When it comes to saving and preparing for retirement, one of the most difficult questions to answer is what will you need. For some, retirement is a vague, distant concept that merits little thought, while for others, retirement is in the near future and may be a source of great anxiety. While every person’s situation is different, there are a couple rules of thumb that should help clear up the mystery of what you will need to maintain your lifestyle.
While many planners and advisors will often quote a top-down rule of thumb such as your retirement needs being 20x your salary, most generic top-down rules aren’t all that helpful in clarifying what your retirement needs will actually look like. For this reason, it makes more sense to break down retirement needs using a bottom-up approach, or more simply, looking at what your monthly budget will be in retirement.
A good place to start is your current monthly net income, especially if you are close to retiring. By monthly net income, we mean the amount that is deposited into your checking account each month, which is a good estimate of your monthly needs. For most individuals, your net paycheck is your income after taxes and contributions which is a reasonable starting place since your taxes will likely change in retirement (we will add them back later) and you will no longer be contributing to retirement plans once you retire. If you contribute a significant amount to savings you’ll want to subtract that as well since you aren’t living off of those savings. Once you have that number you’ll want to consider your mortgage next. Depending on your situation, you may end up downsizing or you may pay off your mortgage completely, which will decrease your monthly needs. At this point you may want to consider other needs and goals that will arise in retirement that you didn’t have before – things like a travel budget, a home remodel budget, or long-term care insurance that should be added back. Finally, when you’ve adjusted your current net income to reflect these adjustments, you’ll want to factor in your expected tax rate in retirement. This can be done by dividing your annual net income needs by 1 minus your expected tax rate. For example, if your expected monthly net income need is $6,000 then your annual net income need will be $72,000 (6,000 x 12) and, assuming your expected tax rate in retirement is 25%, then your gross, or total, annual need will be $96,000 (72,000/.75). This should give you an idea of what your retirement needs will be each year, which you can then compare to your current savings and other expected sources of income in retirement.
Of course, there are other variables to consider, such as inflation and how social security will factor into your plan. If you’d like to learn more about funding your retirement or having a custom financial plan built we invite you to contact one of our advisors today.