When you're getting ready to retire, there's no shortage of things to think about. The months and years leading up to your target retirement date can seem quite overwhelming because of it.
However, most of the decisions and considerations involving retirement can be broken down into three categories. With that in mind, here's an overview of the three main steps to making sure you're ready to retire and what you should keep in mind about each one.
How much money will you spend in retirement?
You may have heard that you should expect to need about 80% of your pre-retirement income to sustain the same lifestyle after you retire. In other words, if you and your spouse have combined income of $100,000, you should anticipate needing $80,000 per year in retirement.
This is a good rule of thumb for the most part. After all, this takes into account that you won't need to save money for retirement anymore and that some of your expenses will be lower -- commuting expenses, for example. So, it's completely reasonable to say that the average retiree will be fine on 80% of their pre-retirement income.
However, you're probably not the average retiree. Thus, I'd suggest starting with 80% of your current income and modifying it accordingly. For example, if you plan to travel extensively in retirement, add a travel component to your budget. If you plan to go out to eat a lot more than you did when you were working, add some money to your budget for this as well.
On the other hand, if you plan to reduce your expenses after retirement, you can adjust this figure downward. For example, one popular retirement strategy is to plan for your mortgage payoff to coincide with your retirement date. If you do this, you can subtract the amount you've been paying from your budget. It's not uncommon for retirees who pay off their homes, cars, and credit cards before retiring to live completely comfortably on far less than 80% of their pre-retirement income.
How much income will you have in retirement?
Once you've determined how much income you'll need, the next step is to determine how much income you'll have available.
Start with income you know you'll have. Social Security is the biggest fixed income source for most retirees, and you can get a good idea of how much to expect based on your planned retirement age and work history on your latest Social Security statement. You can access yours at www.ssa.gov, and if it's your first time on the site, you'll need to create a free account.
If you have any other fixed income sources, such as a pension from a job, or an annuity you've already purchased, be sure to consider that as well.
Next, consider your savings. There's no perfect rule that tells you how much income you can sustainably draw from your savings, but many financial planners use the 4% rule. Essentially, this says that if you withdraw 4% of your retirement savings during your first year of retirement and increase your withdrawals in subsequent years to keep pace with inflation, your savings have a good chance of outliving you.
Here's an example. Let's say that you check your Social Security statement, and if you retire right now, you can expect to receive $2,500 per month between you and your spouse. In addition, you're entitled to receive a $600 monthly pension from a former job. You also have $800,000 in retirement savings, which would translate to another $32,000 in annual income ($2,667 per month).
Adding your income sources together shows that you can expect to have $5,767 in sustainable, inflation-adjustable retirement income per month, or just over $69,000 per year, if you were to retire right now. If this is more than you anticipate needing, you're probably financially ready to retire.
At the end of the day, the big financial test to determine your retirement readiness is actually quite simple. If the income you'll have exceeds the income you'll need by a comfortable margin, you're probably good to go, at least from a financial standpoint.
What will you do next?
Retirement isn't always just a question of dollars and cents. There are plenty of people who are financially capable of retiring, but who choose to continue to work. So, as a final thought, it's important to make sure that you're mentally ready to retire as well.
A big part of retirement readiness is dealing with the "Then what?" question. In other words, once you leave your job for the last time, what will you do with all of your time? Doing nothing may sound nice in principle, but according to most experts, it gets old very fast.
Maybe you plan to travel often, or to drive across the U.S. in an RV. Maybe you plan to use your time to volunteer, or to help take care of your grandchildren. Maybe you plan to join some sort of social organization, or to exercise every day. The bottom line is that when you're preparing to retire, it can be just as worthwhile to come up with a plan for your time as it is to come up with a financial plan.