It's Time to be Realistic about Retirement
From how much you'll need to how you'll spend your time, your retirement plan needs to be grounded in reality.
Some people approach retirement strategically with the confidence they will have job security that lasts until their chosen retirement date and enough wealth when the time comes.
These lucky few can look forward to retirement differently than the majority of us. They aren’t being forced to retire at a certain age, but rather they determine what their asset level should be to enjoy a comfortable retirement and concentrate on accumulating sufficient wealth to achieve it. The key to their contentment is having work span flexibility and an understanding of their retirement financial needs, based on a strategic process.
The takeaway: They don’t retire at 65 because “That’s what you do.” Instead, they discover how much it takes to retire comfortably, make it their goal and, once they reach it, make the timing of their retirement on their terms.
Unfortunately, many of us do not have this flexibility, due to unexpected work or health issues. Therefore, it is critical to have a plan in place with built-in contingencies to handle the resulting lifestyle consequences.
How Much Do You Need to Live On?
Everyone is faced with one reality: No one knows how long they’ll be retired. So, knowing how much to save is a tricky proposition. Retirees are often told to plan on living on 70% to 80% of their preretirement income. Unfortunately, this advice can result in an unrealistic and unsuccessful retirement, where funding shortfalls cause an undesired lifestyle changes.
Retirees are confronted with many variables, many of which they have limited or no control over, such as investment rates of return, life expectancy, health costs and rates of inflation. On the other hand, certain expenses are controllable, based on quality of life preferences, as well as lifestyle decisions and the individual’s chosen retirement age.
In determining one’s retirement financial needs, people often look at their salary and use that as a basis for their planning. But it’s not that simple. Theoretically, someone making $100,000 a year as a salary has a percentage going to Social Security and Medicare (7.65%) and perhaps, pretax retirement savings of 10%. Taking just those two variables into account, this individual might think they wouldn't have to save enough to create $100,000 per year in retirement income to enjoy a similar lifestyle. They are now down to needing $82,350 per year.
What this equation doesn’t factor in, however, is that certain employer-provided fringe benefits may now have to be personally paid for in retirement, including health care, Medicare premiums, life insurance premiums and other similar benefits. Those kinds of oversights are what could leave retirees coming up short down the road.
The bottom line is that when trying to determine how much you’ll need for retirement, making a blanket discount-to-salary assumption does not make sense.
The best strategic retirement plan starts with a formal process and builds out a realistic life plan that takes into account all of the above variables, then stress-testing them to demonstrate that retirement can be successful. The plan then becomes a living document that should be updated at least annually to reaffirm that the retirement goals are attainable.
Too often, retirement planning is started late in life and close to retirement age. This has created a trend of delaying retirement by up to 10 years due to insufficient savings and increased life expectancies.
Retirement Spending Myths vs. Reality
Planning for retirement involves quantifying spending, and this should not be based on a spending myth or rule of thumb. For example, as we saw above, using the 70%-80% rule of thumb without taking into account lost fringe benefits and medical needs could mean having 20% less real assets for retirement than needed.
Given the importance of accounting for the retirement variables people face, it’s best to spend the time to go through a methodical process that includes figuring out your current spending and your realistic retirement lifestyle.
Determine how much you spend now
Break down how much you spend now into broad categories such as fixed costs and variable costs.
- Fixed costs include housing, maintenance and Medicare insurance.
- Variable costs include food, entertainment, taxes, travel, personal services, utilities, shopping, transportation and work-related costs, etc.
Other spending areas to consider include non-covered health care (e.g., dental, vision), charitable donations and risk-related insurances, such as life insurance, long-term care insurance for nursing home care and liability coverage.
Establish your ideal, realistic post-retirement lifestyle
Knowing whether you plan to work part-time in retirement, how much you can expect in Social Security benefits and any pension you can expect to receive will help determine some retirement spending decisions and the lifestyle you may intend on living.
Once you establish the type of lifestyle you are hoping to live, for budgeting purposes, split your retirement needs into the following three intervals. These intervals reflect different levels of activity and levels of spending and assume you are healthy when you start retirement:
- First five-10 years post-retirement: Spending increases, because the newly retired are apt to spend time and money vacationing, going out to eat and crossing items off of bucket lists. Rare is it that people retire to the couch and spend their golden years watching TV.
- Years 10-15 years post-retirement: Spending typically levels off as health needs replace lifestyle needs. Traveling is a hassle, and less discretionary spending is taking place.
- Years 15+ post-retirement: Health and life maintenance costs take up the bulk of any excess discretionary lifestyle spending.
It is not unusual to find that during the first post-retirement segment spending actually increases by 10%-25%, depending on the level of desired activity, followed by a leveling or drop-off of 10% in the next segment. The final segment is really a function of assumed health and health-related needs, but we find it is better to assume no drop-off from level-two spending. In all cases remember that variable costs need to be inflation-adjusted when doing your planning. The ongoing annual review of your retirement plan allows you to update these segments to be more conscious and sensitive to your actual and expected health and lifestyle limitations.
Retirement Planning Is About More than Money
Clearly, post-retirement costs are a function of lifestyle choices. Most people do not expect the eight to 10 hours a day previously spent at work to be replaced in retirement with couch potato time, but rather they assume their time will be spent traveling, visiting family, volunteering or working part-time, investing in new vacation homes, etc.
Suddenly not working can result in boredom. Successfully retiring is more than having the means, it has to have meaning. Retirees want a sense of purpose and prefer to have a regular schedule. Setting up retirement goals and planning a post-retirement lifestyle is just as critical as having the money for when you finally decide to call it quits.
The key takeaway is to start the planning process early. Do not base decisions on rules of thumb, but do the math based on lifestyle choices. Finally, take into account contingencies and plan accordingly.
This article is for informational purposes only. It is not intended as investment or tax advice and does not address or account for individual investor/taxpayer circumstances. Please click here for important additional disclosures.
About the Author
Andrew Bass, CPA, CWM, PFS
Chief Wealth Officer, Telemus
As the chief wealth officer, Andrew Bass is responsible for all strategic financial and life management services of Telemus. He works with high-net-worth members to ensure their financial life plans are designed to achieve realistic goals in both the short and long term.