A MoneyDiva.com Special Report:
3 Steps to Take, NOW, to Guarantee Yourself a Fabulous Retirement Income
Planning for retirement can seem like having a second job! And one with an annoying, overbearing boss, at that. There’s no denying that creating and executing a plan for the last quarter of your life takes some time and effort but it doesn’t have to be so overwhelming.
By following this step-by-step guide, you can relax, knowing you’ve covered the basics and are headed towards a secure and prosperous retirement.
Discover What Your Retirement Income Needs Will Really Be...
STEP 1: How Much Your Savings and Investment Accounts Must Provide
First, you need to decide how much income you want to fund your post-work lifestyle from your retirement funds each month (or year).
To find this number, you’ll need to figure:
>> Projected income from pensions and annuities you’re vested in.
>> Projected income from Social Security or other government backed retirement programs. **
>> Projected expenses after retirement.
The difference, between what you’ll need to live the life you desire and your income from pensions and programs, is the amount you’ll want to withdraw from your investment accounts each month or year.
** If you're not sure how much to expect from your Social Security account, get a step-by-step worksheet: Just send me an email at: SS(at)MoneyDiva.com titled: Find My Social Security Number.
We all know making long-term plans includes a fair amount of guesswork; in this phase, your expenses are the biggest variable. Many planners try to simplify finding your retirement income needs by using a percentage of your current income.
You’ve got a choice of three methods to estimate how much income you’ll want in retirement.
1. You can give yourself a quick quiz (First Tab below)
2. Or, consider each of the nine major expense categories and whether yours will increase or decrease in retirement (Second Tab)
3. Gather your current budget data and use the retirement ratio formula to find your target (Third Tab)
- 1. QUIZ
- 2. CATEGORIES
- 3. FORMULA
Retirement Expenses Quiz
1. Will your mortgage (or rent) payments change?
My home will be mortgage free.
The mortgage/rent won’t change much.
I plan to increase my housing costs.
2. What will you pay for health insurance and treatments?
I expect my payments to decrease.
My medical costs should be similar.
My insurance and out-of-pocket will increase.
** Unless you have access to a guaranteed, low cost health insurance program (or plan to relocate to a country with universal coverage), most of us can expect a rise of 5% or more per year in medical costs over our lifetimes!
3. How much debt will you carry in retirement?
I am (or plan to be) debt-free by retirement.
I’ll continue making my regular payments.
I plan to borrow more money while retired.
4. What kind of major purchases do you anticipate making in retirement?
Little or none - my home and car are fine.
I’ll need to replace cars and appliances.
I plan to upgrade after I retire.
5. How much (and what type) of travel will you want to do during retirement?
Not much - I’ll let the world come to me.
I enjoy getting out to see folks.
I’ll finally have plenty of time to see the world!
6. What do you plan to spend on hobbies, gifts and other recreational activities?
Not so much - I’ve got what I need.
I plan to maintain my activities and giving.
More time means I’ll spend more on recreation.
7. Will you continue to provide financial assistance to children and/or parents?
No - they’ll be able to take of themselves.
Some - they count on my help.
More - I’m wealthy and they need help.
Retirement Income Quiz Score:
Income Replacement Ratio:
Zero - 1
2 - 4
5 - 8
9 - 12
Of course that’s still an estimate - but within your answers to these seven questions lays the solution to creating the retirement lifestyle you desire. You can spend more time comparing your current expenditures and your post-working life projections and create a detailed budget, divided between early, mid and later retirement phases, to get a more accurate projection of your investment income needs.
9 Expenses that Change as You Age:
There are nine major expense categories that vary with each individual’s situation and desires. Major planners will work through a best-case, worst-case and average for their future expenditures. They’ll also factor in the three general phases of a retirement lifetime: early, middle and late stages when your mix of these major expenses can change dramatically.
Whether you start with one general estimate based on your current expenses or make several variations, be sure you factor these into your plans:
TAXES - usually one of your highest expenses, you just might not notice since they’re deducted from your paycheck!
At the federal level, you’ll get an additional deduction when you turn 65 and many states also up your deduction or completely exclude some pension income.
Social Security and Medicaid taxes combine for 8% - 10% or more of most wage-earners’ gross income. Those stop when you stop earning income (tho some Social Security payments are taxable).
