Calculating your retirement needs
If retirement is around the corner for you, now is the time to look at your retirement savings and calculate your financial plan. When retirement was years away, knowing how much income and savings you will need may have involved a lot of estimates. Now you can be more accurate. Make sure you consider the following factors when you plan for life after retirement.
The length of your retirement. According to a 2016 report by the National Center for Health Statistics, if you retire at age 65, the average man can expect to live about 18 more years and the average 65-year-old woman can expect to live almost 21 more years.1 Have you accounted for a retirement of 20 years or more?
Your retirement lifestyle. Your lifestyle will help determine how much income you’ll need to support yourself. Half of all retirees cut their spending by at least 5.5 percent in the first year of retirement and by at least 12.5 percent by the fourth year of retirement.2 Remember you’ll most likely be spending your money differently as a retiree. Your commuting expenses may practically disappear, but your spending on health care may increase over your retirement years. A typical guideline for how much to spend annually is 60 percent to 80 percent of your final working year’s salary, but if you want to take luxury cruises or start a business, you may need 100 percent or more.
Earned income. Will you be working during retirement? Even on a part-time basis, an income can reduce your need to tap retirement assets for ongoing living expenses.
Health care costs and insurance. Most Americans are not eligible for Medicare until age 65, and even then, Medicare doesn’t cover everything. You can purchase Medigap, supplemental insurance to cover some of the extras, but even Medigap does not pay for long-term custodial care, eyeglasses, hearing aids and other ongoing essentials.
Inflation. Because the rate of inflation can vary over time, it’s a good idea to tack on an additional 4 percent each year to help compensate for increases in the cost of living.
Running the numbers
After you’ve considered the above circumstances, the next step is to identify potential income sources, including Social Security, pensions and personal investments. Also review your asset allocation―how you divide your portfolio among stocks, bonds and cash.3 Are you tempted to convert all your assets to low-risk securities? This may place your assets at risk of losing purchasing power due to inflation. You may live in retirement for a long time, so try to keep your portfolio working for you now and in the future, and remember asset allocation does not assure a profit or protect against a loss in a declining market.
A new phase of planning
Once you’ve assessed your needs and income sources, it’s time to look at tapping into your nest egg. First, determine a prudent withdrawal rate. A common approach is to liquidate a maximum of 4 percent to 5 percent of your principal each year in retirement; however, your income needs may differ.
Next, you’ll need to decide when and how much to withdraw from your tax-deferred and taxable investments. Investors are required to take annual withdrawals from employer-sponsored retirement plans and traditional IRAs after age 70½. Be aware that these withdrawals are subject to federal income tax. Withdrawals from tax-deferred accounts made prior to age 59½ may be subject to an additional 10 percent tax. In the case of employer-sponsored plans, there are special rules that apply to plan participants aged 55 and older who separate from service.
The advantage of maintaining tax-deferred investments for as long as possible is their ability to compound on a pretax basis and thus offer greater earning potential than their taxable counterparts.
1Center for Disease Control. “Mortality in the United States, 2015,” December 2016.
2Change in Household Spending After Retirement: Results from a Longitudinal Sample, EBRI Issue Brief No. 420, November 2015.