Your Retirement Plan - the Basics in Running the Numbers

When it comes time to figure out if you are prepared to take the plunge into retirement, the best way to test your preparedness is to run a retirement “numbers” analysis. Put simply this means calculating if your expected income during retirement can meet your expense needs through your lifetime. The problem lies in figuring out what numbers to use in your run so it is helpful in determining if you can afford to retire. After all, the more accurate the data entered to generate the analysis the more meaningful and realistic the outcome. Here’s a practical list of items to consider when running your retirement plan numbers:

Expenses at Retirement
This is perhaps the most difficult number for people to come up with; unfortunately it is also a number that is crucial to running a realistic retirement plan. An underestimation of your expense needs may mean you run out of money sooner than projected by your plan, while an overestimation may leave you with no hope of retiring. Therefore, it is very important to accurately reflect your expense needs when generating a retirement run. So how does one figure out what they will need during retirement? A conventional rule of thumb states that retirees should plan to cover 70%-80% of their current income during retirement. While this may be a good starting point, the best way to accurately reflect your needs is to work up a budget. It is not necessary to figure out your expenses to the penny, but creating a budget based on your historical spending habits will give you a more precise picture what you actually expend on a monthly basis.

Sources of Income
Besides figuring out your expenses, retirement planning also involves figuring out how you will pay for these expenses once your regular work paycheck stops. Traditionally, there have been three sources of retirement income available to people: Social Security, employer-provided benefits (i.e. pensions) and personal savings.

Social Security
The important thing to decide when entering Social Security benefits in your plan is at what age you will start receiving benefits. Retirees are eligible to begin benefits as early as age 62, but at a reduced amount. Naturally, the longer you wait, the higher the benefit. When to take Social Security depends on a number of factors (i.e. when you plan to actually retire, your life expectancy, your income needs, etc.). Check the annual statement provided by the Social Security Administration to see what your expected benefit is for certain retirement ages [they usually provide three numbers: benefits at age 62, your normal retirement age (can be anywhere from 65-67) and age 70]. When doing your retirement run, refer to this statement to accurately reflect the benefits you will receive from Social Security. In addition, remember that your Social Security benefit is adjusted annually based on inflation, and this should be taken into account when generating your retirement plan.

Employer Benefits
Though employer-sponsored pension plans are going the way of the dinosaur nowadays, there are still a few companies out there who offer this as a benefit. Like Social Security, pension plans can be an additional source of lifetime income that can help pay your retirement expenses, and should not be ignored when doing a retirement run. If you are one of the fortunate few whose company does have a pension plan, when you approach retirement be sure to contact your HR department to find out: 1) if you are entitled to a benefit under the company’s plan; 2) how much the benefit would be if you are entitled to one; 3) when you are eligible to receive it; 4) if the benefit has a cost of living adjustment associated with it (to take inflation into account); 5) if survivor benefits are provided by the pension plan; 6) if your company offers a lump sum payout option (we would recommend you seek professional advice to see if this option is best for you).

Savings and Investments
Increasingly, what you have managed to save yourself will make up the brunt of your retirement income as traditional pension plans disappear and the fate of Social Security benefits remains in question. Consequently, when it comes time to seriously plan for your retirement it’s important to gather all the information on available savings and investments. This means tracking down statements for all retirement accounts (employer-sponsored plans, IRAs, annuities, etc.), taxable brokerage accounts and any other savings. Moreover, once you have gathered all of your account information, it is recommended that you consolidate what you can to make your portfolio easier to manage. In addition, remember to factor in any annual additions you are making to your portfolio prior to your retirement (i.e. retirement plan contributions, automatic savings deposits, etc.).Remember the more accurate the information about your savings, the more accurate your run’s projection will be regarding the amount you will have to draw from during retirement.

Other Income Sources
Beyond the three traditional sources mentioned about, retirees may also generate income by other means. For example, you may want to work part-time or own rental property, which can be used to supplement your other income sources. Or, you may be in line for an inheritance or decide to sell property for which you will receive a lump sum. These are all factors that if possible, should be taken into account when running the numbers in order to complete the income portion of your retirement plan.

The Variables
Besides expenses and income, a retirement plan relies on certain variables; some of these are beyond your control (i.e. when you will die, what the inflation rate will be), while others you can affect by choices you make (i.e. your expected rate of return, what year you retire). The important thing to remember when choosing what numbers to input for your variables is to remain realistic. Often the only way to do so is to rely on historical data, such as the long-term average of inflation, the long-term returns of stocks and bonds, and studies on life expectancy. Whether you run the numbers yourself or seek the advice of a professional, make sure you agree with the way the numbers used were generated and that they have a basis in reality.

Above all, it is important to remember that a retirement run is a snapshot at a certain point in time based on certain assumptions made. As much as we try to base a run on realistic assumptions, no one can predict the future. Thus, a truly successful retirement relies on flexibility – which may mean spending less when the market does poorly and conversely being able to spend more when the market does better than expected. With a flexible mindset, outliving your money becomes easier to achieve.