Have you spent any time envisioning what your retirement will look like? I have. Here’s our ideal plan. My husband retires from his company when our youngest heads off to college. Then we sell our home and move to the mountains. “The mountain home I don’t have,” as I call it, will be smaller than our current home, very energy efficient, and much easier to keep clean.
In this ideal world, our housing costs shrink, there are no kids to eat all the food, no homeowners dues, and lower taxes. Then, my husband can work at what he loves to do instead of running the rat race.
Not everyone’s retirement needs are the same; some people aim to spend their retirement in luxury, while others simply want to maintain the same standard of living during their golden years as they had during their working life. So, the income you will need in retirement will largely depend on your own needs and goals.
Your Retirement Income
Once you transition into retirement, your income level and the source of your income both change. For most of your life, your income probably comes from your job. While some people might have one or more income streams that are not related to their paycheck, most of us work at our job (or jobs) and use this income to pay our bills and save for retirement.
When retirement finally arrives, the paychecks generally stop. This is why retirement planning is so important. With the right savings plan in place, you will have the retirement income you need to live the life you want.
But where exactly does retirement income come from? There are three main sources of retirement income.
The first is Social Security. This is a very basic level of income, but not enough to sustain you to live comfortably. You will need more.
The second source of income is some type of recurring income. Think of this as a pension, income from rental property, an annuity policy, or some other source of regular passive income. Not everyone has this reliable source of income, so you will need more.
The third source comes from personal savings. This your company’s 401(k) or 403(b) plan. It also includes IRA’s and Roth IRA’s as well as other savings and investments you have.
You may need to draw money from alternative sources, such as a second job or your home equity. All combined, your goal is to be able to cover your expenses for the duration of your life.
Your Retirement Expenses
You would think that your expenses and overall cost of living would stay the same during your working years and retirement, but this is generally not the case. Expenses can fluctuate for a variety of reasons. For most people, the following categories of expenses are the most likely to change from your working years to your retirement:
Housing Expenses
Working adults usually rent or pay-to-own a living space. Owning your home going into retirement will help cut down on living expenses as you age. You may, however, wish to adjust your living situation by moving into a retirement community, or to a less expensive apartment, house or condominium. The type of housing will also affect your utility costs, though these costs do not usually change as much when you retire.
Medical Expenses
Younger, working adults generally face fewer health complications and do not need to make use of health services as often. However, as we age, we face an increasing number of health complications and associated costs. Medicare covers some of these costs, but you will still have to pay part of your medical bills out of pocket. A large chunk of your retirement income may go toward medical expenses, including doctor’s visits, medications, and age-assistance services.
Travel & Leisure
During your working life, you may not always have the time or funds to travel as much as you’d like. Once you retire, you can dedicate more time to leisure activities like travel, but you must also find a way to pay for it. Even if you have no desire to travel, you may have other expenses associated with leisure activities and hobbies.
Retirees tend to travel and be more active in the early years of retirement when they are in good health. You may find that you spend more early on but run out of funds in your later years as medical expense increase. So, if you’d like to spend your golden years traveling the world or participating in other fun activities, you will need to consider these expenses when planning your retirement.
How Much Do You Really Need in Retirement?
Many factors and individual goals will affect the income you need in retirement. That said, conventional estimates offer a good guide to help you determine your own retirement needs. Traditionally, financial advisors recommend aiming for a retirement income equal to 80% of your current income. For example, if you currently make $100,000 per year, you should work to make $80,000 in retirement income annually.
Why do you need less money in retirement if some of your expenses (medical, travel, etc.) will likely increase? When you’re working, a significant portion of your paycheck goes toward retirement savings. Once you’ve retired, you can start drawing from your retirement funds rather than paying into them. In addition to these savings, expenses tend to be greater earlier in retirement and then drop off as we become more infirm and more difficult to get around. Our world gets more limited, which means that our retirement income does not necessarily need to be as high as our working income.
It is also important to note that, while 4% has been bandied about as a safe amount to withdraw from your investment portfolio, this number will also vary based on your needs. You may have higher medical expenses than expected, or perhaps you’d like to use some of your retirement funds to redecorate your house or pay for travel. In any case, you’ll want to carefully calculate how much you withdraw to ensure that your retirement income does not drop too low.
The Bottom Line
If you’ve read this far, it’s safe to say you understand that planning for retirement is a lifelong process and not something that happens shortly before you stop working. You can expect your planning to undergo a series of changes throughout your working years.
At each step, however, you will evaluate your progress, adjust targets and make decisions so you can meet your ever-changing goals.
A successful retirement does not solely depend on your ability to save and invest wisely but also on your ability to plan — which leads us to the question in the title of this post: How much income will you really need in retirement? Well, the answer is….it depends on your specific needs and goals. But one thing’s for certain. It’s much better to be overprepared than do nothing and hope for the best.
Are you looking for personalized advice to improve your retirement income? Jumpstart your savings and debt management strategy today with Pathfinder Planning!
Pathfinder Planning LLC provides personal financial planning advice and asset management for a simple fee to young adults and working families in North and South Carolina through group classes, one-on-one planning, and ongoing advice.
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