Posted by: drdata921 | July 26, 2013

Five Steps to Assessing Your Retirement Financial Readiness

“DO I HAVE ENOUGH MONEY TO RETIRE?” As the wave of boomers approach retirement, this is the question on the minds of many. But, how do you find an answer to this most important, but complex of questions? Will a refrigerator crate over an urban heating grate be your version of “condo living” in retirement or will you thrive? There is a lot written on this topic, but how do you put the pieces together to get an answer for you?

As I have attempted to come to grips with this issue in my own retirement planning, I have identified five steps. Follow these steps and you should have a sense of whether you are able to retire from a financial perspective:

STEP #1: Determine what income will be available when you retire. Estimate these four sources:

Social Security: The Social Security Administration can provide an estimate of your retirement benefits. Go to the following link to view your personal information.

Pension Benefits: Pensions are becoming more and more infrequent these day. If your current employer offers a pension plan, contact your Human Resources Department for an estimate of benefits at your proposed retirement date.

Retirement Savings: If you have retirement savings in a 401K, IRA or the like you will need to guestimate the value at your proposed retirement date. Use the Savings Forecaster tool that you can download from this blog to forecast your balance to your retirement date.

Post-Retirement Income: If you are anticipating working in retirement or hope to start a home-based business, you should estimate the annual income you may derive from this.

STEP #2: Estimate your expenses in retirement:

Expenses: The general belief is that expenses will decrease in retirement, although this is dependent on individual spending patterns. Start with your anticipated income just before you plan to retire. Estimate your current expenses. If you use personal finance software such as Quicken, this should be easy. Then for each major spending category such as food, housing, taxes, etc., estimate what they will be in retirement. Some categories of spending may go up, such as entertainment, healthcare, etc. However, some will clearly go down. For example, you will not be contributing to a 401K or IRA when you retire. You will not have Social Security or Medicare taxes coming out of your check if you don’t work. Transportation cost should decrease if you are making a long commutes now. If you downsize your residence, your housing costs such as utilities and property taxes should decrease. Use the Expense Spreadsheet that you can download from this blog to help guide you.

Relocation: If you are planning to relocate to a different city when you retire, the cost-of-living in the new location may increase or decrease compared to your current residence. There is also the issue of taxes that might change. To get a handle on the cost-of-living in your new location compared to your current residence, go to the following link:

STEP #3: Estimate the unknowns. There are three that are important here:

Inflation: Inflation affects your cost-of-living and is important. We don’t know with any certainty what it will be in the future. However, one good bet is to use the longterm average of 3.4% – 4.0%.

Investment Returns: Unless you plan to draw out your savings in retirement and stuff it in a mattress, you should earn a return on the balance. It is difficult to provide a specific percentage because it will vary with your mix of investments. However, you can research the internet for guidelines on the historic returns for each investment class you own and do a weighted average estimate of the returns you can expect. Investment returns extend the life of your savings.

Lifespan: How long will you live in retirement? In other words, how long must your savings last? For an estimate of your expected lifespan, go to the following link and complete the on-line questionnaire:

STEP #4: Bring all of the information you have gathered together to get an estimate of how well you are financially positioned for retirement. Typically, you will search out an on-line retirement financial calculator, put in the inputs you developed in Step #1 – Step #3, and get an answer. Retirement financial calculators are very useful for assessing your financial readiness. However, the more accurate your assessment of your retirement income, expenses, and the unknowns, the more reliable the results. Don’t be overly optimistic. In this case, hedging your bets (being a little pessimistic) will probably work better for you. You can download the Retirement Funds Longevity Calculator from this blog to help you.

STEP #5: Consider the uncertainties. Many on-line retirement financial calculators have relatively simple outputs. You put in your numbers and it comes back with a specific answer. For example, given your information, it may tell you that you will be financially solvent for 24 years or some specific number like that. However, the reality is that given the uncertainties a specific number may be deceiving and is likely to be inaccurate. The more sophisticated financial calculators use a statistical procedure known as “Monte Carlo” to estimate etirement financial readiness. Monte Carlo changes the question from “how long will my retirement savings last” to “what is the probability that it will last for various time periods. For example, what is the probability that savings will last for 20 years, or 24 years, or 30 years? There are no certainties in the world. There are only probabilities of various things happening. This is a much more realistic way of assessing your finances and takes into account the volatility and uncertainties. A Monte Carlo financial calculator is available on the Retirement Funds Longevity Calculator that you can download from this blog.

Retirement financial planning can be complex. However, if you follow the five steps above, you should be on more firm footing when trying to answer the question of your retirement financial readiness.


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