Figuring out what portion of income you need

If you’re like most people, you need less money to live on in retirement than during your working years. That’s because in retirement most people don’t need to save any of their income and many of their work-related expenses (commuting, work clothes, and such) go away or greatly decrease. With less income, most retirees find they pay less in taxes, too.

On the flip side, some categories of expenses may go up in retirement. With more free time on your hands, you may spend more on entertainment, meals out, and travel. The costs for prescription drugs and other medical expenses also can begin to add up.

So what portion of your income do you really need as you make your retirement plan? The answer isn’t simple. Everyone’s situation is unique, so examine your current expenditures and consider how they may change in the years ahead. (Check out Chapter 6 for more information on budgeting and managing your expenses in retirement.)

To help figure out how much money you need, keep the following statistics in mind. Studies have shown that retirees typically spend 65 to 80 percent of their pre-retirement income during their retirement years. Folks at the lower end of this range typically:

• Save a large portion of their annual earnings during their working years.
• Don’t have a mortgage or any other debt in retirement.
• Are higher-income earners who don’t anticipate leading a lifestyle in retirement that’s reflective of their current high-income lifestyle.

Those who spend at the higher end of the range tend to have the following characteristics:

• Save little or none of their annual earnings before retirement.
• Still have a significant mortgage or growing rent to pay in retirement.
• Need nearly all current income to meet their current lifestyle.
• Have expensive hobbies that they have more time to pursue.

We can’t offer a definitive answer as to how much you personally may need to have for your retirement. Just make sure you carefully look at all your expenses and figure out how they may change (see Chapter 6).

Grasping what the numbers mean

When determining how much money you need for your retirement plans, you want to think in terms of your goals and how much you should save per month to reach your desired goal given your current situation.

In Eric’s previous work as a personal financial planner and lecturer, he came across many folks who had done some basic number crunching or had consulted a financial advisor. Far too often, these folks got a number — a big, bad number like $3.8 million — stuck in their heads. That number was the size of the nest egg they needed to achieve a particular standard of living throughout their retirement.

Rather than obsessing about a large number, you need to examine your own standard of living that can be provided by the assets you’ve accumulated or will likely accumulate by a preferred retirement age. You can then begin to put the numbers into perspective for your own individual case. We get to that task in the later section, “Crunching the Numbers.”

Social Security retirement benefits

Social Security is intended to provide a subsistence level of income in retirement for basic living necessities such as food, shelter, and clothing. However, Social Security wasn’t designed to be a retiree’s sole source of income. When planning for retirement, you’ll likely need to supplement your expected Social Security benefits with personal savings, investments, and company pension benefits. If you’re a high-income earner, you particularly need to supplement your income — unless, of course, you’re willing to live well beneath your pre-retirement income. (Refer to Chapter 10 for more discussion on Social Security.)

If you’re still working, you can estimate your Social Security retirement benefits by looking at your most recent Social Security benefits statement, which the federal government sends annually to adults age 25 and older. Statements usually are mailed three months before your birthday. If you can’t locate your most recent statement, you can get one fairly quickly either by requesting it online at www.ssa.gov (click on the Your Social Security Earnings Statement tab on the home page) or by calling 800-772-1213 and requesting form SSA-7004 (“Request for Social Security Statement”). You also can set up a “my Social Security” account on the Social Security website that lets you obtain updated benefits estimates, verify your earnings, and take other actions.

Like many people, you may be concerned about your Social Security. You may be afraid that it won’t be there when you retire. Although you may have to wait until you’re slightly older to collect benefits or endure more of your benefits being taxed, rest assured. Congress has been reluctant over the years to make major negative changes to Social Security, because doing so would risk upsetting a large and highly active voting bloc of retirees and near retirees.

With your Social Security benefits statement in hand, you can see how much in Social Security benefits you’ve already earned and review how the Social Security Administration (SSA) determines these numbers. With this information, you can better plan for your retirement and make important retirement planning decisions.

Pensions

When putting together your retirement plan, you also want to consider any pensions you have available to you. You may have previously worked for an employer offering pension benefits or you may currently work for a company with such a plan. Also known as a defined benefit plan, a company pension plan is one that your employer actually is contributing to and investing money in to fund your future pension payments.

In a typical plan, the employer may be putting away about 8 to 10 percent of your salary (this money is actually in addition to your salary, because the money isn’t taken from your income as it would be if you were contributing to a retirement plan such as a 401(k) plan). The money is then invested mostly in a mix of stocks and bonds (as it is in a balanced mutual fund).

