Retirement Planning Guide
Whether you are just starting your career, winding down toward retirement, or somewhere in between, there are positive steps you can take toward financial security.
Retirement planning is not a single step but a continuous series of actions. You plan, you work toward your plan, and then you adjust your plan and keep working toward it. The most productive steps can be taken very early in your career, yet the work is never done not even once you retire.
How Much Money Do I Need to Retire?
If the basic retirement planning question is "how much money do I need to retire," a retirement savings calculator can give you a pretty straightforward answer. It can help you figure out how much money it will take to see you through retirement, and how much you need to save each year between now and then to reach your target.
The answers you get from a retirement calculator are just the starting point. This guide will help you understand how to work with a retirement savings calculator, but the information those calculations give you is by no means a final answer.
Those calculations are based on assumptions about how long you will work, what inflation will be like in the years ahead, and how much your investments will earn. All of those things might turn out to be different than you expect, which is why you have to revisit those calculations from time to time so you can adjust to how things are actually playing out.
Also, your retirement savings calculator might give you a target you can't afford to meet right now. That's not the end of the world, because you still have options. You can either reduce your retirement lifestyle expectations, or you can plan to raise your savings rate over time as your career progresses and your earning power increases.
Putting Retirement Planning Into Action
Even though your retirement plan will always be a work in progress, you need to take steps to put that plan into action. Think about getting your spending habits retirement ready now.
This means saving and investing.
- Use a retirement calculator to come up with a budget that allows for setting aside money out of each paycheck for retirement saving.
- Learn some basic investment concepts that will help you put those savings to productive use.
As with creating a retirement plan, the implementation of that plan is a continuous process rather than a single step. Your investment needs change as your career progresses. Investment results and market conditions also change and require you to adapt.
Perhaps most importantly, you'll find that there's always more to learn about investing. As you learn, you can put what you've learned to use by adjusting your investment approach.
Stay the course and adjust as needed
Once you start saving and investing for retirement, don't expect everything to fall into place automatically. Investment results may disappoint, your lifestyle goals might change, or you might have fallen behind on some of your savings targets.
This is why you regularly need to review your plan and your progress toward it and make adjustments from time to time. Resetting the plan and taking steps to implement your revised plan will help keep you on track over the decades it takes to save for retirement.
So when is the right time for retirement planning? This process of constant adjustment means that the answer is always "now."
Setting Up Your Retirement Plan
There are two main parts to setting up a retirement plan: figuring out how much money you will need to retire, and planning how to come up with that money.
Setting your target
Figuring out how much money you need in retirement involves examining what it will cost to support the lifestyle you plan and projecting that cost out over the total number of years you expect to be in retirement.
A retirement calculator can crunch the numbers for you, but the results you get are only as good as the information you put into the calculator. So, using a retirement calculator effectively depends on coming up with good assumptions about a variety of things that will affect your financial needs in retirement.
Coming up with good assumptions can be more difficult than it sounds, because you don't know in advance how long you will live nor how inflation will raise the cost of living by the time you retire. However, the more you know about the variables the better you will be able to base your retirement plan on informed estimates of those variables.
Figure out your retirement expenses
There's a simplistic rule of thumb that says you should shoot for living on 80% of your working income during retirement. While this is good in theory, there are many variables.
Trying to base the amount of retirement income you'll need on how much you earn during you career can be a flawed approach for several reasons. Some people earn much more than they need to support their lifestyle, while others rely on borrowing to support their standard of living. In each case, income is not a very accurate indicator of living expenses.
Therefore, the best place to start when calculating retirement expenses is by taking a look at how much you spend each year. Identify how much you spend and what you spend it on.
Look at your list of expenditures and figure out how that list might change when you retire. There are certain expenses, like those associated with raising children, that should no longer be necessary by the time you reach retirement age. Also, you might have paid off your mortgage by then and thus have much lower housing costs or decide to downsize to a smaller place.
