Are you on track for a comfortable retirement? We mean one in which you can vacation in Aruba if you choose, see the grandkids often, and have the same lifestyle as when you were working. Retirements like this are not spontaneous events. They're created over time. Planning is the way to create them.
It's a good idea to develop a specific retirement plan, whether you're 23 or 63. You need to have a working estimate of what your expenses will be once you retire, what your projected income will be, and how much you need to save. Once you develop it, review it every three years to make sure you're still on track.
Note that we don't mean just review your retirement portfolios. The composition and performance of your overall portfolio -- stocks, fixed income, and so forth -- should be reviewed every year, so you can be sure you are still meeting your performance goals. We're talking about a more comprehensive planning process in which you think about where you are financially versus where you want to be in your mid-60s and onward.
You should also review the comprehensive plan every three years. Here's why. You could sit down, roll up your sleeves, and come up with projected expenses today. But life may have big changes in store. You could move to a place where real estate prices and taxes are much higher than in your old stomping grounds. You could have a child. Maybe you or your partner will decide to stop working and stay home with the kids.
Do a larger family, higher real estate prices, or becoming a one-earner household affect how much you can save for retirement? Do they affect the expenses you're likely to have once you retire? They're certainly likely to!
The same is true of all life events. New jobs, marriage, and children are likely to have an impact that affects your retirement. So are real estate choices. A significant change in health, job loss, economic downturns, promotions: All are changes that can affect retirement planning.
As a result, you should review your retirement plan periodically to make sure you are on track for a comfortable retirement. Here's a checklist. Make these three estimates now and update them triennially.
1. Project your expenses in retirement
You need solid estimates for your expenses in retirement. There's a widespread belief that financial needs drop significantly once we retire. It ain't so. Prudent planners will anticipate that at least 80% of their pre-retirement income will be needed to maintain their lifestyle in retirement, and it could be more.
Why? Well, look through your current expense categories and consider which ones you'll still need in retirement. Food, utilities, taxes, and insurance payments are all likely to be about the same, unless you move to a lower-cost area. Some expenses, such as healthcare costs, may rise, as people tend to need more medical attention as they age. A couple retiring at 65 is estimated to need $399,000 over the rest of their lifetime in healthcare costs. The only expenses likely to drop are those associated with working, such as commuting and clothing costs.
Ask yourself these questions. Do you have any expenses likely to fall or be eliminated entirely in retirement? Are you likely to have your mortgage paid off in retirement, for example? If so, you can eliminate that expense. But a growing number of older people are still paying off mortgages when they retire. If you're in that category, plan for it. Are you likely to still be paying off credit card debt? Student loan debt? A growing number of older people are paying off these debts.
Which of your expenses will likely be about the same? Food? Eating out? Entertainment? Insurance? You want a sense of which categories will be roughly the same in retirement.
Then, calculate which of your expenses may rise. Healthcare is certainly one, but energy costs have also risen steeply in recent years. You'll need to heat your house and keep it cool, and you'll need gas for your car.
We can't leave this section without touching on inflation as a factor in expenses. Inflation is always with us, and while it hasn't been a big factor lately, over the long run it erodes your money's purchasing power at a rate of slightly more than 3% per year. It's smart to factor 3% inflation at a minimum into your projected costs for nearly every category. Costs you know to be stable, such as payments on a fixed-rate mortgage, constitute the only exception. In other words, if you currently pay $800 a month on food, assume that amount will rise about 3% every year.
2. Estimate your income at retirement
Next, you want a reasonable forecast of your income at retirement. Having an income estimate allows you to figure out the pieces of the pie you'll have, and thus the pieces of the pie you'll need to save.
If you're receiving a Social Security statement, check it to see the benefit projections for you. The average right now is around $17,500 per year. Yours might be higher or lower, depending on your earnings. While Social Security benefits are not lavish, they do provide an important foundation for many older people. You want to know yours.
The estimate changes over time depending on your earnings and other factors, so be aware you need to check periodically.
Yes, we know that Social Security is among the programs often threatened with a chopping block in Washington. As a result, it's nearly impossible to predict what will happen with Social Security in the future. But, long story short, it's also a widespread and popular program likely to continue, especially if you're within a decade or so of retirement.
Then, estimate your income from your current retirement nest egg. Unless you have other income, such as rent checks from a property you own, this will constitute the rest of your cash flow in retirement.
Generally speaking, retirees can withdraw money from their nest eggs using the 4% rule and feel secure it won't run out. If you have $10,000 saved right now, in other words, you could withdraw $400 per year. If you have $100,000 saved, you could withdraw $4,000, or roughly $333 per month.
3. Forecast your retirement savings
The final item on this checklist is to estimate the savings you'll have at retirement given your current rate of saving, or the amount you'll need if you're not currently saving.
If you don't have any retirement savings, don't panic. You have plenty of company; more than half of American families have no retirement savings, according to the Economic Policy Institute.
Start by establishing a target. Again using the 4% rule, a good target is 25 times your estimated income at retirement. If you need $60,000 per year in retirement, for example, your nest egg would need to be $1.5 million.
It's a good idea to use a retirement calculator and build in multiple projections. A retirement calculator allows you to see how much your nest egg can grow over time. That's the chief reason that it's important to start saving as early as you can.
A person who begins putting $200 per month into a retirement savings account at 25, for example, will have saved $96,000 by the time they hit 65. But if we assume even a 6% annual return on the savings, on the low side of the historical average for the stock market, it rises significantly. That portfolio would be worth a handsome $393,700 at retirement, according to a report from J.P. Morgan Asset Management.
Even if you start saving later, the returns are still enough to power an impressive retirement nest egg. That $200 monthly amount contributed steadily from the age of 35 to 65 totals just $72,000 in contributions, but can grow to more than $200,000 if you boost your savings by 6% annually.
The key is to start saving for retirement as soon as possible. The best places are tax-advantaged retirement savings vehicles such as 401(k)s and Individual Retirement Accounts (IRAs). For an overview of both, see here. If you need advice on cutting expenses now to clear financial space for savings, see here. If you are 50 or over, see here for advice on how to catch up on your savings as much as possible.