Two terrific attributes of pension plans are:

• The savings happen automatically. Unlike a retirement savings plan like a 401(k), you don’t have to think about your pension plan. You don’t have to cut back on your spending or complete any forms. Your employer is putting away money on your behalf month in and month out.
• You don’t experience any investment hassles or challenges. The pension fund manager does all the heavy lifting with regard to investing the money. So there’s no need for you to research or monitor financial markets or investments.

If your current or previous employers have a pension plan and you may have accumulated benefits, request a copy of each plan’s benefit description and a recent statement of your earned benefits. (When we get to crunching the numbers for your retirement plan, you need your pension benefit statements.)

Based on your years of service, your benefits statement will show you how much of a benefit you’ve earned. Your current employer’s statement or the person or department that works with benefits may also be able to show you how your pension benefits will increase based on working until a certain future age.

Investments

The many types of investments you may have are an important component of your retirement plan. These investments may come in various forms, such as bank accounts, brokerage accounts, mutual fund accounts, and so on. Your investments may or may not be in retirement accounts. Even if they aren’t, they still can be earmarked to help with your retirement.

Take an inventory of your savings and investments by gathering recent copies of your statements from the following types of accounts or investment options:

• Bank accounts — checking (especially if it holds excess savings), savings, CDs, and so on
• IRA accounts
• Taxable accounts at brokers and mutual funds
• Employer retirement accounts, including
  • Profit-sharing plans
  • Employee stock ownership plans (ESOPs)
  • 401(k)s, 403(b)s, and so forth
• Investment real estate

We provide numerous bits of information elsewhere in this book about how to invest your retirement money as well as where to save it. At this point, you simply need to take an inventory of your current assets and use that information in the “Crunching the Numbers” section to determine where you stand regarding retirement planning.

Your home’s equity

If you’ve owned a home over the years, and it has a decent amount of equity in it (the difference between its market value and the mortgage debt owed on it), you can tap into that equity to provide for your retirement. In order to tap into your home’s equity, you have two primary options:

• You can sell your home. After you sell your home, you can either buy a less costly one or rent.
• You can take out a reverse mortgage. With a reverse mortgage, you draw income against your home which is accumulated as a debt balance to be paid once the home is sold (check out Chapter 8 for more info).

If you’re pretty certain you’d like to tap your home’s equity to help with retirement, consider how much equity you would use.

Understanding assumptions and how they work

Whether you use a retirement calculator online or via a work booklet, make sure you’re aware of the different assumptions used. This section details those assumptions.

In this section, we specifically look at the T. Rowe Price assumptions and online calculator. In order for you to be able to make the best use of this site, we review the following important key assumptions. If you choose not to use this online tool, you can use the discussion of the assumptions that follow for other retirement planning tools including the T. Rowe Price work booklet.

• Asset allocation: The calculator asks you to enter your current allocation (mix of major investment classes) and then to select an allocation for after you’re retired. For the retirement allocation, you can choose a fixed 40 percent stock, 40 percent bond, 20 percent money fund, or you can have the mix gradually shift away from stocks each year that you’re in retirement. Either choice is fine, but we have a slight preference for the latter of the two options.

  The calculator doesn’t include real estate as a possible asset. If you own real estate as an investment, you should treat those assets as a stock-like investment, because they have similar long-term risk and return characteristics. You should calculate your equity in investment real estate.

• Age of retirement: For this assumption, you plug in your preferred age of retirement, within reason of course. (For example, plugging in age 53 is pointless if you’ve selected that age knowing that the only way to accomplish that date is by winning the lottery.) Depending on how the analysis works out, you can always go back and plug in a different age. Sometimes folks are pleasantly surprised that their combined accumulated resources provide them with a decent enough standard of living that they can actually consider retiring sooner than they thought.

• Social Security: The T. Rowe Price calculator asks whether you want to include expected Social Security benefits. We’d rather that the calculator didn’t pose this question, because you definitely should include your Social Security benefits in the calculations. Don’t buy into the nonsense that the program will vaporize and leave you with little to nothing from it. For the vast majority of people, Social Security benefits are an important component of their retirement income, so do include them.

  Based on your current income, the T. Rowe Price retirement program will automatically plug in your estimated Social Security benefits. So long as your income hasn’t changed or won’t change dramatically, using their estimated number should be fine. Alternatively, you could input your own number using a recent Social Security benefits statement if you have one handy. Or use the Retirement Estimator at the Social Security website (www.socialsecurity.gov/estimator).

After you enter your personal information and decide on the preceding assumptions, you’re ready to finish the calculations on the T. Rowe Price website. Price’s completed analysis shows how much you can live on per month and then compares that with what you’re stated goal or amount was. The calculations include doing 1,000 market simulations, and it works 80 percent of the time. (See the nearby sidebar “Monte Carlo retirement simulations” for a more detailed explanation of this type of modeling, if you’re interested.)

