“How much retirement income will I need” is, at best, a guesstimate. There are simply too many variables to determine your exact number: How long will you live? How healthy will you be? Will you or your spouse need long term care? What will the real rate of inflation be? How much will you have to pay in taxes…?
So does that mean that you shouldn’t try? Of course not!
If you’ve ever developed a business plan, you know it’s an estimate based on current assumptions. As the business launches and matures, the business plan is used as a baseline, serving as a crucial point of references for changes that need to be made.
A retirement income plan is no different;
it’s the critical first step is figuring out what your income needs will be.
After all, you need to first figure out where you want to go to figure out how to get there.
But where is “there”? And is “there” a fixed place or is “there” somewhere different based on your age?
If “there” is retirement, isn’t it safe to assume that your income needs will change over the 30 years of retirement? Of course they will! So in our little play on words here, “there” is not a set destination, it’s a moving target.
There are many different ways that we will discuss here to estimate/calculate how much retirement income you will need; the idea is to come up with three estimates, one for each decade of retirement (the “Go-Go Years, the Slow-Go Years, & the No-Go Years).
Once you know how much money you are going to need, you can work backwards, set milestones, and make better decisions about which vehicles and strategies to use without getting distracted by the thousands of marketing messages you receive on a regular basis.
When you start to develop a retirement income plan, you start to eliminate the worry that many people, even those with substantial salaries &/or savings, have about their retirement.
Unfortunately, many people are saving for retirement without a clear picture of their objective. Proof of this can be found in the 2011 EBRI Retirement Confidence Survey which found that 44 percent of people who tried to figure out their financial futures ended up making changes to their retirement savings plans.
That’s why we’ve developed a proprietary financial planning process called
The Retirement Lifestyle Guardian™.
How Much Retirement Income Will I Need
There are various ways to calculate retirement income… You could use a rule of thumb, use one of the many calculators available online, or develop a monthly budget estimate. Let’s take a look at all three.
1. Use a Retirement income Rule of Thumb
There are various rules of thumb that you can use to help you estimate your retirement income needs.
Multiply your current salary by 12
This rule suggests that you should aim to have saved up 12 or more times your current salary to retire comfortably.
So if your current salary is $100,000, you would want to have $1,200,000 in retirement savings.
70% – 80% of your pre-retirement income
This rule says that it’s likely that you’ll need at least 70 to 80 percent of your pre-retirement income to maintain your standard of living during retirement.
Here’s a suggested formula for calculating the amount of income you’ll need:
Average annual income over the 10-year period prior to retirement x .70 = bottom of range
Average annual income over the 10-year period prior to retirement x .80 = top of range
Total Income Needs (-) Social Security & Pensions Payments (x) 25
This rule says that you should have a lump sum of 25 times your estimated annual income needs after you deduct your social security benefit payments and pension payments.
For example, if you expect to need $75,000/year and your Social Security benefits will be $25,000, than you would need $1.25 million ($50,000 x 25).
Note: Rules of thumb are probably best used as benchmarks for your more calculated and accurate estimate. If your estimate is close to at least one of these rules of thumb, great, you’re probably on the right track. If they’re not, you might want to review your numbers and figure out why the variance.
2. Use a Retirement Income Calculator
If you look, you will find online calculators for just about anything you need. But the results that these calculators generate are only as good as the assumptions you put in combined with how they are programmed.
Some retirement income calculators help you figure out how much you need to save on a yearly basis to get you there.
- US News has one such calculator available here
Others tell you both how much you need to save now and how big of a nest egg you need to have put aside.
- Dinkeytown is another great website with calculators for just about every financial concept you can imagine.
- Possibly the best retirement income calculator I have come across for people over 50 can be found here.
This particular calculator shows you how to:
- Safely Increase Income Withdrawals 25% without using account-draining Income Riders.
- Protect Against Market Loss.
- Protect against Inflation and Adjust for Cost of Living Increases without selling clients expensive riders.
- Protect Against Excess Charges and Fees.
- Protect Against Longevity Risks and properly utilize Mortality Credits.
- Create Six-Figure Payout Gains, after providing for lifetime guaranteed income.
If you are over 50, find out how much income you could generate from your savings with this
Deferred Income Annuity Calculator
3. Estimate Monthly Expenses
Rules of thumb and calculators are handy tools, but good old fashion number crunching is ultimately the most accurate measure of what your income needs are going to be.
