Back when I was in the retirement plan business I used to tell people that while almost everyone has a retirement plan, very few have a plan to retire. When asked, most people cannot answer the question: “how much does it cost you to live”. The answer to this is where you start your “plan to retire”.
First, you want to focus on your “fixed costs” (property taxes, insurances, utilities, etc). These are costs that you have little control over and must pay. Any expenses that can be eliminated or changed easily are “discretionary expenses”. Most people find their fixed costs are not very high. Try to reduce those fixed costs as much as possible as you are approaching retirement (i.e. downsizing houses as you approach old age). The lower these fixed expenses are the less income you will need to pay for them. Lowering the amount of income you need means the less assets (principle) you need to produce this income for those expenses.
How much income will you need in retirement? A good rule of thumb is to start with your current gross income from your paycheck. You can also look at your last tax return and use the “Gross Income” (before deductions) and then subtract the amount you put into savings that year. That tells you how much you live on including discretionary expenses. Assume that amount is $100,000, then if you assume you can earn 5% on your investments, you would need to have $2 million in savings to produce $100,000 of income. This gives you an idea of how much your savings need to be. On the other hand, you can project how much savings you will have at retirement and multiply by 5% (or whatever rate of return you want to assume) to determine how much you will have to live on in retirement. Then you adjust your cost of living to match that amount.
For most, replacing principle that has been withdrawn from your investments after retirement is not easy. Things like home repairs, car purchases and repairs, and other large purchases are reasons many people do withdraw principle. Cars will have to be replaced or repaired, so you should assume one or the other or both will occur. To avoid this, you want to budget those items into a spending plan. Ideally, try to either renovate your house prior to retirement, so you can go 10-15 years without repairs, or move to a new house. Renting or moving into a senior living community helps eliminate those issues.
Obviously, try to save as much as you can before retirement using 401K plan, IRA’s, Roth IRA’s or just savings (or all of the above). The more you save the less you live on.
Call us if you would like assistance with designing a “plan to retire”.