Budgeting for Retirement: Not a One Size Fits All Proposition
One of the most widely used rules of thumb in retirement planning is the notion that you will need 70-80% of your pre-retirement income once you retire to live a comparable lifestyle. Another suggests that you should save eight times your final salary for retirement. Surely, there is some merit to these rules and admittedly, they can serve as a great guidepost when retirement is still far off in the horizon. But should you bet your future on them?
What is the concern with planning your retirement based on the rules of thumb?
By definition, a rule of thumb is:
A principle with broad application that is not intended to be strictly accurate or reliable for every situation. It refers to an easily learned and easily applied procedure or standard, based on practical experience rather than theory.
Retirement is far too important to leave to principles that are “not intended to be reliable.” If every person, couple, and household is unique, then doesn’t it stand to reason that the way they approach planning should be as well?
Think about some of the retirees in your circles. Perhaps your parents travelled around the world for several years, while your aunt lived a quiet, but comfortable, retirement in her home. Meanwhile, a family friend spent most of their retirement battling severe health problems. Retirement was clearly different for all of them. Then, after further thought, you remember that your parents only travelled for the first ten years of their retirement, then they settled into a more subdued routine at home; the first half of their retirement looked very different than the second.
The best thing you can do as you approach retirement (10-15 years out) is to approximate a thoughtful projection of your retirement budget. The more you can work through this process, build in appropriate cushions and tighten these figures, the more accurate your retirement income needs will become. It’s also important to recognize that there are two components of retirement budgeting: your initial retirement where spending will likely be higher and your “advanced years” when life slows down and many of your expenses dwindle. That being said, a few expenses, such as medical, will increase with age and should be factored accordingly.
Once you have a firm grasp of your spending needs, the next step is to look at your guaranteed sources of income (i.e., social security, pension, etc.) and figure out the difference between your expenses and income to begin to settle on your annual needs in retirement. Your retirement income can be an important component to these calculations.
Imagine you expect to have $70,000 per year in living expenses during retirement. Because of a pension and social security, you will be able to cover $60,000 without drawing from your portfolio. You are left with a relatively modest need to fill of $10,000/year once you do retire. Postponing retirement until you accrue 7-8 times your salary would be excessive and likely cost you some of the best years of your retirement. (Please note these are simplified numbers and don’t consider more sophisticated planning items such as inflation and taxes).
On the other hand, if you have followed the “rules” and saved enough to satisfy the various rules of thumb, but you have fairly extravagant plans early in your retirement, then you may end of cannibalizing your portfolio early on and could risk running out of money. Perhaps you have extensive travel plans or expect to maintain two households, so you can avoid the winter but stay close to family. You may very well need to save more than what the rule of thumb will dictate.
You might benefit from working with a Certified Financial Planner ™ to help you create a customized retirement budget. But there are also decent tools available if you’d like to give it a shot on your own…. Keep in mind that much like rules of thumb, these are not one size fits all, and may require adding additional expenses unique to you!