Obviously, your monthly budget will change over the course of time. The younger you are, the more likely your monthly expenses at retirement will be substantially different than they are today.
But as I said earlier, a retirement income plan is ever changing and will need to be revised, upgraded, and adapted. To figure out what your monthly expenses will be at retirement, start by figuring out what your monthly expenses are today.
Once you have a precise budget of your current cost of living, you want to estimate which expenses will go up due to inflation (cable, electric, phone, internet, food…), which will go down (work related expenses such as gas), which will disappear (home mortgage), and what new expenses might you have in retirement that you didn’t have before (i.e.: travel costs to visit the kids and grand-kids, cruises, etc. …) and come up with an estimate of your monthly living expenses for each stage of retirement.
Once you have this estimate, use one of the rules of thumb to see how close you are. Keep revising this budget as you get closer to retirement.
The Six Pillars of Retirement Income
I strongly believe that a retirement income plan should have a strong foundation that can stand up to the anything.
If you adhere to this line of thinking, then you should make sure that your basic living expenses, the things that you cannot or do not want to live without, are secured by your guaranteed sources of income such as Social Security, Pensions and Annuities.
Once you have an idea of how much income you are going to need, next comes the question “how do I generate the retirement income I need.” There are six primary sources of retirement income.
Social security retirement income
Social Security is your first line of defense. Yes, people argue that Social Security is going to go belly up and won’t be around for Millennials and Generation-Xes… and they may very well have a point.
There is serious question in the international financial community as to how the US plans to meet its foreign debt obligations and that of its citizens (Social Security, Medicare, etc…), but for now, Social Security benefits are an integral and vital part of retirement income plans.
Pension Retirement Income (Defined Benefit Plans)
Although most pensions are guaranteed by the credit worthiness of the entity paying it, there are been many examples of over the past 30 years of people’s retirement plans going awry because the pensions they were promised disappeared.
The norm 30+ years ago, these plans have been, for the most part, replaced by Defined Contribution Plans (like the 401k). Whereas the employer used to have to take the investment risk and provide a “defined benefit” to its employees upon retirement, this risk has now been passed on to each individual employee. The employer now just has to provide a “defined contribution” (a match) to its employees.
But, if you are promised a pension, it’s as close to a guarantee as exists today.
Annuities (Personal Pensions)
Much like corporate pension plans, annuities provide a pension-like payment aimed at providing long term income through retirement. The difference is instead of your employer investing your deposits and then later paying you an income, you work with an insurance company to achieve the same objective.
Annuity income is one source of guaranteed retirement income. Yes, these guarantees are backed by the claims paying ability of the carrier so it is best to choose a carrier with a high rating and more importantly, with a high liquidity ratio.
Personal Retirement Accounts (Defined Contribution Plans)
These “qualified” accounts are funded with pre-tax dollars and usually make up the foundation of your retirement savings. They are funded with pre-tax dollars so all withdrawals at retirement will be taxed at your ordinary income rate (whatever that is at retirement). These include 401(k), 403(b), 457, KEOGH, Simple IRA, SEP IRA, IRA plans.
After-Tax Retirement Accounts.
These “non-qualified” accounts are funded with after tax money and are usually set up in brokerage accounts, trust accounts, annuities, stock accounts, mutual funds, etc…
These monies are usually subject to yearly capital gains and income taxes, unless invested in tax-deferred instruments such as annuities.
Tax-Free Retirement Income
There aren’t many things left that are tax free nowadays. The interest on municipal bonds (Muni-Bonds) is tax-free at the Federal level but capital gains on Muni Bonds is taxable. They are usually best suited for high net worth individuals seeking some tax shelter.
Roth IRA’s can be a very useful tool for managing your tax bill at retirement but just like a traditional IRA, there is a limit to how much you can contribute on a yearly basis. Also, if you earn more than $131,000 (single) or $193,000 (joint), you may not contribute to a Roth IRA.
LIRPs (Life Insurance Retirement Programs) have been growing in popularity as more and more people begin to understand the benefits they provide, namely that funds grow tax-deferred and can become a source of tax free cash flow to fund your retirement.
Saving enough for retirement and making sure you are able to stay retired, and just as important, without constant worry about outliving your savings doesn’t just happen. It means having a plan and working with a trusted retirement income planner!
That’s why we’ve developed our proprietary financial planning process called
The Retirement Lifestyle Guardian™.
Contact me at your convenience to find out more about
how we can help you retire with confidence!
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