Realistic Expectations

The smartest approach to planning a satisfying retirement is having realistic expectations.

Retirement Worksheet

The first step in making sure your expectations for retirement are realistic is having a clear sense of what you'll be spending, both on the everyday costs of living and on the special activities you're planning.

Ways and Means

The widely accepted, and often repeated, retirement rule of thumb is that you need between 70% and 90% of your preretirement income to maintain your standard of living after you stop working. That formula may be too simplistic, though, to figure what you'll actually be spending.

One place to start is to calculate what the essentials are costing you right now: food and clothing, heat and home maintenance, utilities, insurance, and property taxes. You can be fairly confident you'll go on paying these bills and that inflation will push their cost up.

Next, think about the things you're likely to spend less on. Your mortgage may be paid off, you won't be commuting, and maybe your financial responsibilities for children and parents will come to an end. You may be paying less in income tax, and after you retire you're no longer paying into Social Security.

But also consider the additional expenses you may encounter, such as medical and dental care and the cost of your plans for winter in a warm place and summer in a cool one, or perhaps long-postponed trips or classes and equipment to master new skills.

Expecting the Unexpected

Ideally, what you would like to know ahead of time are the things that may go wrong, putting a financial strain on your retirement income. Although you can't predict what might happen, you can prepare by creating an investment account equal to up to two years of living expenses to be ready for market drops or emergencies.

It's generally smart to keep your reserve money liquid, which means you can turn it into cash easily if you need it. For example, you might put some of these assets in money market accounts for immediate access, and some in US Treasury bills or certificates of deposit with six-month to one-year terms.

The danger of investing your emergency fund in stocks or other equities is that you risk having to sell during a period when prices are down if you need cash immediately. This is one case where — on a limited portion of your portfolio — stability is more important than growth.

The value of a reserve fund that you draw on only in a real financial emergency is that you'll have quick access to money when you need it most — whenever that is.

Maintaining Your Savings Rate

If you've been saving and investing for much of your adult life, now isn't the time to stop. In fact, if anything, it's the time to jump up the rate at which you're putting money away, to perhaps closer to 15% of gross income rather than 10%. That will help boost your chances of having the future income you need.

Doing the Math

The tried and true way of figuring out the cost of living in retirement is to list all your current expenses and then estimate what they'll be when you plan to retire and on into your retirement years.

You can do this using a mathematical formula that accounts for:

You can find work charts like the one illustrated here to help guide you through the calculation. Check the websites of your bank, brokerage firm, or mutual fund company or ask your investment professional to refer you to a source.

Factors to Consider

As you prepare a retirement budget, you'll want to take these factors into account:
People who retire in their 60s can expect to live into their 80s.

To estimate a retirement income of 80% of your final salary, you have to account for inflation. The number will be higher than 80% of your current income.

You have to anticipate changes in Social Security in the future, which means you may get less income from that source.

You can't predict the cost of healthcare insurance or out-of-pocket costs after you retire.

There's a direct relationship between age and health costs: About 7% of Americans between ages 65 and 74 need help in handling the tasks of everyday living. But by age 85 almost 30% do.

That may mean you'll face nursing home or home care costs.

Source: Urban Institute

Looking at the Future

The most revealing thing that projecting your future needs will tell you is how much you will have to add to your retirement accounts each year to produce the income you need to maintain a comfortable life. In the example above, the assumption is that you're able to add about 14% of your income each year.

But projecting future needs emphasizes how important the rate of return is to your retirement assets. In some periods, when investment markets are depressed, you may not achieve adequate growth, especially if markets are down at the time you begin taking income. That's why, to ensure you'll have money as long as you need it, the most you should plan to withdraw each year is 4% to 5% of your assets.