In planning for retirement, determining how you will derive your retirement income is perhaps your most important consideration. Retirement income can come from a variety of sources: a company pension or other fixed-benefit retirement plans; a 401(k) or other retirement savings that you can either keep as a nest egg or use to produce an income stream; nonretirement savings held in taxable accounts; Social Security; an inheritance; even income from continuing to work.
80% Of Preretirement Income
You will have to determine how much income you actually need in retirement, to ensure that the income you’re planning for will be sufficient. How much income will you need for retirement? A longstanding rule of thumb has held that you will need approximately 80 percent of your preretirement income to maintain roughly the same standard of living. This guideline takes into account that certain expenses will decline or be eliminated immediately upon your retirement: daily commuting expenses, wardrobe expenses, certain entertainment expenses, and of course the percentage of your salary that you were contributing to your company’s pension fund or your own 401(k) or other individual retirement account. And if you’re downsizing your living space by moving to a smaller home, you’ll save in countless ways, from property taxes and insurance to utilities bills and lawn care expenses.
What Will You Do In Retirement?
However the 80 percent guideline is just that — a guideline. The most important consideration in determining your income needs is how you plan to spend your retirement. Many retirees, particularly if they retire early and in good health, find that their spending actually goes up in retirement, at least in the early years. Many retirees travel, and if you want to travel in some comfort or visit exotic, faraway destinations, that will cost you money. Retirees often spend more on entertainment; you’ll have more leisure time for various pursuits that will cost you extra. Retirees eat out more often. And, as you begin to slow down in your later retirement years, you’ll inevitably spend more on health care. Even if you have good health insurance, there will be copayments and other health-related expenses to bear.
The best way to determine how much income you’ll need in retirement is to work out a budget. Start with your monthly expenses: housing-related expenses, utilities, insurance premiums, groceries, fuel, and other costs you can’t avoid. Then factor in any debt servicing you still have, whether a mortgage or credit card debt. Totaling these necessary expenses, you’ll begin to get some idea of a rock-bottom minimum income.
Then figure in your discretionary spending: how often will you eat out? Go to the theater? Throw dinner parties? Play golf? And work out a budget for travel. If you plan to splash out during your first year of retirement on a four-month, round-the-world extravaganza, you might tap into savings to cover the cost. If you’re more likely to take shorter annual trips to the beach, to the mountains, overseas, then work the costs into your budget.
Maintain Your Emergency Fund
Most financial advisers hold that, when you’re working, you should maintain a cash fund, equivalent to at least three or four months’ worth of living expenses, that you can tap into in emergencies. You should continue to maintain such a reserve fund in retirement, to cover medical emergencies, for instance. If you don’t have such a reserve fund, then build one up gradually, and work that into your budget as well.
Factor In Inflation
Once you’ve gone through the numbers, you should have a better idea about your retirement income needs. You might find that you’ll need close to 100 percent of your preretirement income during the first few years of retirement, and that your needs will gradually diminish after that. However, don’t forget that, over the years and decades, inflation will erode your purchasing power, particularly if you’re relying on a fixed-income pension for your primary income.
With these various factors in mind, it shouldn’t be too difficult to come up with some rough numbers, and you can always make adjustments later. But work out the numbers well before you’re actually retired. If you find there’s a great disparity between your retirement needs and your actual projected retirement income, you’ll then have time to ramp up your savings or take other measures to ensure that you’ll have a comfortable and fulfilling retirement.