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One of the more confounding issues that pre-retirees must wrap their head around is how to create a growing stream of income from their savings after their paycheck stops. To solve for this, consideration should be given to various pieces of a retiree’s financial life. How much income will they need to maintain their lifestyle? How much did they save for retirement? How did they save, in pre-tax retirement plans and/or in taxable accounts? How is their money invested? What decisions are they making around guaranteed sources of income (such as Social Security and /or Pensions)? And the list continues!
With so many pieces of the retirement income puzzle to sort and organize, and so much at stake, what starting point makes the most sense? We strongly recommend starting here: get clear on your three numbers.
Number 1: How much does/will your lifestyle cost?
We believe you begin with the end in mind. Imagine you have already retired, and your paychecks have stopped. Before you can determine how you will replace those paychecks, you will need to get really clear about how much you spend today. Many soon-to-be and recent retirees tell us “I just want to maintain my lifestyle,”; therefore, it’s crucial to have a solid grasp of how much money you routinely spend right now so that you can have a realistic estimate of what you will need in the future.
Our budget sheets (included in our Starter Pack on IncomeForLifeBook.com), can be used to carefully account for both current expenses and what is expected to be spent in retirement. Going line by line and being thoughtful and thorough is a better exercise than estimating, say, 80% of your current salary. Make sure you are considering how your lifestyle may change; for example, commuting costs may go away but travel or dining expenses may increase. What additional healthcare costs may you have?
Also consider any additional “wants” for retirement. Now, with the freedom of additional time on your hands, what are the things you may want to do that will cost money? Will you want to learn a new skill or get a new hobby? Are there causes you want to support or gifts you want to give? Try to paint the most realistic picture possible as having a clear picture is important! Think about putting a puzzle together: how successful will you be if you don’t have the picture on the box?
Once you have a solid first number to work with, you will need to do some calculations:
Number 2: How will that number need to grow?
It isn’t as simple as coming up with your income number above and using that number year after year for the length of your retirement! Whatever your income need is on day one of your retirement, you will need to have a plan in place to double and maybe even triple that number over a two-to-three-decade retirement. Although the rate of inflation can go up or down in any given year, the average rate, over the last ninety years, has run approximately 3%.
Protecting your purchasing power—the ability to maintain your lifestyle on Day 1 of your retirement as well as twenty to thirty years in the future, needs to be a top priority. Many retirees have not adequately planned for growing their income to keep pace with inflation. And we can understand why! Although inflationary factors are hard to miss right now, it’s not unusual for the creep in prices to go unnoticed, as when you are working you will most likely experience a corresponding increase in your wages. The pain, therefore, isn’t as apparent as it is to someone who has been retired for five years or more.
Now, you may be thinking: "As I get older, I will be doing less; therefore, my income needs will decrease, not increase!" and to this we will say, "That's fair; However, have you considered that although you may be spending less on your lifestyle expenses, your health care costs may be increasing?" It may not come as a surprise that health care costs increase at a rate significantly higher than normal inflation.
You must get clear on how your income will need to grow over the course of your retirement. If you fail to plan for inflation, your purchasing power by the end of your retirement may be cut in half!
Number 3: What does that number look like before Taxes?
The paradigm shift of this retiring generation is that the bulk of their accumulated wealth often resides inside of pre-tax retirement accounts, such as an IRAs, 401(K)s, 403(b), etc. Pre-tax meaning the initial dollars went in un-taxed and the accounts have been growing tax-deferred ever since. What this means is that Uncle Sam has been waiting for his share of your money for decades! Every distribution from your retirement accounts will need to account for the taxes owed on the distribution. If you need to spend $10,000 monthly from your IRA, you may have to withdraw somewhere in the range of $12,000 to $13,000-- or more, to account for the taxes that will be withheld. Proper planning for your retirement income will need to account for knowing what that gross number looks like on a monthly or annual basis. Which means, understanding how different types of account withdrawals will be taxed becomes vitally important in this next phase of your life.
Pre-retiree’s often focus on what they get to retire from and give less consideration to what they are retiring to. Our advice is to paint the clearest picture you can of what you need and want your retirement to look like. Then develop a comprehensive income plan with a firm understanding of these three numbers before you make the big transition. For more information, Contact us today!