Just as some expenses might drop, others might increase. Health care expenditures for people in their seventies can be several times what they are for people in their twenties. With time on your hands in retirement you may want to travel more or take part in other leisure activities that cost money.
By itemizing your expenses you can start to pick and choose which of those expenses will be part of your retirement lifestyle. Add up the total and you will have an estimate of the retirement budget that would be necessary to support that lifestyle.
The next step is figuring out how much money it would take to sustain that lifestyle throughout the length of your retirement years.
How Long Will You Live After Retirement?
Here's one of the odd things about retirement plan: a long life is normally thought of as a blessing, but when it comes to retirement planning the possibility of living a long life adds to the risk that you will outlive your money.
Naturally, there is bound to be some uncertainty about how long you will live. It's especially hard to predict when you are young and just starting to save for retirement. However, there are some ways you can make an estimate that is good enough for long-term planning purposes, and you can also take steps to cushion against the risk of relying on a lifespan estimate.
How Does Life Expectancy Affect Retirement Planning?
Start by considering the question of life expectancy. According to the Centers for Disease Control, the average life expectancy for a newborn baby boy in the United States is about 76 years. For a newborn girl, it's about 81 years.
It might seem logical to use those averages to estimate your lifespan for retirement planning purposes, but there are a couple of problems with that.
For one thing, those averages are impacted by the portion of the population that dies young. Of course, you'll only reach retirement age if that doesn't happen to you. That means that a person reaching retirement age can now be expected to live beyond those overall average lifespans of 76 years for men and 81 years for women.
In fact, the Social Security Administration (SSA) projects that at age 65, the average man can expect to live for nearly 18 more years. That would extend his total life expectancy at retirement age to about 83 years. The average woman at age 65 can expect to live just over 20 years, so her total life expectancy at retirement age is a little past 85 years.
Using life expectancy at retirement age rather than overall averages gives you a better estimate of how many years of retirement you will have to fund, but this still can leave a substantial risk of outliving your money. After all, those life expectancy figures are averages, meaning that roughly half the population lives longer than those averages.
Thus, counting on an average life expectancy at retirement means you will have roughly a 50/50 chance of outliving your money. If this represents an unacceptable level of risk to you, think about pushing the lifespan assumption in your retirement calculations well beyond the average.
Of course, if you do that it will mean needing to fund more years of retirement, which will require a higher level of savings while you are working. Try running a few different longevity assumptions through your retirement calculator. This will help you come to terms with the trade-off between reducing your risk by using a longer lifespan assumption and the extra cost it would take to fund your retirement on that basis.
How Will Inflation Impact Your Retirement Money?
When you go through the exercise of looking at your current expenditures to estimate what your retirement budget should be, remember that everything in that budget is likely to cost more in the future due to inflation.
Retirement calculators will often adjust future dollar amounts for inflation, but this relies on an assumption of what the inflation rate will be.
Over the past 50 years, inflation based on the Consumer Price Index has averaged 3.9% a year. However, inflation can be quite variable. Over the first half of that 50-year period inflation averaged 5.73% per year. Over the second half, it averaged just 2.19%.
How much does a difference of just a few percent a year make? Projected over a long period of time, a seemingly small difference in your inflation assumption can have a huge impact.
For example, if you are 30 years from retirement and you use an inflation assumption of 2% you would come to the conclusion that it would take $18,113.62 at retirement to fund the equivalent of $10,000 in today's dollars. However, if you use a 5% inflation assumption you would calculate that it would take $43,219.42.
As with the lifespan assumption, choosing an inflation assumption involves a trade off. A higher inflation assumption reduces the risk that your savings target will not be enough to afford the cost of living when you retire, but it will also require you to save more money to meet a higher retirement savings target.
Work with a retirement calculator to find the sweet spot between an inflation assumption that is too low to be realistic and one that is so high it sets a retirement saving target you can't afford.