RETIREMENT SAVINGS - if you’ve been diligently saving 10%, 15% even 20% of your gross income, you can reduce your retirement budget by a corresponding amount.
HOUSING - many older people are able to downsize their living space. Once kids are grown and out on their own, the expense and burden of maintaining a large home make moving into smaller quarters attractive.
Or, if you complete paying off your primary residence mortgages, you’ll only need to account for taxes, insurance and maintenance expenses in your retirement budget.
But remember, your heating and cooling bills may increase if you spend a lot more time at home!
DEBT SERVICING - more retirees are carrying their consumer and medical debts into retirement. And, if you’ve got a substantial retirement income, you won’t have a problem finding lenders who will gladly help you get into and stay in debt.
According the the Federal Reserve, the average household debt repayment has dropped from a 2007 recession high of 13.2% of income to 9.9% of 2014 income -- that’s still nearly 10% of the average budget.
If you start a debt repayment program that involves paying off the highest interest loans and stop accumulating new debt, you could knock another 10% off your retirement income needs.
EDUCATION - are you helping send kids or grandkids to school? There’s a big expense that decreases or goes away altogether when you retire!
WORK RELATED - do you wear business suits to the office? Commute? Give gifts to a gaggle of co-workers? Even your morning cuppa joe gets cheaper when you make it at home instead of stopping at Starbucks everyday.
HOUSEHOLD SERVICES - this may go up or down, depending on how much help you’ve been hiring. It will also vary as you go along. Maybe you enjoy doing the yard-work or the dusting now that you have more free time but as you age you may not be able to continue keeping up with the chores.
HEALTHCARE - as we noted in the quiz, even with Medicare we’re going to need to allocate an increasing amount to maintain insurance coverages and pay non-covered expenses. Healthcare inflation has run well above the core rate of inflation for most of our lives. While it may level off, this expenditure is too important for maintaining your standard of living to ignore.
The most recent projections I’ve seen say that a 65 year-old couple needs to allocate $220,000 over their retirement lifespan for medical and health related expenses. AARP hosts an online calculator where you can get a more customized estimate based on your answers to some health related questions. Start your own estimate of retirement health expenses by clicking the AARP button above.
Also, If you’ve not yet calculated your longevity, I recommend you spend a few minutes answering the questions at www.Livingto100.com and get an idea of how long you need to plan on living!
- ENTERTAINMENT - this is where you can plan to spend a bit more in early retirement and then scale back as you age. It’s also very discretionary. If you hit your high-end account balance target, feel free to indulge. If you’re a bit short, postpone that big 70th birthday blowout!
And, for Our Math Lovers…
If you really like formulas and spreadsheets, gather the following figures and calculate the ratio of your current income you’ll need in retirement:
Gross Current Income (GCI)
Current Income Taxes (CIT)
Savings from Current Income (SCI)
plus or minus
Net Change in Expenses (NCE)
Retirement Income Taxes (RIT)
Gross Current Income (GCI)
equals yourIncome Replacement Ratio (IRR)
OR: GCI - CIT -SCI +/- NCE + RIT / GCI = IRR
Now you can find the total income you'll need in retirement (the ratio of future income times current income), subtract any pensions and programs income you can count on receiving, and end up with the amount of income you'll need to produce from your savings and investment accounts.
I check my net worth, my spending and saving progress, and my portfolio (combined from several different bank, real estate and brokerage accounts) using Personal Capital at least once a week, sometimes every day ...
... after all, it's free and so easy.
Personal Capital has great tools for tracking spending (some users have cut their spending by as much as 15%), but what I love most is their automated financial dashboard.
That's where you will look at all your assets and debts, it will look at your asset allocation, project where you'll be at retirement, and find suggestions about how to manage risk and improve returns.
It's free, I think their tools and charts are great, and it's worth checking out
- like you can do by clicking here>>
STEP 2. How Much to Expect from Your Savings and Investment Accounts
Next, you’ll need to know what ROI (return on investment) you can realistically expect on your retirement savings/investment accounts. This is where standard financial planning attempts to assess your “risk tolerance” and allocate your funds between debt (bonds) with fixed returns, equity (stocks) which provide both dividends and capital gains/losses along with volatility, and cash (near zero returns).
