Develop a Realistic Retirement Plan that Delivers Security
The 5 Keys to Develop a Realistic Retirement Plan
for the Retirement You Deserve
Some financial experts are predicting what they call an imminent retirement ‘apocalypse’.
They cite many reasons, including the disappearance of pensions, shortfalls in future Social Security obligations, instability of markets, and the uncertainties of future cost burdens like healthcare.
While all are factors that contribute to retirement uncertainty and could lead to dire events, we believe the real crisis is much worse, but far more easily solved.
The real retirement crisis is a widespread absence of retirement planning by future retirees.
Northwestern Mutual’s retirement Planning and Progress 2015 study showed that only 20% of U.S. adults have a written plan for their financial future, meaning 4 in 5 do not have a plan.
Regrettably, too many are focused more on planning their annual vacation than their financial destination of retirement, as revealed in an Edward Jones retirement planning survey.
The comparison of vacation to retirement is not by chance, as retirement preparation is essentially working 40 years to prepare for a vacation that’s anticipated to last 30 years.
That many spend more time planning their annual two weeks of vacation than their eventual 30-year long one is indeed the most apocalyptic of retirement crises.
Get a Fast and Easy Start on a Basic Retirement Plan
The great news is that developing a realistic retirement plan is not difficult, especially with the many powerful and free online tools that are available today.
Ideally, you should do your first basic plan in your mid 20s just to become familiar with how one works. Even if you’re in your 30s or older, it’s never too late to make a first-pass plan.
Although a full and comprehensive retirement plan includes both financial and non-financial dimensions, the quickest and easiest way to ease into planning is with a basic retirement calculator.
There are many ‘best of’ tools we provide on our 100 Free Resources page, but here are three best-in-class calculators that will handle almost any needs.
First is a fast, simple tool that will give a high level result in just a few minutes. The Vanguard Retirement Calculator requires only 8 key numbers, and uses sliders for input. It’s great for quick answers and doing easy multiple what-if scenarios.
For those who want to take their financial projections to a higher level, including creating multiple economic scenarios and then testing them against historic data that go back more than 80 years, the FIRECalc Retirement Calculator is one of the best we’ve found.
Finally, for future retirees who have more complex situations that include multiple income sources, and who want the ability to print out the results, the FinacialMentor Ultimate Retirement Calculator is a great choice.
Doing a first pass plan can be a huge wake up call to see how much you’ll really need. And it’s resourceful when that wake up call comes when you have decades remaining to create the bright financial future you deserve for your golden years.
The Power of the Five Big Retirement Planning Levers
Using a calculator also gives you a much better sense of the power of key inputs. The five big levers are:
- How many years until retirement
- How much you already have
- How much you can save per year
- Expected earnings on your savings
- Guaranteed streams of income in retirement
By adjusting the years you have left to generate income for retirement you’ll see the value of time as an ally of a secure retirement.
The first obvious impact is that the more years you have to save for your retirement from your job or business income, the more you can accumulate.
But the less obvious value of time is the massive power of compound interest.
Compound interest is so powerful, that in our second retirement planning success driver, Save Early & Automatically, it’s the number one reason to start saving for retirement as early as possible.
How much you already have saved is the second biggest lever because is provides a foundation for your future efforts.
Money you’ve already saved, and of course swear to never touch ahead of your retirement day, will earn interest for you every day.
The more you have today, the smaller the gap between what you have and what you need to bring your ideal retirement to life.
Although your early 20s to your mid 30s may feel like the hardest time of your life to save as you encounter many potential firsts – moving out, buying a home, getting married, having a child – it’s the best time to start to ensure retirement success.
In reality, for many, the hardest time to save for retirement can be their mid 40s and into their 50s.
Although incomes are typically higher than the earlier years, what makes this phase of life financially challenging is that many are called on to cover the cost of college, provide support for parents, and help kids get a start after college.
Some will also face job loss with higher difficultly in finding a similar replacement, encounter the financial and emotional impact of divorce, or experience health issues that can hurt earning capacity.
In fact some will be forced to retire well ahead of when they planned, leading to potentially disastrous consequences.
By starting your retirement savings as young as possible, by your 40s you’ll already have momentum on your side in case you encounter circumstances that temporarily reduce the capacity to save for retirement.
If you wait until your mid 40s to start, however, one bad event can take a weak retirement start and turn it into a retirement disaster.
Your third lever is how much you can save per year. This lever, while not easy, is quite simple. The difference between your income and your spending is where your capacity to save resides.
The ability to keep your expenses under control in relation to your income is so important that we’ve made Controlling Your Burn Rate & Debt our first retirement success driver.
In preparing for a secure retirement, the level of your income is far less important than your ability to save. Some earning $50,000 per year have more saved for retirement than some making $150,000.
And while it’s often challenging to increase your income in the short term, you can make progress on your savings starting this very moment. And each dollar you save generates retirement income for decades to come.
The fourth lever, expected earnings on your savings, is simply the interest rates you anticipate earning, on average. Of all the levers, this is the one over which you have the least direct control.
The rate you earn will be partly based on the level of risk you’re willing to assume, and mostly on economic factors over which you have zero influence.
For savers unwilling to accept any risk in loss of principal, the years since the start of the Great Recession have been devastating. The 30-year Treasury rate for May 2006 was 5.2%, which sank to 2.59% by April 2015.
If you were building your retirement plan in 2006, using a 5% return was certainly reasonable, if not outright conservative.
But fast-forward nine years and your real earnings were cut exactly by half. And there wasn’t anything you could do about it, except to accept significant risk to chase the original 5% return.
