You thought you would have many working years left until retirement; however, thanks to COVID-19 and the recent economic crisis, retirement or semi-retirement may be suddenly forced upon you. Understandably, this is a scary and upsetting time! You’re in your late fifties or early sixties, which are typically your peak earning years—thereby your peak savings years—and now that has been cut short. In fact, you may have to start withdrawing from your savings to bridge the income gap. You may be facing the very real possibility of not returning to a job with a comparable salary, or not returning to work at all.
How then do you plan for this uncertain future? With so much at stake, what starting point makes the most sense? Our advice is to begin assessing where you stand today by determining your three retirement numbers. These three numbers will create a baseline for more comprehensive planning, which will provide you with a roadmap for how best to move forward.
Number 1: How much does your lifestyle cost?
Assume the worst-case scenario—imagine you will not go back to work, and the paychecks have stopped. Before you can determine how you will replace those paychecks, you will need to get clear about how much you spend each month. It’s crucial to have a solid grasp of how much money you routinely spend, which will help you create a realistic estimate of what you will need coming in the door. Break your expenses down into needs and wants. For example: mortgage payments, property taxes, utilities, insurance, and groceries, versus dining out, gifts, travel, and entertainment. To begin this exercise, include everything you are spending now to support your lifestyle. Edits can come later if needed.
Our budget sheets can be used to carefully account both for current expenses and what is expected to be spent should you not return to work—whether this is temporary or if you do, in fact, retire. Some costs may decline, such as commuting costs, where others may increase, such as healthcare costs. Going line by line and being as thoughtful and thorough as possible is a better exercise than estimating. Try to paint the most realistic picture possible.
Number 2: How will that income need to grow?
This isn’t as simple as coming up with your first number above and using that number year after year for the length of your retirement. Whatever amount you calculate that you’ll spend initially in retirement will increase, so you will need to have a plan in place to double, and maybe even triple, that number over the next three or more decades. This is to offset the effects of inflation.
Protecting your purchasing power—the ability to maintain your lifestyle from day one of your retirement to twenty or thirty years in the future—should be your top priority. Many people may not fully understand how much their income is going to have to grow in retirement just to keep pace with inflation. And we can understand why! During your working years, it is easy to miss the upward creep of your daily expenses. While items get more expensive to purchase year after year, most people are also likely making more money year after year. The effect of inflation, therefore, isn’t as apparent. Talk to anyone who has been retired for five years or more, and you’ll find they have a different perspective! You want to be clear on how your income will need to grow over the course of two to three decades. By failing to plan for inflation, your purchasing power by the end of your retirement can easily be half what it was in the beginning.
Oftentimes we hear clients say, “As I get older, I will be doing less; therefore, my income needs will decrease.”
“That’s fair,” we say. “However, have you considered that although you may be spending less on your lifestyle expenses, your health care costs may be increasing?” It may not come as a surprise that health care costs increase at a rate much higher than average inflation.
Number 3: What is the number you will need before taxes are withheld?
The reality for the baby boomer generation, and those generations that follow, is that for most us, the bulk of our accumulated wealth resides inside of pre-tax retirement accounts, such as an IRA, 401(k), 403(b), etc. Pre-tax means that it has never been taxed and has been growing, tax-deferred, ever since. Therefore, Uncle Sam has been waiting for his share of this money for decades! What this means is that if you need to spend $1,000 from your IRA, you may have to withdraw somewhere in the range of $1,220 to $1,370+ in order to account for taxes due. Proper planning for your retirement will include accounting for this, so you’ll know what you need to have accumulated on a “before tax” basis to be able to generate the income you need.
After determining those three numbers and doing some basic planning calculations, you will usually fall into one of two camps. Either you have saved enough to produce a growing paycheck for the rest of your life and are doing the right things with your money, or you will find you fall short and have to pivot. If you need to work and save, how much salary will you need and what additional savings will be necessary to reach your goals? Will part-time work suffice? Will a reduction of your monthly wants allow you to support your needs, and for how long? You will face many such decision points while trying to navigate this detour. Having the framework in place to orient your decision making will be the key to a successful outcome.
The point here is that whatever camp you fall into, power comes from knowing. In order to be in the driver’s seat, you will have to understand what you need to do to move toward the future you envision.
With these three numbers, you can begin assessing what steps you will need to take to cross the finish line, and for most people, their finish line is to retire with confidence and clarity.
S. Joseph DiSalvo, ChFC, AIF and Marie L. Madarasz, AIF of Quest Capital & Risk Management, Inc. are experts in Retirement Income Planning, who have used a proven process for more than two decades to help clients achieve sustained success and lifelong prosperity. You can learn more about their process from their bestselling book, Income for Life, and visiting the Income for Life book’s website for supplemental materials.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.