The rules of thumb (i.e., “you’ll need 70% of your pre-retirement income”) drive me crazy. They’re nothing short of dangerous given the wide variety of people’s plans for retirement.
There’s really no viable alternative to sitting down and calculating how much you’re going to need.
Fortunately, it’s not as difficult as you might think: Start with your current income and expenses, and simply adjust for what you expect to change. A few examples:
- You won’t need to save for retirement anymore, so you can adjust your necessary income downward to account for that.
- How will your income change? Do you plan to retire completely, or do you expect to continue working part-time?
- Will you still have a mortgage payment?
- How much will your health insurance premiums increase?
- Will your entertainment costs go up or down? For example, do you plan to travel or does your dream retirement consist of hanging out with your grandchildren who live a few blocks away?
You don’t need a precise, to-the-penny budget. Any estimate based on your own goals and needs is going to be more accurate than the amount recommended by a rule of thumb.
Caveat: If you’re in your twenties or thirties, be sure to account for the fact that your goals can change significantly over such a lengthy time frame. For example, if you were to ask me now about my plans for retirement, my answer would be: “I don’t ever plan to retire. Running a business is too much fun.”
But who can say whether I’ll still feel that way in 30 years?
For More Information, See My Related Book:
 |
Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less  |
"A wonderful book that tells its readers, with simple logical explanations, our Boglehead Philosophy for successful investing." -- Taylor Larimore, author of The Bogleheads' Guide to Investing
{ 10 comments }
Like most financial *rules* this one need to be applied to an individual’s specific situation. These rules make me NUTS also because when discussing them you have to get over a person’s initial stubborn reaction of “but it is a rule.”
I agree with you, Mike. When I was creating a retirement savings calculator for my site, I struggled with a balance between simplicity and accuracy. Sure, I can say enter your current income and then do a calculation to use only 70% or 80% of that. But it’s not very accurate at all. Like you said, the best solution is to sit down and figure it out yourself. And again, as you pointed out, it’s not that hard at all.
@Evan: The first thing that came to my mind when you said people think “but it’s a rule” was “Rules are made to be broken.”
Don’t forget to factor inflation into your calculations when planning how big that future pot/income needs to be.
Some figures, like how much your health insurance premiums will increase, are tough to predict. I think it’s a good idea to do your best to create an estimate of expenses, but build in a fallback plan, e.g., less travel or working more at a part-time business to deal with unexpected changes.
To piggyback on what Susan Tiner said, it can be useful to come up with two retirement income numbers:
1. What you’d like to have
2. What you’d need at a minimum (basic needs, not “I need a yacht.”)
@Paul: “And again, as you pointed out, it’s not that hard at all.”
But the problem is in my opinion that there are aspects that are hard to predict. Life expectancy, for one. Onset of a catastrophic illness requiring expensive unreimbursed care. Unanticipated major legal problems. Possible changes in the social security laws that could significantly impact benefits. Forced early retirement if you’re in your 60s, lose your job, and can’t find another. A severe bear market just when you’re starting your retirement. Take your pick. Paying off the mortgage and deciding whether or not to travel are easy by comparison.
@Larry:
As far as life expectancy goes, your best guess can be made by using calculators customized based on your health, habits, and history. One example is livingto100.org. No, it’s not going to be exact. But it’s a much better estimate than using the average life expectancy.
Catastrophic illnesses are the reason you get health insurance or long-term care insurance.
Liability insurance is for those unanticipated legal problems.
You can choose to plan for life without Social Security.
You can find ways to create your own income sources (part-time business, freelancing, etc.) so a forced retirement won’t hurt so much.
You can plan for what you’ll do if a bear market hits when you plan to retire. (Extend your working years, take a part-time job, start a part-time business, cut back on your nonessential retirement expenses, and so on)
Am I saying you’ll be able to plan for every possibility? No. That’s not possible. But you can look at what things are likely to happen and plan for those. And if you’re really worried, you can plan for a worst case scenario as well.
Sitting down, looking at your current expenses, and adjusting them for what’s likely for your retirement does not require a Ph.D. or M.B.A. It’s going to take you more than 5 minutes, but it’s not that hard.
To plan for a worse-case scenario would require me to have a far larger portfolio than I am ever likely to develop. Frankly, if they were going to pull the plug on Social Security, I’d probably be in deep trouble, because my projected benefit at full benefits age (66; I was born in 1948) is greater than 50% of my current net and I don’t have such a huge portfolio that I could do without that. But I don’t think SS is going away that quickly. Actually, with all the calculators and simulations I’ve tried, the one consistent element is that the best way to increase your available retirement funds is simply to work a few years longer. So if I retire at 67, I can live with that.
Most people can’t afford to fund a worst-case scenario because it would require more money than they can accumulate. So you have to plan for what is most likely for your situation and focus on that. If that plan doesn’t work out, you’re not going to die. You’ll just have to make adjustments and adapt.
You’re right that delaying retirement by a few years can do wonders for a retirement projection. This is especially true if there’s a bear market just as you want to retire. Best to put off retirement or get your income from somewhere other than your portfolio.
Paul Williams is quite right. The goal has to be to try to create as much future income as you can practically manage, while also perhaps trying to engineer your life so you have some flexibility as to exactly when and how suddenly you retire.
As for inflation, I believe it’s even worse than current ‘subtract 2% from returns’ thinking. The reason a lot of old people seem so poor is because of salary/lifestyle inflation, which runs a lot higher than official inflation.
If you were looking ahead in the 1970s, then you weren’t putting things like mobile phones, computers or broadband Internet connections into your projections, for instance.
If you don’t want to fall into relative poverty, you need to aggressively tackle this issue, which is why I favor some equity allocation if you can afford the risk in retirement.
Comments on this entry are closed.