Key Takeaways:
- Estimating retirement income needs starts with your current spending but should account for changes in taxes, savings, housing, lifestyle, and healthcare costs.
- There is no single percentage of pre-retirement income that works for everyone, so your retirement budget should reflect your personal spending habits and goals.
- Building a cushion into your retirement income estimate can help you prepare for unexpected expenses, family needs, and rising healthcare costs.
Do you know how to estimate how much money you will need in your retirement?
New retirees often boast about the joys of no longer needing an alarm clock for work. They boast about their new life where they can do whatever they please. However most new retirees find the financial aspect of their transition to retirement somewhat frightening.
Trying to calculate your cash flow needs can be tricky. there can be a huge variation regarding how much money you will need vs. what the “average” retiree will need. Each of us is unique with our cash flow needs during retirement.
Some will only need 60% or their pre-retirement income while others may need 90% of their pre-retirement income.
Unforeseen expenditures such as healthcare costs can change wildly, year by year.
Step 1: Find a Realistic Baseline for Your Income
The place to start would be with your working income. If you are close to retirement and seek to maintain the same standard of living in retirement as you are now experiencing, using your current salary as a baseline is reasonable.
Step 2: Subtract Your Savings Rate
Review how much you are saving of your salary for retirement purposes. Subtract that amount from your baseline salary amount.
Step 3: Subtract Any Tax Reductions
When you retire, you are no longer paying Social Security or Medicare taxes. Therefore that is the sum of money that you can subtract from your needed retirement income. However, retirees will be required to begin taking distributions from their retirement plans and that money will be taxed as ordinary income. Keep that in mind.
Step 4: Subtract any Anticipated Housing Cost Reductions
Housing costs are another item with the potential to change substantially in retirement. Will you have a mortgage when you retire? Do you plan on downsizing or relocating when you retire?
Step 5: Factor in Lifestyle Changes
Retirees should consider changes such as: commuting (gas, auto maintenance, insurance), clothes for work, and meals while on the job. These factors can lower the amount of money that you will need while in retirement. However, if a heavy travel schedule or an expensive hobby is on your to-do list, any cost reductions could be canceled by increased expenditures.
Step 6: Add Higher Health Costs
If there is one item that seems to increase and increase well above the average rate of inflation, it is health care costs. These costs can skyrocket toward the end of life.
Step 7: Add a Cushion
It is wise to approach this exercise knowing the future is unknown. Seniors have been called upon to help their adult children or their families. Homeowners can experience unexpectedly costly repair bills at the worst possible time.
It is prudent to assume that whatever you are budgeting for can cost more than originally predicted. Better to be safe than sorry.