When you place you retirement savings in equities you can rightly expect a higher average return, but the variance between years can be severe.
The bottom line is that you must be conservative in estimating your potential returns given the uncertainty that exists even with no risk Treasurys. Additionally, your investment strategy should be built around pursuing your targeted returns with consistency.
The final lever is guaranteed streams of income in retirement.
Social Security is the first and most widely received income source for your golden years, although there is concern that within few a decades it will not be able to pay 100% of its obligations.
While anything is possible, it’s likely that the U.S. government will make good on the obligation, but may introduce other factors to reduce the value of the monthly payments. This could include some form of means testing or increased taxes on those of higher earnings.
For the lucky few who are eligible, a pension represents a powerful retirement income source. Unfortunately, pensions are rapidly disappearing, and even the companies that offer them for existing employees don’t provide this benefit to new employees.
There are other sources of guaranteed, or close to guaranteed, income for retirement. The most popular is annuities, which have both their benefits and drawbacks.
Keys to Keeping Your Plan Realistic
While retirement calculators are a powerful tool in projecting financial health for your golden years, they have one major inherent risk.
Because it’s so easy to generate different scenarios, one can fall into the trap of becoming too optimistic on one more of the five levers.
The temptation to adjust beyond reality is especially high when your analysis shows a significant retirement savings shortfall.
The most impactful but dangerous lever to overestimate is how long you’ll work. It’s so perilous that one of our retirement disaster drivers is Working Longer May Be Just Fantasy.
It’s easy to mathematically overcome a sizeable shortfall by tacking on a few extra years beyond the age you originally expected to work. The problem with this artificial fix is that recent research shows the current average retirement age is 62.
The second most dangerous area of overestimation is on retirement returns. Long-term averages can be very misleading, especially when it comes to stock market returns.
You cannot control how the markets behave, but they can have a significant impact on your financial security in retirement, especially if a sharp downturn hits right after you retire.
Many retirees were deeply hurt during the market collapse that began in 2008. Those who were heavily weighted in equities saw their retirement accounts drop by 40-50% or even more.
Retirees who panicked and pulled out near the bottom saw their retirements destroyed.
And yet, once tumultuous periods like 2008-9 are diluted by being added into a 75-year average, their devastating impact is masked.
The lesson here is not to depend exclusively on averages to project your returns. For the portion of your retirement savings that are at risk of loss of principal, it’s important to keep in mind the impact of sharp downturns.
The final area in which it’s important to be realistic is your annual expenses once you retire.
If you overestimate what you need you may unnecessarily delay enjoying the retirement you’ve worked hard to build. Or you may feel the deep anxiety that comes from the sense you haven’t saved enough, when in reality you already have enough for the retirement of your dreams.
If you underestimate what you need to cover your annual expenses, the outcome is that you could be forced to cut your lifestyle well below what you expected.
Although it’s impossible to accurately forecast factors like the cost of health insurance or interest rates, your current ability to control your expenses and keep within a budget can be the most valuable skills for predicting your expense in retirement.
Closer to Retirement Your Plan Should Become More Detailed
As you get into your 30s, you need to move beyond just a framework for how you’d like your retirement to look. Depending on your target retirement age, you may only have two or three more decades before the big day.
For some in their 30s, retirement savings accounts are growing strongly. This may beg the question of: “If I already have a strong savings rate, why do I need to bother with a concrete retirement plan so early on”?
The answer is that outcomes in our lives are the result of earlier actions we did or didn’t take. Having a detailed plan, with sufficient runway to act upon it, is much more likely to result in the retirement you deserve.
The reason advance planning gives you the biggest advantage is that it’s your first checkpoint of what it will truly take to bring your vision to life.
If you’ve modeled out that you want two homes, two cars and three large trips every year, and that in order to make this happen you need $100,000 annually in retirement, but your current savings rate and other factors indicate $50,000 is more likely, you know you have a problem.
In this case, the good news is you’ve caught the problem early, and you have time to adjust.
Those adjustments might include: scaling back your vision to be less costly; freeing more cash from your current income by cutting your burn rate now; taking an extra job to produce more income; changing jobs to get a higher salary; or engaging your kids to take more responsibility for funding their college education and other expenses for which they may be depending on you.
Financial success comes from consistently making the right small and large decisions, and then being agile along the way to get back on-track when the unexpected happens.
Having decades in advance of retirement gives you a valuable reference point to determine if you’re headed in the right direction. And even if you’re sure your current vision won’t change, you still need to consider it a ‘living plan’.
Things, both good and bad, will happen in your 40s and 50s that will mildly or even radically change your picture of retirement. It’s okay to change and evolve.
It’s not okay to try to wing it with no plan, or inflexibly cling to a plan based on now invalid assumptions. You and your loved ones deserve better.
Once you have an initial formal plan, it’s essential that you get it validated by an objective, outside source. You can hire a fee-only retirement planner or, if you have a willing acquaintance who has the background and success with retirement planning who can review it, that can work too.
We are not always objective in our own affairs, and sometimes we overlook important details, so an outside review can be invaluable.
Additionally, an outside source can be an objective reference point if you and your significant other are not in complete agreement on the plan structure or requirements.
Hearing the opinion of an outside party is sometimes more palatable than hearing it from a loved one.
Although my aunt and uncle’s retirement ended in disaster for mistakes they made after retirement, one of the things they did right was to develop a realistic retirement plan. They validated it with a financial professional, and they followed it closely, making them solidly prepared for the retirement they envisioned.
There are no do-overs in retirement, so you have to get it right well ahead of your big day. Taking the extra step of validation will provide additional peace of mind.