Four Key Questions For Your Retirement Plan

May 06, 2013

In last week’s blog post, I introduced my idea of creating a list of forty things to do before I reach my 40th birthday. The ultimate goal in creating my 40 by 40 list was to establish goals across important areas of the life experience while at the same time, helping define my own vision of an ideal retirement. Regardless of what your retirement vision may look like, there are four basic questions that should be a driving force behind your retirement planning activities:

How long will my retirement last? This question is really asking how long you plan on living. It isn’t always the easiest question to address, but the reality is that life expectancy plays a major role in our retirement planning projections. The longer we live, the greater the costs of retirement.

The long-term goal of retirement truly is long-term.  At age 65, an average couple has a greater than 50/50 chance that one person will live beyond 90. Before you can estimate how many years you will spend in retirement, you obviously need to figure out when you want to retire. If your retirement date is a moving target or you are just not quite sure the age that works best for you, then use a few different retirement scenarios to compare your options for each realistic retirement date.  I always suggest using a realistic (but optimistic) life expectancy but personalize your assumptions based on your own health and wellness history as well as your family’s history of longevity.

How much will retirement cost? The best approach is to start anticipating whether you plan on simply trying to maintain your existing standard of living or not.  For anyone within 5 years of retirement, an actual budget plan for retirement becomes more important. Otherwise, the general rule of thumb is to start with around an 80% income replacement goal and adjust this up or down depending on if you want to live a more active or conservative lifestyle.

That’s because research studies suggest that retiree expenses on average are typically between 75-85 percent of pre-retirement income. Just keep in mind this number is merely a ballpark estimate and reviewing your current and future budget is a more reliable method. A variety of other factors such as your planned lifestyle expenses, future inflation rates, health care costs, and whether or not you will have mortgages and other debt paid off impact the total price tag of your retirement.

How much will I need to save to reach my retirement goals? In order to replace about 80% of your pre-retirement income, you will generally need to save about 10-15% of income throughout your working years. But if you are early in your career or focusing on paying off high interest consumer debt, at least try to contribute up to your employer’s matching contribution if one is provided. Otherwise, run a basic retirement calculation to assess your actual target savings amount to get you on track.

How much of your retirement nest egg can you afford to spend each year? Conventional wisdom among financial planners often relies on a “safe withdrawal rate” of 4% per year. The Rule of 25 is very similar to the safe withdrawal rate. It means that in theory, you need 25 times your first year’s additional income needs for your retirement nest egg.

For example, if I need an additional $50,000 per year in retirement expenses not covered by Social Security, pension, or other income sources, I will need $1.25 million (25 times $50,000) to reach this income goal. This is a general rule and the term “safe withdrawal rate” can be misleading. The key is to remain flexible during your early retirement years as the real safe withdrawal rate depends on the sequence of investment returns and inflation rates during the first 10 years of retirement.

Retirement planning is a process and not a one-time event. Unfortunately, most people spend more time planning a vacation or a major purchase than how they will live in retirement. The good news is that the retirement planning process doesn’t have to be an overwhelming endeavor if you focus on these four questions.