Are You Ready to Retire?

You've been contributing diligently to your retirement accounts for years with the dream of being able to travel the world or just spend more time with your family. As you approach that magic date, those dreams may now seem shattered with the recent market downturn. Will you still be able to retire or should you work longer and save more? That's a question we've been getting quite a bit lately. Here are some considerations to help you answer that big question:

1) What does retirement mean to you?

What would you do if you didn't have to go to work? First of all, retirement is as much an emotional as a financial decision so make sure you actually want to retire. Lots of people find fulfillment at work and might miss it more than they realize.

Even if you know you're emotionally ready, envisioning your lifestyle in retirement can help you determine how much money you'll need to afford it. All things being equal, if you want to do a lot of international travel you will likely need more money than if you just want to spend more time relaxing at home with your family. Likewise, you'll need less income if you're planning to relocate to a lower cost area.

2) How much income will you need?

Once you've thought about what your lifestyle will be like, it's time to sit down and look at the numbers. Financial planners typically say you need about 80% of the income you had while working. That's partly because you won't be saving for retirement or contributing 7.5% of your wages to Social Security and those two items alone can add up to about 20% of many people's incomes. You also won't be commuting to work, spending as much on business attire, and perhaps eating lunch out as often. On the other hand, you may be spending more on health care, travel, and long term care insurance. You can start with your current expenses and estimate what you think those expenses will look like in retirement on this retirement budget worksheet.

3) How much income will you have?

Pension. If you have a defined benefit pension from your current or previous employer, consider yourself lucky since you're in a shrinking minority of the workforce. You should be able to ask them for a projection of that pension so you know what to expect. When it comes time to take it, just be sure to choose a payout option that protects your spouse or anyone else who may be dependent on that pension income when you pass away. You might also want to consider choosing a cost-of-living adjustment if it's available. Otherwise inflation could reduce the value of that pension considerably over time.

Social Security. While they are no longer mailing out those annual statements, you can get an estimate of your benefits based on your actual earnings record on the Social Security website. The one decision you have is when you'll start collecting those benefits. Most people take it as early as possible at age 62 but if you can afford to postpone it, you may be better off, especially if you think you'll live longer than the average person of your age. That's because your monthly benefit grows by about 8% for each year you delay until it maxes out at age 70 1/2. If you're married and wait until your full retirement age, you can apply for a spousal benefit equal to half of your spouse's benefit (assuming they've filed for benefits), let your benefit continue to grow, and then take your higher benefit later. On the other hand, if you take your benefit before your full retirement age, you'll only get the higher of either your spousal benefit or your own reduced benefit. Choose carefully since once you make your decision, you can no longer go back and change it.

Other Income Sources. Don't forget to include other sources of income you may have like an annuity or rental income. You may also want to work part-time or turn a hobby into a side business. If you have equity in your home and need additional income, a reverse mortgage can be thought of as a last resort.

4) How much do you have in retirement savings?

Here's where you add up all of your retirement accounts like a 401(k), IRAs, retirement plans from previous jobs, and any other investment accounts that you can use to supplement your retirement income. Unless you're going to use the money for something like paying off your mortgage or purchasing an annuity, you'll want this money to last as long as you do (which will likely be 20 years or more) so keep that time horizon in mind when you're deciding how to invest the money in retirement.

5) Will your savings last as long as you do? Once you have those three numbers (expenses, income, and savings), you can enter them into this calculator to see how long your savings should last. For "net income," you can reduce your total gross income by about 20-25% as a rough estimate if you don't know your effective tax rate. For "inflation," the long term average has been about 3-4%. For "rate of return," you can assume 6% if you're conservative, 7% if moderate, and 8% if aggressive.

After inputting the numbers, the calculator will show you about how long your savings can be expected to last. To avoid the risk of outliving your money, you may want to make sure you don't run out of money before you turn 95 or even 100. If you're coming up short, think about ways you can earn additional income, cut back on your expenses, or invest more aggressively. Just remember that you won't be able to work forever and that investing more aggressively also entails more risk so cutting expenses is the safest route.

If you're able to make the numbers work, congratulations! If not, you at least have a better idea of where you are and what you need to do. After all, knowing is half the battle.