If you have not been actively investing for 10 years or more, you’ll have to do some guessing about the ROI and risk you'll assume. If you’ve established a track record and have been following a customized plan, you can project based on your own results and proven risk tolerance.
Note too, that the financial planning community uses a couple rules-of-thumb regarding the percentage of your accounts you can withdraw annually and still have a good chance of funding your entire 20+ year retirement life. The most conservative is 4% of the balance.
Using what’s called a Monte-Carlo calculation (probabilities), you can see how changes in your beginning balance, withdrawal rate, the number of years you plan to be retired and your Stock/Bond/Cash allocation change the possibility of you running out of money before you die.
Vanguard offers a free and easy calculator (just click the images below to create one for yourself).
Here are two different ways to get the probability of your accounts enduring to over 90%. The first one projects a full 30 years of retirement, a “conservative” 25/50/25 stock/bond/cash allocation and the 4% withdrawal from a million dollar beginning balance:
So, for every $10,000 in annual income you need from your investment accounts,
you’ll need to start with a quarter million dollars.
But, if you’re willing to work 5 more years (cut retirement down to 25 years) and save another $700,000 plus be more aggressive in your allocation (70/20/10), you can take out 4.4% per year and have a 91% chance of dying before your money runs out!
You’ll need only $226,667 in your account for every $10,000 of annual income for a 25 year retirement if you’re willing to keep 70 percent of your investments in the more volatile equities.
The asset returns in Vanguard’s simulation are based on the long-term performance of some representative indexes:
- Stocks on various equity indexes (they’ve changed over the years) that, in Vanguard’s opinion, represent achievable returns for average investors;
- bonds on high grade corporate indexes and
- cash returns are based on the short-term Treasury Bill indexes.
As the disclaimer says, your results may vary.
3. Know Your Number - Target for Savings and Investment Balances
Now that you have an income target and an earnings estimate, you can determine the size of the account you’ll need to build before hitting your retirement age.
In the financial press, this is referred to as your “NUMBER”
I teach people to find both their minimum number and a high-end number. Once you reach your minimum, you can consider taking some chances - what if you quit your high-paying, high-stress job early and go work for that non-profit at a drastically reduced salary?
Or maybe just start taking all your vacation days and check a few of those bucket-list items off before you’re too old to enjoy an elephant ride through the jungle?
But, you've still got your big, high-end number that keeps your accounts growing and would fund all your dreams: round-the-world trips, grandkids' colleges, charitable endowments - whatever you've got on your list!
>> Let's see how this works with four examples:
- Ruth – divorced, mom of two college students
- Carol & Bob – dual income, two college bound teenagers
- Craig and Bettie – single income, three children
- Jackie – single, no children
Ruth, age 50, has a fairly high expense lifestyle to go along with her executive level salary of $120,000. She pays her mortgage, two car payments (one for her, one for the kids to share when they’re home) and some college fees. She plans to pay off her mortgage before retirement, own a paid-off car and have no other debts. She got half the pension and half the 401k in her divorce 8 years ago but she hasn’t added to her retirement accounts since.
She likes her job, it’s physically easy with a minimum of travel, so she’s planning to work until she’s 70 (or they put her out to pasture, as she says). Then, hopefully, a quiet retirement with visits from the grandkids and a modest retirement lifestyle – remaining in her home (renting out a room is an option), flower gardening, quilting and a little travel visiting relatives and friends.
That means her expenses in retirement should be lower - let’s say 70% of her $120,000 income: $84,000. If she works until age 70, she’ll receive a higher Social Security payment - about $40,000 (from the easy to use estimator at: http://www.bankrate.com/calculators/retirement/social-security-benefits-calculator.aspx).
She’s also entitled to ½ her husband’s pension which starts when he turns 60 - about $10,000 a year ($100,000 before she retires that can go into her savings/investment accounts). Total, she needs $34,000 a year from her retirement accounts for at least 25 years.
Using the conservative 4% withdrawal and 25/50/25 allocation, she needs to have a minimum of $850,000 by age 70. With 20 years to go, she should be able to use the power of compounding to easily meet or exceed that goal!
They currently have high expenses with a mortgage, two car payments and college account funding. But, they plan to pay off their mortgage before retirement, complete the kid’s college, pay-off both cars and other debts. They don’t plan any major expenditures and anticipate a modest retirement lifestyle – remaining in their paid-for home, gardening, local fishing and kayaking and some domestic travel visiting (and staying) with relatives and friends.
