The most difficult part of long-term financial planning is estimating the income for the remaining length of one’s working life. At the age of 50 or even 60 years, many people will look at the size of their retirement nest egg and state that they plan to work for many years to come. The reality is that most people retire earlier rather than later than they had planned – by three years on average. The 2013 Federal Reserve Survey on Household Economics and Decision-making found that the average target for retirement was 65 years. However a combination of the individual’s health status with corporate reorganizations led the actual retirement to closer to 62 years, the first year when workers become eligible to file for Social Security pension payments.
The next task is to estimate spending needs for your remaining lifetime — and that is far more difficult. When asked how much savings are needed for a retiree’s lifetime, the common rule of thumb is eight to ten times annual income. However with remaining lifespans closer to 30 or 40 years, savings of even ten times annual income would be woefully inadequate. Alternatively, you might rely on the estimates of Teresa Ghilarducci, who wrote the 2015 popular book, How to Retire with Enough Money. She estimates that for $100,000 in annual retirement income, you need about $2 million in savings to add to your contributions to Social Security.
Taking a more sophisticated approach, financial planners often recommend that individuals target replacement income at 75 to 85 percent of spending during their working years. The concept is that, once an individual retires from the workforce, she or he will need just over three-quarters of the previous level of income to maintain the same standard of living since she or he will no longer be obliged to pay for commuting costs, a clothes wardrobe for business meetings and other expenses related to maintaining a professional career.
They also point out that spending is not at a constant level throughout one post-career life. Rather spending tends to decline one or two percent per year for the first few years as business-related expenses are no longer incurred. Then as the years progress, retirees start to spend one or two percent per year more on travel and particularly on healthcare in what is commonly called a “retirement smile.” Unfortunately, the historical income and spending patterns for the U.S. population does not support this thesis.
With a crystal ball in hand, the numbers folks among us would like to be able to chart income and spending year by year for individuals and households. However in the absence of a magical ball, we need to do our own forecasting.
I am not a fan of budgeting. When I was in college, I used to withdraw the equivalent of $10 at a time from my bank branch – am sure they loved me – so that I could track how I spent my pennies on lattes and lunches. But once freed from poverty (or so it felt), I could put $20 (now worth $100) in my wallet and feel like a rich woman.
However there are lots of online tools for budgeting and retirement planning. Dave Ramsey’s www.everydollar.com helps track how all the dollars are spent. Mint.com helps track your digital money as it moves in and out of your bank account. For long-term planning, the U.S. Department of Labor has a tool Taking the Mystery out of Retirement Planning (2014). The American Association of Retired Persons (AARP) has a Retirement Calculator that takes basic information such as annual spending, annual income, accumulated savings, monthly pension income and churns out estimates. You should also estimate your likely out-of-pocket health care costs. AARP’s personalized calculator is helpful (https://healthcostscalc.aarp.org/content/health-savings-checkup/aarp-site/en/welcome-page.html).
Good luck with all that. If you have the patience and organized mind of an accountant, these are better than the back-of-the-envelope estimates. However if you are endowed with such qualities, you have probably already developed your own spreadsheets to plan your financial future.
So if you are a numbers person, estimate your lifespan, look at your current level of savings and estimate how much more you will need to save to have the retirement life of your dreams, factoring in at least $200,00 for retiree healthcare costs in the final years and assuming that you retire three years earlier than planned.