You’ve been saving for retirement during your working years, and now it’s time to begin living off of those savings in retirement. One of the biggest retirement-planning mistakes you can make is not knowing how much money you will need to live comfortably in retirement.
A rule of thumb often quoted in the investment industry is that retirees will need about 70% of their pre-retirement salary to live comfortably in retirement. This is based on the assumptions that retirees will have fewer expenses and, as a result, will need less money. Once you retire, you will no longer be paying FICA taxes and contributing to 401(k)s and IRAs and mortgage payments if your house will be paid off. But what you save in these expenses can be replaced by spending on other expenses.
The following are some of the most often overlooked and underestimated expenses to consider during retirement.
1. Free Time
Many individuals fail to factor in the amount of free time they will have in retirement. When you are working eight hours a day, five days a week, you are making money, not spending it. However, once you retire, you now have an additional 40 hours a week of free time to fill — every week for the rest of your life. That’s a lot of time sitting around the house all day watching television or reading a book. Without a job to go to, every day is like a Saturday. You can go to movies, have lunch, buy clothes — you can do whatever you want.
One could easily spend an extra $50 a day, which, over the course of a year, is $18,000. If you originally planned on living on $50,000 a year in retirement, spending an additional $18,000 would decrease your expected standard of living by about 35%.
2. Unexpected Expenses
Unexpected expenses don’t stop happening just because you are retired. This is why it is important to have a separate savings (emergency) account earmarked for unexpected expenses (i.e., a new roof for your house, a new car, or a new water heater) in retirement as it is having when you are saving for retirement. Taking the money to pay for any unexpected expenses from your retirement savings can significantly reduce how much money you can spend on your everyday living expenses.
3. Inflation
Inflation can be a silent killer in retirement because it has the potential to erode your savings and your income over time. Inflation doesn’t literally reduce the number of dollars you will have in the future, but it does reduce your purchasing power. At the historical average inflation rate of 3.5%, a person retiring today on an annual income of $50,000 would need $60,000 of income to maintain the same lifestyle in five years, and more than $70,000 in 10 years. Without factoring in the effects of inflation, a retirement plan based on $50,000 of income in today’s dollars will only purchase about $35,000 of goods and services in 10 years.
4. Taxes
If all or most of your money is in retirement plans (i.e., 401k and rollover IRAs), it is important to factor in the role of taxes when determining your take-home withdrawals from those accounts. Any income withdrawn from these accounts will be taxed at your federal tax rate. For example, you have determined that you will need $40,000 of annual income in retirement. You plan to have $1,000,000 in retirement savings and a 4% withdrawal rate will provide you with $40,000. However, that amount doesn’t include taxes. If you happen to be in a 25% tax bracket, you will pay $10,000 in taxes, reducing your annual income to $30,000. To have $40,000 of after tax income means you would need to withdraw about $54,000 from your savings. This increases your withdrawal rate from 4% to 5.4%, which can significantly increase your chances of prematurely running out of money.
One of the biggest reason retirees spend less money in retirement isn’t because they want to live on less money, it’s because they have to. Upon reviewing a potential new client’s portfolio, these expenses are rarely, if ever, factored into their overall retirement strategy. When it comes to developing a plan for retirement, it is important to consider all of the potential expenses you may encounter during your retirement. And the best time to develop a plan is before rather than after these expenses occur.
Martin Krikorian, is President of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford MA. He is the author of the investment books, “10 Chapters to Having a Successful Investment Portfolio” and the “7 Steps to Becoming a Successful Investor.”
Martin can be reached at (978) 244-9254, Capital Wealth Managements website; https://ift.tt/1ieUUGe, or via email at, info@capitalwealthmngt.com.
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