Retirement planning is not an easy task.
The two biggest assumptions you’re forced to make are projecting how long you’ll live, and determining how much you will need annually to support your lifestyle.
The problem with the first assumption is that no one really knows how many years they have left.
Guess too short and you’ll live your final days in financial distress as you outlive your money. This is a significant concern as it’s consistently identified as future retirees’ #1 fear.
Guess to long and you’ll deny yourself the opportunity to enjoy your well-deserved retirement as much as you might have because you’ll hold back funds for future years you’ll never see.
There really is no good solution except to consider your genetics and overall current health, but even those factors can steer you wrong.
But there is some good news.
You have tremendous control over the second factor, determining how much you’ll need annually. This is often referred to as your retirement savings target or income replacement target.
You need to focus on what you can directly control.
Smart wealth accumulators can eliminate a large degree of uncertainty regarding what they’ll need to cover their annual expenses because they already have strong control over their annual spending before retirement.
And when you think about it, whether it’s pension, Social Security, annuity income, or income and withdraws from assets, retirement comes down to one critical objective: expense coverage for the rest of your life.
But even with your expense patterns known, there’s still much debate over the level at which to set your retirement savings target in order to have a high probability you’ll be able to cover your expenses.
Many retirement experts will say you need to replace 80%+ of your gross income to survive in retirement. We believe this number is dead wrong for most.
1. One-size-fits-all numbers, by design, ignore your unique situation. The only real value of such a generalized retirement savings target is to open the conversation or thought process that should lead to a more specific number reflecting your unique situation.
2. During their working years, savvy wealth accumulators are already living their lives and running their households for well less than 100% of their current gross income. The really aggressive ones may be already saving 10%-15%+ for retirement. So guess what? When you’re in retirement, you no longer need to save for it!
3. In retirement, your total living costs will likely go down. No more work clothes, no more commuting, no more paying for things you now have the time to do for yourself. You may have some increased leisure costs, but many future retirees overestimate how much they’ll travel on a sustained basis. And studies show the later you get into retirement, leisure expenses fall. Of course you do need to consider the potential increase in health care expenses but your premiums for Medicare gap insurance may be lower than the premiums you paid for full family coverage during your working years.
4. Your family financial obligations are likely trending down. Buying braces and extra cars for new drivers, covering auto insurance, and helping with college tuition should all be in the rear-view mirror.
5. You typically enter your peak earning years by age 50. In your 30s and 40s your obligations were likely higher (raising kids, paying the mortgage, helping your parents), and you did it all on lower income. So if you’re in your 50s, you may consider using your lower previous income as a basis for projecting expense coverage needs.
6. Your income taxes are likely to be lower. No one can predict future shifts in the brackets, but it’s very likely you’ll keep a larger percentage of your income in retirement. When it comes to what’s taxable, odds are that your income will be lower than during your working years, and therefore will be taxed at a lower marginal rate. In addition, some income may come from long-term capital gains, which are usually are taxed lower than ordinary income. It’s also likely that some of your retirement funding will come from withdraws on regular savings or Roth IRAs, where there’s no tax because it’s already your money, free and clear. Finally, you’ll no longer pay Social Security payroll tax of nearly 8%, and the standard annual income tax deduction for retirees is higher. All these factors are in your favor to keep a higher percentage of your income.
7. Income level is not considered. For those who are fortunate, one of the many advantages of having a higher than average income is that your percentage of discretionary income is larger than those of average income. Daily necessities like gas, utilities, cable, cell service, groceries, staple items, and healthcare costs the same dollar amount (unless you’re buying the premium offerings and/or somehow consuming substantially more) for consumers for all income levels. But the higher income person, saving the same percentage of income as the lower income person for retirement, will have more total dollars saved. And the percentage of those dollars consumed for base necessities in retirement will be lower. Therefore, higher income retirees can enjoy their retirements on a much lower percentage of their pre-retirement income than those of average income. Of course the inverse is true for those of lower income, who may need 90% or more of their pre-retirement income just to cover necessities.
If 80% is not the go-to target, what’s the right way to approach your annual funding needs in retirement? Start with your Burn Rate.
Your current annual living expenses—your Burn Rate—gives you a reliable starting point to predict your future expenses.
Of course things will change in retirement, but your current tendency to spend versus save, your current dining out frequency, and your existing patterns in a bunch of other discretionary spending categories, is part of your financial DNA.
Your current Burn Rate will provide insight far more powerful than the averages that one-size-fits all retirement models are forced to use.
Not only will your Burn Rate give you perspective for your retirement needs, it shows you how your current spending presents a ‘double negative’ when it comes to retirement.
The higher your Burn Rate, the more you’ll need to save for retirement. That’s the first negative.
The second is that a higher Burn Rate consumes cash you could otherwise save towards retirement right now. Living beyond your means will rob you of the brighter financial future you deserve.
But here’s the huge double win when you cut your annual spending.
Reducing your Burn Rate accelerates your projected retirement date by reducing what you need to save for retirement AND by helping you save more quickly to get there!
Lowering Your Burn Rate means:
- You can save more total cash for retirement
- You need less total cash retire on
A massive Double Win!
Of course we at Retirement Is All On You would never discourage saving as much as you reasonably can to fund retirement.
So what’s the danger in overestimating what you’ll really need in retirement?
Danger #1 is that for some, traditional retirement models will say they need $1.5MM, $2MM, $3MM or even more, and that target may seem so daunting they simply throw up their hands and never start.
For others, danger #2 is that they may delay their retirement longer than necessary, missing out on what many refer to as the best years of their life.
How sad would it be for your golden years to be short, meaning you don’t get to enjoy what you worked so hard to build.
Going back to the first assumption you need to make in retirement planning, which is how long you’ll live, we never really know the answer.
My aunt and uncle, who both passed before they expected, fortunately retired at 55 and 48 respectively. Had they not done an incredible job of preparing for an early retirement their golden years would have been but tragically short.
Starting a financially sound retirement as early as you can gives you the chance to begin enjoying the rewards you deserve.
By focusing on your Burn Rate, and its relation to what you need in retirement, you can begin immediately building a brighter financial future by being motivated to cut your living expenses today!
Don’t fall for one size fits all financial advice like the 80% rule as a default retirement savings rate.
Take the time to develop the right answer for you. And make sure that you consider not only what to do to plan for a secure retirement, but also what to avoid so your retirement doesn’t end in disaster.
It will give you more peace of mind knowing you’re headed in the direction that will provide you with the brighter financial future, and eventually the retirement, you deserve!