like a jigsaw puzzle
Second, put the easy pieces of the puzzle in place before you fill in the middle.
My dad loved jigsaw puzzles – he’d dump the 1,000 pieces on the table, being careful to lose not even one. His job? Making order out of chaos.
Your journey to planning your retirement is the same. You need to be aware of all the pieces that will affect your retirement, and you can’t ignore any.
Dad always started with the easy part – the edges of the puzzle. Those pieces are easier to find and fit together.
We can easily discover your investment pieces – your 401k, IRA’s, real estate and/or inheritance – but how should you manage them in retirement? How much risk should you take, and how will you react in those years when the market falls, rather than grows?
The more difficult pieces in the puzzle are the buildings, roads, cars and sidewalks in the middle of the puzzle, the pieces that tend to blend together, but Dad would study the box top, recognize patterns and begin to fit those pieces together, too.
How will you work with your pension, and with social security? The rules are arcane and bizarre, but we know these sources of income should help. But will these income sources keep up with inflation? Much like the buses and cars, these pieces warrant some study, but will eventually fall into order when we pull back and look at the bigger picture.
Finally, notice the tiny variations in the sky - the toughest part of any puzzle.
Finally comes the sky – the toughest part of any puzzle – a full third of the picture, but with tiny shade variations rather than patterns. Dad always asked for help with the sky.
In planning for retirement, the sky represents the “unknowns.”
- How much will you spend in retirement?
- Will your spending actually decrease as you age and slow down?
- How will you handle medical costs in retirement – how will Medicare affect you?
- How will you handle the costs that Medicare doesn’t cover?
- How long will you live?
- Will your pension and social security stop when you do?
- How will you protect your spouse from that loss of income?
- Do you need to protect your spouse with life insurance on you? Long term care insurance? Earthquake insurance on your house?
- How much insurance is too much, causing you to go into insurance premium debt?
- What about increases in taxes and inflation? Those will increase your cash needs. Every year. Are there smart tax strategies in retirement?
And here’s a big “sky” question to ponder: What sort of legacy would you like to leave to your world, to your kids, to your community? How can you most effectively move towards those goals?
Dad was always pleased when he finished his puzzles. Even when he was 94, in the grip of Alzheimer’s, and doing ten piece puzzles rather than 1,000. He’d tap the last piece in with a flourish, sit back in contentment, and smile at his ability to make order out of chaos.
You will be pleased as well. The task that looked so daunting at first is now complete, with well-reasoned and researched strategies. Rather than a static puzzle, your forecast will constantly be improved and changed as you review it and look at the changes in your life and changes in your personal priorities.
You have created order out of chaos too, a personal plan of who you can be and should be. As always, we’re here to help you with the sky - so send us an email, give us a call, or visit us online.