Are You on Track for Retirement? 5 Ways to Make Sure You Can Retire on Time
It’s called “retirement planning,” but one of the first things you need to accept about the process is that those plans can and do change repeatedly. Therefore, having a process for anticipating and dealing with the need to change course is an essential part of retirement planning.
The reason you need this kind of flexibility is that retirement planning is based on a series of assumptions about the future:
- What inflation will be
- How well your investments do over time
- When you actually retire
- When you or your spouse die
Since there is a fair amount of uncertainty associated with each of these assumptions — especially when they are made over a period of decades retirement planning should acknowledge that you are not working toward one certain outcome, but rather toward a range of different possible outcomes.
To assess the impact that range of possibilities may have on your retirement, you should consider stress testing your retirement plan while you are still working. Consider some of the things that could go wrong, and figure out how much impact that could have on your retirement saving and spending targets. This should help you understand what kind of contingency plans might be necessary if everything does not go perfectly according to your assumptions.
5 Ways to Make Sure You Have Enough Money to Retire
The following are five examples of how your retirement planning assumptions may turn out to be off track — and how you can stress test your retirement plan by finding out what would happen if these unpleasant changes come to pass
1. Assume the Value of Your Retirement Investments Falls by 20%
If your retirement investments are in the stock market or in other volatile vehicles, you must prepare for the possibility of a decline in value. Historically, the U.S. stock market has had a negative return in nearly one out of every three years. On six occasions, calendar year declines have exceeded 20 percent, and there have also been a few instances when multi-year declines have compounded losses.
When it comes to building your retirement savings, investment losses are especially devastating later in your career, as you near retirement. That’s when you have the most savings to lose, and the least time to recover. So, stress test your retirement plan by seeing how a 20 percent decline in your last year before retirement would affect your retirement spending.
What Can You Learn From This?
See if you can put together a workable contingency budget based on the reduced spending amount you’d have available. If the result of a decline would be too damaging to your retirement budget, use this as a reminder to start reducing your stock allocation and increase stable investments, such as certificates of deposits, as you approach your retirement date.
Assume Your Retirement Expenses Are 15% More than Expected
Retirement calculators use inflation assumptions to project expenses, but inflation is highly variable. Plus, estimating anything over a long period of time is almost inevitably going to result in some inaccuracies.
Suppose you used a 3% annual inflation assumption in your retirement planning calculations over the next 25 years. If actual annual inflation was higher by just two-thirds of one percent, that would be enough to elevate your retirement expenses by 15%.
What Can You Learn From This?
As you save for retirement over the years, keep a close eye on how actual inflation is tracking with your assumption. If prices are rising faster than you planned, you may have to boost your retirement saving rate to keep up.
3. Assume You’ll Live 10 Years Longer than Expected
Perhaps the most confounding thing about retirement planning is that longevity is actually a form of risk-the longer you live, the more money you need.
If you used an average life expectancy in your retirement plan, don’t forget that roughly half of all people live longer than average. If you don’t want a 50/50 chance of outliving your money, run a retirement calculation assuming you live at least 10 years longer than the average retiree.
What Can You Learn From This?
Two things: Since longevity is uncertain, the more of a cushion you can build into your retirement assumptions the better. Also, using a longer life expectancy should guide you to be more cautious about the rate at which you deplete your savings in retirement.
Assume Your Home Will Sell for 40% Less Than Its Current Value
Many markets across the U.S. saw declines of that magnitude during the housing crisis that began in 2006, so it could happen again. If you are counting on the value of your home to bolster your retirement savings by downsizing in the future, keep in mind that the value you receive depends greatly on what kind of market you sell into.
What Can You Learn From This?
The possibility of any type of investment setback should encourage you to build enough retirement savings to offset that kind of setback.
In particular, since people often have a dominant share of their net worth tied up in their homes, the uncertainty of future real estate values should encourage you to diversify your savings in different types of investments in a 401(k) plan or other retirement plan.
Finally, building in some flexibility as to when you sell your home can insulate you somewhat from being forced to sell at a bad time.
5. Assume Your Employer Reduces Matching Contributions on Your 401(k)
If you participate in a 401(k) plan you may be receiving matching contributions from your employer.
Keep in mind that these contributions are not mandatory, and the employer could change the plan document to reduce or eliminate them.
This would require you to raise your 401(k) deferrals to compensate, or else plan on having less retirement savings.
What Can You Learn From This?
Be aware that if your employer changes the matching formula for your 401(k) plan, you should immediately rework your retirement calculations accordingly. Also, if you are thinking of changing jobs, be sure to think through what the matching formula at your new job would do to your retirement plan.
Doing these kinds of stress tests might seem like a scary exercise, but if trouble lurks, it’s better to be prepared than caught completely by surprise.