The T. Rowe Price analysis allows to you make adjustments, such as your desired age of retirement, rate of savings, and how much you expect to spend per month to what age you’d like your savings to last. So, for example, if the analysis showed that you have much more than enough to retire by age 65, try plugging in, say, age 62 and, voila, the calculator quickly shows you how the numbers change.

Making the numbers work

After you crunch the numbers, you may discover you need to save at a rate that isn’t doable. Don’t despair. You have the following options to lessen the depressingly high savings you apparently need:

• Boost your investment returns. Reduce your taxes while investing: While you’re still working, be sure to take advantage of retirement savings accounts, especially when you can gain free matching money from your employer or you’re eligible for the special tax credit from the government. When investing money outside of retirement accounts, take care to minimize taxes. For more on investing strategies, see Chapter 7.
• Work (a little) more. Extend the number of years you’re willing to work, or consider working part time for a few years past the age you were expecting to stop working. Refer to Chapter 18 for more information regarding working during retirement.
• Reduce your spending. The more you spend today, the more years you’ll have to work in order to meet your savings goal. See Chapter 6 to find out how to manage your spending in retirement.
• Use your home’s equity. If you didn’t factor using some of your home’s equity into your retirement nest egg, consider doing so. Some people are willing to trade down into a less costly property in retirement. You also can take a reverse mortgage to tap some of your property’s equity. We talk more about home equity and reverse mortgages in the earlier section “Your home’s equity.”

Dealing with excess money

When Eric was working as a financial counselor, one of his favorite parts of the job was going over the retirement analysis with clients who had accumulated more than they needed to achieve their desired lifestyle. Often, this was a surprise to the client, so some folks had a hard time believing the good news.

If you find yourself with extra money, the good news is at least you don’t have to worry about making sure you can continue your current standard of living during retirement. In this situation, consider taking either of the following actions:

• Enhance your retirement. We’re not suggesting that the only way to a happy retirement is to spend money, but don’t be afraid to enjoy yourself. While you’re still healthy, travel, eat out, take some classes, and do whatever else floats your boat (within reason, of course). Remember that come the end of your life, you can’t take your money with you.
• Earmark a portion of your assets for your beneficiaries. You may want to leave something for your family members as well as other beneficiaries, such as your place of worship and charities. If so, you need to determine the approximate dollar amount for each of the beneficiaries. Estate planning is so important that we devote Part 4 to it.

Of course, life can throw you unexpected curve balls that could cause you to incur higher than expected expenses. But if you’re always preparing for rainy day after rainy day, you may lead a miserly, unenjoyable retirement.

Personal connections

A lot of research shows that those individuals who have strong and healthy connections in their later years tend to be happier, enjoy better health, live longer, and live longer independently. As you’re preparing for retirement, make sure you spend time making and maintaining healthy personal relationships. Doing so is an investment that pays dividends by improving the length and quality of your life.

If you have children of your own (and perhaps they give you grandchildren), you’ve got a built-in network of younger folks to keep you actively involved. If you don’t have any children or grandchildren, or if you want more personal connections, you can forge friendships with people younger than you through your activities, hobbies, fellowship, and so forth.

Personal health

Your health is much, much more important than your financial net worth. Just ask folks who have major medical problems — especially those they could have avoided — if they wish they had taken better care of their health. Although anyone can experience bad luck or bad genes when it comes to health, you can do a lot to stay healthy and enjoy enhanced longevity and the best possible quality of life. Chapter 2 can help you take action and plan ahead for health.

Activities, hobbies, interests

For folks who have had full-time jobs, retiring and having no job to occupy their days sounds alluring. However, some retirees feel a lack of purpose and miss the satisfaction that comes from meeting the challenges of work. A fringe benefit of most people’s work is the human interaction that comes along with it.

When planning for your future, consider the following as good substitutes for work, because they provide challenges and foster friendships and connections with others:

• Activities and hobbies: Exercising is a good choice to include in long-term plans; it provides vast health benefits and opportunities to meet new friends and hang out with old ones. If you’re not into exercising, perhaps you can look at different hobbies you like, such as collecting something. You can meet interesting people and make new friends by going to auctions, garage sales, and such. People like to collect all sorts of things; just be careful you don’t spend too much money.
• Part-time work: Working part time, especially when you have more flexibility in setting your hours, can be an excellent part of a retirement plan. It can provide enjoyments and a challenge — not to mention some extra dough. Check out Chapter 18 for more on continuing to work during retirement.
• Volunteering: Giving something back to society pays many dividends. You can find a zillion volunteer opportunities. Your place of worship, organizations that support a cause you believe in (for example, fighting cancer or heart disease), and schools are super places to start looking. Stumped for ideas? Try a service like VolunteerMatch (www.volunteermatch.org).