1. Preparing a Retirement Plan


Preparing_for_RetirementHow much money will you need to have for your ideal retirement scenario? Where will it come from? The recent rocky economy, talk of Social Security reform, and a few high-profile pension fund failures have many Americans thinking more seriously about how they will fund their retirement.

For years, financial planners have talked about retirement income as a "three-legged stool:" Social Security, employer-related pension or retirement plans, and personal savings including tax-advantaged retirement investment accounts. Because they are healthy and active, more retirees are adding a fourth leg to that stool—part-time work.

Financial planning for retirement is about having a plan for your money. It basically comes down to five questions:

  1. How much money will you need to retire?
  2. How much time do you have to get there?
  3. Where are you now in saving for retirement?
  4. What investment vehicles give you a chance to get there?
  5. How much financial risk are you willing to take in saving and investing for retirement?

Determining how much income you will need

A good way to make an accurate estimate of how much income you'll need is to keep track of your current living expenses for at least six months or as much as a year. This figure gives you a current estimate of the money it takes to maintain your current standard of living. Note your goals for retirement: Do you plan to move to a smaller home or different community? Do you plan to travel more?

Next consider what expenses will probably decrease (or go away entirely) and which may increase. Be sure to estimate these expenses for both you and your spouse. Here are some examples:

Possible decreasing expenses:

  • Commuting costs and business travel.
  • Union and/or professional dues.
  • 401(k) plan contributions and Social Security tax deductions.
  • Business clothing.
  • Work-related social expenses.
  • Certain automobile expenses.
  • Income taxes.
  • Mortgage payments (depending on the duration of your mortgage).
  • Child-rearing expenses.
  • Health insurance payments (depending on cost of employee-plan or individual plan)

Possible increasing expenses:

  • Travel, entertainment, and hobbies.
  • Medical and dental expenses.
  • Medigap health insurance premiums.
  • Long-term care insurance.
  • Gifts to family members (particularly if you choose to use gifts in your estate planning).
  • Volunteer expenses.
  • Care of elderly parents.

After you have a good estimate of all projected annual expenses, including "discretionary" expenditures, estimate the total amount you (individually or as a couple) will need for annual income.

How many years will you need that annual income? At what age do you plan to retire? 65? Earlier than 65? Later than 65? When does your spouse plan to retire? Also consider your life expectancies. Do family members routinely live into their 90's? Estimate the number of years you'll need income. Multiply the yearly income by the number of years. This will give you a rough estimate of the total amount you may need.

FoolProofTip: Remember that inflation over the years will increase the annual income that you will need to maintain the same standard of living. In recent years inflation has remained fairly low: since 1995, rates of inflation have ranged from 1.6% to 3.8% annually according to the U.S. Bureau of Labor Statistics (with the exception of 2009 which at -.04% had essentially no inflation). But even that range of annual increase in the costs of goods and services increases the total income you need. You can use the FINRA Retirement Calculator to estimate the impact of inflation at various rates. (FINRA is the Financial Industry Regulatory Authority.)

Determining the income you will have

To determine an estimate of the total income you have, given your current situation, you need to gather information from several sources.  

  • List an estimate of what you'll receive from Social Security.
    Use your estimate from Social Security. You can get your Social Security Statement online using your my Social Security account. You can also use the Retirement Estimator on the Social Security web site. Once you have a benefit estimate—either from your statement or from one of the benefit calculators—you can use other calculators on the Social Security web site to see how different retirement dates and situations might affect your benefits. For example, the Retirement Age Calculator shows how retiring early reduces your monthly benefit.
  • List the estimated amounts of any assured income—pensions, disability benefits, annuities, etc—you will receive. (Read more about pension and annuity payouts.)
  • List the current amount of money you already have saved. Because you desire only a rough estimate, use the total of current balances in IRAs, 401(k)s, mutual funds, and other investments.

What's the total of these potential sources of income? Note that for the purposes of this rough estimate, you need just the sum of the estimated amounts you've listed.

Determining how much more you will need

You now have two figures: 1) how much you will need and 2) how much you potentially and reasonably will have on hand. The difference between the two figures is how much more you will need to save.

You can enter your figures into our Retirement Savings Calculator to help you estimate the additional money you will need to save to meet your retirement income goals. Dividing this lump sum by the number of years you have left until retirement will give you a very rough idea of the amount you'll need to save annually.

Using other Retirement Savings Calculators. A number of websites have retirement savings calculators that let you plug in various figures to predict approximate future income based on the factors you provide. You may wish to run the numbers on several calculators in order to compare.

The Retirement Planner from 360 Degrees of Financial Literacy (American Institute of CPAs) allows you to plug into one form many of the figures we just discussed for a rough estimate of what you'll have and what you'll need. The simple format enables you to compare many possible scenarios.

Retirement Planner from CNN/Money. This calculator allows you to estimate more factors and takes into account potential tax rates and type of investment strategy used for retirement savings.

Retirement Calculator from FINRA, the leading private-sector provider of financial regulatory services (overseeing brokerage firms and brokerage agents).


Next: 2. Retiring a Millionaire

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