They will reduce expenses and keep them fairly low, living on about 70% of their pre-retirement income. If their current, combined, gross income is $100,000 and stays at that level until they retire at age 67 (their full social security benefit age), they will need an income of $70,000 per year, of which about $40,000 comes from the Social Security program (a very rough estimate - get a better, personalized one from: http://www.ssa.gov/retire2/estimator.htm ).Assuming they have no defined benefit (pension) plans, they need to withdraw $30,000 per year from their savings/investment accounts. Using the conservative 4% withdrawal and 25/50/25 allocation, they need to aim for a minimum of $750,000 in their savings and retirement accounts by age 66.
Craig and Bettie live a modest lifestyle on one $50,000 income which they plan on maintaining after their children leave home and they reach full retirement age at 67. They have little or no debt but they anticipate caring for their parents during the first 10 years or so of their retirement.
Their tax rate is fairly low, they haven’t been saving for college expenses or retirement and they drive an eight year old car that will need to be replaced at least once during their retirement.
Compared with the couple above, Craig and Bettie will need a higher replacement ratio, as much as 90% - 100%, because they don’t earn as much in their pre-retirement years, have fewer expenses they can reduce and can anticipate substantial costs for the care of their parents.
If Social Security pays them $22,000 per year, and Craig’s auto-worker pension pays him $11,000 per year, they’ll need to withdraw $17,000 per year from their (non-existent) savings and investment accounts.Using the conservative calculations, they need to accumulate at least $425,000 before retirement. Maybe Bettie can get a job and direct the majority of her earnings to their savings?
Jackie has always been a renter - she’s been forced to relocate several times to stay employed - but wants to buy a small retirement home.
She isn’t a big spender but wants to do some traveling and scuba dive more often when she retires at 67 years old. She saves about 10% of her income in her employer’s 401k plan (with a 2% match), carries no consumer debt and pays a small portion of her health insurance. Her car is paid off but she’ll need to buy at least one newer model car before retirement and another one after she retires.
If Jackie plans on buying with a mortgage (almost always more expensive than renting for the first 10 years), spending more on entertainment and covering her own medical expenses, she will need to replace at least 100% of her pre-retirement income to finance her expected retirement lifestyle.
Assuming she collects $20,000 in Social Security, she’ll need to withdraw $25,000 per year from that 401k which needs to be at least $625,000 if she expects it to last her 30 years!
It’s a good thing Jackie is young and has lots of time to save… but, she also needs to learn how to create income from her savings/investments so her savings can compound over the next 20+ years she works and throughout her retirement.
So, I hope you can see how important planning and knowing your answers to these three steps are to your secure (and fabulous) financial future.
REMEMBER: GO NOW and ...
1. Decide how much income you want from your retirement funds each month or year.
Take the quiz in step 1, or
Use the budget projections to find the ratio of retirement income need to your current income or
Work out a realistic retirement budget for each of the major categories of expenses.
2. Project the ROI (return on investment) you need to meet your savings and investment income goals.
Know that yes, it is possible to earn significantly more than the “conservative” 4%. But, that means you want to learn (and are willing to do the work) to improve your returns and get comfortable with volatility (and use it to your advantage). **MoneyDiva can help you with this process too!
The sooner you start, the sooner compounding, the “8th Wonder of the World”, according to Albert Einstein, kicks your returns into high gear.
3. Know: Your minimum NUMBER and your high-end NUMBER.
How much more do you need in your accounts to securely withdraw enough to fund your retirement lifestyle?
And, what’s your plan for getting to your NUMBER?
>> Will you work more years?
>> Can you reduce the costs of your desired lifestyle?
>> Or learn to increase the ROI of your investments?
All these are options - you can pick one or combine them to achieve financial freedom during your “golden years”. But, to live the fabulous retirement of your dreams, you need to plan ahead and start ASAP!
I’d love to hear about how this special report helps you find and achieve your retirement income goals. Talking about income and financial information can be a taboo subject so, if you’d prefer to email me privately, with your calculations or any questions send me an email at: Leah(at)MoneyDiva.com
While I can’t offer specific financial advice, I am happy to clarify any points, direct you to more resources and cheer you on!
Live Long and Prosper, Leah the MoneyDiva.com