- Estimate how much you will need in retirement by first identifying your goals.
- Anticipate likely expenses such as housing, travel and college tuition.
On the face of it, the math seems fairly simple. It's a matter of income versus expenses. The key question is: will your monthly income be sufficient to cover your monthly expenses? As you think about your life in retirement, it's important to take a close look at your anticipated expenses. Remember that your retirement could cover a 25-year period, or longer, and you need to feel confident that your retirement income will cover your retirement expenses.
Identify Your Retirement Goals
The first step in determining how much income you will need in retirement is to pinpoint your goals. Your basic financial goals may include having the ability to pay your bills for the rest of your life, maintaining your lifestyle, establishing a cushion for unforeseen expenses, maximizing your estate or leaving a legacy to heirs and/or a charity. Also factor in other goals that come with financial costs, such as funding advanced education, starting a business or providing for extended family.
Bucket Your Anticipated Expenses
Once you determine what you want to do in retirement, you can begin estimating the income required to fund those ambitions. Of course, not all expenses are created equal. Categorizing your anticipated expenses can help you to prioritize and compartmentalize your income planning.
- Essential expenses include housing, utilities, food, clothing and basic healthcare. These are expenses that must be paid.
- Discretionary expenses include travel, entertainment and gifts. Discretionary expenses can usually be forgone or reduced if necessary.
- One-time expenses are exactly as the name implies. These may include a child's wedding or a grandchild's college tuition, as examples.
Within these categories, your expenses can be defined even further. For example, you may have both ongoing essential expenses (e.g., property taxes, utilities) and fixed essential expenses that last only a certain number of years (e.g., a mortgage). As you transition into retirement, some work-related expenses like transportation and apparel will decrease but the rising cost of healthcare is a financial planning issue for many retirees.
As important as it is to profile your retirement expenses before retirement, it is equally, if not more important to monitor your expenses during retirement. By meeting regularly with your financial professional, you can help ensure that your investment plan continues to meet your needs as they evolve over your lifetime.