How Much Money Do You Need to Retire?

A common guideline is that you should aim to replace 60-80% of your annual pre-retirement income. You can replace it using a combination of savings, investments, Social Security and any other income sources (part-time work, a pension, rental income, etc.). 

The Social Security Administration website has a number of calculators to help you estimate your benefits.

It's important to consider how your expenses will change in retirement. 

Some, like health care and travel, are likely to increase. 

But many recurring expenditures will go down. 

You no longer need to dedicate a portion of your income to saving for retirement. You may have paid off your mortgage and other loans. And other taxes are like payroll taxes, which are taken out of each paycheck, will be eliminated completely.

Regarding taxes in retirement, most retirees have been saving for years in their pre-tax 401(k) or 403(b) workplace retirement accounts. One benefit of these plans is that while contributing, you did not pay tax on any of the income you deferred to your account. The downside to this is in retirement, you will have to pay tax at whatever your marginal tax bracket is. 

The great news for most retirees is that their post-retirement marginal tax bracket is typically lower than when working. This makes saving while working into a pre-tax account like a 401(k) or IRA a great choice. However, there can be some downsides here as well. 

If you have a substantial pension, you could end up in a higher tax bracket post-retirement especially after claiming your Social Security benefit. If this sounds like it could be you, we recommend you work with a tax professional or financial advisor that specializes in tax planning to help you plan for future tax consequences.

Another situation where saving into a pre-tax account versus a post-tax account like a Roth IRA might bite you is if you won't need to draw much from your accounts to meet your retirement needs. Many of our clients have been diligent savers and have personal expenses that will be much lower than while working. Especially once they pay off their mortgages. 

If you weren't aware, retirement accounts like 401(k)'s and IRA's have an IRS mandate to begin taking distributions by age 72 (if turning 72 after 1/1/20) or previously 70.5 (if turning 70.5 before 1/1/20).

These required minimum distributions (RMD's) can be quite the surprise for folks that will not need the full distribution but will be required to take them anyway. The great news is there are tax planning techniques to help you prepare for an optimal tax situation in the future. 

Be sure to adjust based on your retirement plans. If you know you won't have a mortgage, for instance, maybe you plan to replace only 60%. If you want to travel every year, you might aim to replace 100% or even 110% of pre-retirement income.

Cash Flow Planning

A great place to start with determining how much you'll need to retire is by creating a written cash flow plan. You may have heard other terminology for cash flow planning like 'budgeting' which is similar but not quite identical. 

For the purposes of this article, we'll use the terms interchangeably. 

The best place to start with determining your ability to retire is to create a detailed record of your required expenses. We like to break up these expenses into two main categories: fixed and variable expenses. 

Fixed expenses should be expenses that aren't expected to change much on a monthly basis. Mortgage payments, insurance payments, and memberships are common examples of fixed expenses. 

Variable expenses are items you are planning to include in your spending, but may be more flexible in the amount you spend. Examples of variable expenses may include vacations, eating out, and other lifestyle spending. 

Once you have a clear list of your required monthly/annual expenses you will know what your income need will be in retirement. (Pro tip: the first time you create a cash flow plan, leave a bit of wiggle room as most people miss a few things)

Once you have your income need, now you can start creating your plan to meet this income need for the rest of your life. This is where is gets a bit more tricky. 

Many people are great at the initial creating of their cash flow plan but forget the silent killer of long-term planning: inflation. 

Inflation is defined as: "A general increase in prices and fall in the purchasing value of money."

In simple terms, a dollar today will not be able to purchase the same amount of goods in the future due to prices for goods increasing over time. 

The average cost of a loaf of bread in 1990 was 75 cents whereas today it's over three dollars. 

Planning for inflation is one big missing variable many folks planning their retirement on their own often overlook. 

Another common oversight is planning for different amounts of average inflation for different expenses. 

General inflation has been about 2-3% on average over time. The cost of healthcare has increased higher than average inflation (typically 5%). And the cost of college even higher (7%). 

By not accounting for inflation over time, you may be underestimating the total cost of retiring comfortably. 

Once you have your cash flow plan and have accounted for inflation, you can now start to determine how much you will actually need for retirement. 

One expense typically left out of most retirement cash flow plans is planning for long-term care needs. 

Long-term care generally refers to non-medical care (ie, custodial care) for patients who need assistance with basic daily activities such as dressing, bathing and using the bathroom. Long-term care may be provided at home or in facilities that include nursing homes and assisted living.

According the Department of Health and Human Services, 70% of people who reach age 65 will need long-term care and 40% will enter a nursing home. 

In 2050, the average cost for 3 years of long-term care is expected to be about $700,000. Is this cost something you have considered? 

My hope is not to frighten you but to help you think through all the potential costs of retiring before you make the leap. 

If planning for retirement is making your head spin, we are here to help. 

If you are considering retirement in the next 10 years or less, we would love to speak to you on a complimentary retirement strategy call. 

On our call, we'll spend about 45 minutes with you with the goal of helping you identify your retirement readiness. Based on the results of our discussion, we'll recommend specific next steps for you to take to help you get prepared to retire with confidence.

If there are action items that are out of the scope of your expertise, we would be happy to discuss helping you. 

If you would like to take our recommendations and implement them on your own, that's fine too. Our ultimate goal is to help you get clarity on your current situation and what the exact steps you will need to make to transition successfully into a confident retirement. 

If you would like to schedule a complimentary retirement strategy call, you can go to keepitsimplefinancial.com/talk and choose an available time that works for you.