“Do I have enough money to retire?” With the wave of boomers approaching retirement, this is the question on the minds of many. But how do you find answers to these most important but complex questions? Will a refrigerator crate over a district heating grate be your version of “apartment living” when you retire or will you thrive? Much has been written on this subject, but how do you put the pieces together to get an answer for you?
As I’ve tried to address this issue in my own retirement planning, I’ve identified five steps. Follow these steps and you should have an idea of whether you have the financial means to retire:
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 the ssa.gov/estimator/ website.
– Pension benefits: Pensions are becoming less frequent these days. If your current employer offers a retirement plan, contact your human resources department for an estimate of benefits at your proposed retirement date.
– Pension savings: If you have retirement savings in a 401K, IRA, or the like, estimate the balance at your proposed retirement date. Savings forecasting tools are available online.
– Income after retirement: If you expect to retire or plan to start a home business, estimate the annual income you can get from it.
STEP 2: Estimate Your Retirement Expenses:
– Expenses: The common belief is that spending will decrease in retirement, although this depends on individual spending patterns. Start with your projected income just before you plan to retire. Estimate your current expenses. If you use personal finance software like Quicken, this should be easy. Then, for each major spending category, such as food, housing, taxes, etc., estimate what they will be when they retire. Some spending categories may go up, such as entertainment and healthcare. However, some will perish. For example, you don’t contribute to a 401K or IRA when you retire. You won’t have Social Security or Medicare taxes coming out of your check if you don’t work. Your state and federal taxes should drop. Downsizing your home should lower your housing costs, such as utilities and property taxes.
– Move: If you plan to move to a different city when you retire, the cost of living in the new location may increase or decrease compared to your current residence. To get a handle on the cost of living in your new location compared to your current home, visit one of the many online cost of living calculators.
STEP 3: Treasure the unknowns:
– Inflation: Inflation affects your cost of living. We don’t know for sure what it will be in the future. However, a good bet is to use the long-term average between 3.2%-4.0%.
– Investment returns: Unless you plan on taking your savings in retirement and putting it in a mattress, you should be earning a return on the balance. It is difficult to give a specific percentage as it will vary with your mix of investments. However, you can search the Internet for guidance on historical returns for each asset class you own and estimate the returns you can expect.
– Lifespan: How long will you retire? In other words, how long should your savings last? For an estimate of your expected life, go to: http://www.livingto100.com and complete the online questionnaire.
STEP 4: Put all the information you’ve gathered together to get an estimate of how well-positioned you are financially to retire. Most of the time you are looking for an online financial calculator for pensions. Retirement calculators are very useful for assessing your financial readiness. The more accurate your assessment of your retirement income, expenses, and the unknowns, the more reliable the results. Don’t be too optimistic. In this case, hedging your bets (being a little pessimistic) will probably work better for you. Also keep in mind that if the assumptions change, such as when you want to retire, your savings balance, your Social Security benefits, etc., you’ll need to reassess.
STEP #5: Think of the uncertainties. Many online retirement calculators have relatively simple results. You enter your numbers and they come back with a certain number of years your savings will last. However, the reality is that given the uncertainties, a certain number is likely to be inaccurate. The more sophisticated financial calculators use a statistical procedure known as “Monte Carlo” to estimate financial readiness for retirement. Monte Carlo changes the question from “how long will my retirement savings last” to “what is the probability that it will last for different periods of time. For example, what is the probability that your savings will last 20 years, or…