Estimating your retirement income needs – Part 1
You know how important it is to plan for your retirement, but where do you begin? One of your first steps should be to estimate how much income you'll need to fund your retirement. That's not as easy as it sounds, because retirement planning is not an exact science. Your specific needs depend on your goals and many other factors.
Use your current income as a starting point
It's common to discuss desired annual retirement income as a percentage of your current income. Depending on who you're talking to, that percentage could be anywhere from 60 to 90 percent, or even more. The appeal of this approach lies in its simplicity, and the fact that there's a fairly common-sense analysis underlying it: Your current income sustains your present lifestyle, so taking that income and reducing it by a specific percentage to reflect the fact that there will be certain expenses you'll no longer be liable for (e.g., payroll taxes) will, theoretically, allow you to sustain your current lifestyle.
The problem with this approach is that it doesn't account for your specific situation. If you intend to travel extensively in retirement, for example, you might easily need 100 percent (or more) of your current income to get by. It's fine to use a percentage of your current income as a benchmark, but it's worth going through all of your current expenses in detail, and really thinking about how those expenses will change over time as you transition into retirement.
Project your retirement expenses
Your annual income during retirement should be enough (or more than enough) to meet your retirement expenses. That's why estimating those expenses is a big piece of the retirement planning puzzle. But you may have a hard time identifying all of your expenses and projecting how much you'll be spending in each area, especially if retirement is still far off. To help you get started, here are some common retirement expenses:
• Food and clothing
• Housing: Rent or mortgage payments, property taxes, homeowners insurance, property upkeep and repairs
• Utilities: Gas, electric, water, telephone, cable TV
• Transportation: Car payments, auto insurance, gas, maintenance and repairs, public transportation
• Insurance: Medical, dental, life, disability, long-term care
• Health-care costs not covered by insurance: Deductibles, co-payments, prescription drugs
• Taxes: Federal and state income tax, capital gains tax
• Debts: Personal loans, business loans, credit card payments
• Education: Children's or grandchildren's college expenses
• Gifts: Charitable and personal
• Savings and investments: Contributions to IRAs, annuities, and other investment accounts
• Recreation: Travel, dining out, hobbies, leisure activities
• Care for yourself, your parents, or others: Costs for a nursing home, home health aide, or other type of assisted living
• Miscellaneous: Personal grooming, pets, club memberships
Don't forget that the cost of living will go up over time. The average annual rate of inflation over the past 20 years has been approximately 2.2 percent. (Source: Consumer price index (CPI-U) data published by the U.S. Department of Labor, January 2016.) And keep in mind that your retirement expenses may change from year to year. For example, you may pay off your home mortgage or your children's education early in retirement. Other expenses, such as health care and insurance, may increase as you age. To protect against these variables, build a comfortable cushion into your estimates (it's always best to be conservative). Finally, have a financial professional help you with your estimates to make sure they're as accurate and realistic as possible.
See part 2 in the next issue of The Loop.
Article courtesy of Forefield. Securities offered through NPB Financial Group, LLC. A Registered Investment Advisor/Broker-Dealer Member FINRA, MSRB, and SIPC.