The tricky thing about retirement is pinpointing the precise amount of income you'll need to cover your annual expenses. And while you can do your best to estimate that figure toward the tail end of your working years, there are certain factors that could end up throwing your calculations off. Here are a few reasons why your number-crunching might lead you astray.
1. You're assuming your needs won't change over time
When many older workers sit down to map out a retirement budget, they tend to use their immediate needs as a basis for it. For example, if you're in your 60s and are planning to retire within three years, you might assume that your expenses will stay relatively similar once you stop working. As you age, however, your needs might change. You may need to pay more money for transportation if you begin struggling to drive, and you may need to outsource many of the home maintenance tasks you were once capable of tackling yourself. Therefore, don't assume that the costs you work with initially won't evolve, for better or for worse.
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2. You're forgetting about the boredom factor
Going to work is a fairly inexpensive activity, since it occupies most of your time without forcing you to spend money, save for commuting costs and incidentals. Once you retire, however, you'll be left with many hours in the day to fill, and unless you're willing to get creative about sourcing free or low-cost entertainment, you'll need to prepare to spend a certain amount of money to keep yourself occupied. Unfortunately, many pre-retirees don't realize how expensive perpetual entertainment can be, and misjudge the amount of income they'll need as a result.
3. You're not accounting for inflation
A dollar today won't have the same value in 10, 20, or 30 years' time. One reason many seniors fall short on retirement income is that they don't account for inflation, which can impact everything from the cost of food to housing to healthcare. Imagine you currently spend $4,000 a month, and figure you'll need the same amount in retirement to cover your living costs. Over time, that $4,000 will likely evolve into $4,500 or $5,000, even if your bills stay the same, so be sure to factor that into your plans.
Avoiding a retirement shortfall
The last thing you want to do is fall short on income in retirement and struggle later in life. To avoid having that happen, take steps to boost your savings to allow for the fact that your retirement calculations may not be 100% accurate.
If you're 50 or older, you can make catch-up contributions in your IRA or 401(k) that will leave you with more income later on. You might also look into buying an annuity once you've maxed out your IRA or 401(k), which could guarantee you a certain amount of income for life.
At the same time, it pays to go into retirement with a strategy for tapping your nest egg so you don't wind up spending it down too quickly. For years, financial experts have been advising seniors to follow the 4% rule, which states that if you begin by removing 4% of your savings your first year of retirement, and then adjust subsequent withdrawals for inflation, your savings should last 30 years. It's certainly not a perfect rule, but it's a starting point to work with.
If you're worried that retirement will get more expensive for you over time, you might start out with a more conservative withdrawal rate, like 2%, and work your way up to 4% or more as you age. There are different options you can play around with, but the point is to prepare for the fact that you may end up needing more income at different points in retirement than expected.
