Finance & Career
Financial planning, the basis of retirement planning, can provide more satisfaction and security in your retirement years. Many people avoid thinking seriously about retirement until it is only a few years away. Yet starting to make and implement plans for retirement as early as possible—as soon as you enter the workforce- is preferable.
Early preretirement planning allows a sense of control over the changes retirement may bring. With early planning, you have more room for flexibility. Changes in economics, family structure, etc., are inevitable. Reviewing plans periodically can help you adjust to changes in circumstances. Following are actions you can take to help during retirement.
The first action necessary in financial planning is to determine what is important to the individual and family members. Setting goals gives purpose to actions 10, 20, or 30 years from now. A good starting place is to create a paper or computer list of your goals during retirement.
The list might look something like this:
- Retire at age 67
- Move to a different location
- Sell present home
- Purchase a condominium or town house
- Remain financially independent
- Travel extensively
- Maintain present lifestyle
- Continue to be employed part time
- Develop special hobbies and interests (identify them)
- Provide protection from catastrophic medical expenses
- Provide financial support for my spouse after one’s death
- Leave substantial assets to one’s children, family, or a charity
- Maintain membership in civic, social, and religious groups and organizations
In considering each goal, try to assess its financial cost. If anticipated income is less than anticipated expenses, prioritize the most important goals to accomplish and postpone others until later. Hold on to the list and use it as a management tool.
Estimate How Long Retirement Will Last
Each individual and spouse (if applicable) must decide at what age retirement will begin. Next, estimate life expectancy. Many people use 80 as an average life expectancy. Keep in mind that many people live much longer than the average. Many don’t realize that retirement could be as long as 25 to 30 years. Consider the longevity of family members, especially the age of one’s parents. By staying in good health and keeping physically fit, life expectancy is longer than the average.
Retirement planning involves planning for the many years after retirement. Keep this in mind when thinking about finances and other elements of the retirement plan.
Estimate Income Needs
The amount of money needed for retirement living expenses depends on lifestyle and retirement goals. A rule of thumb is to plan for an annual retirement income of 70 to 80 percent of preretirement earnings or 60 percent if there is no mortgage or outstanding debt. Depending on income level, it is possible to maintain a constant standard of living with 50 to 80 percent of preretirement income. This is possible because taxes, work-related expenses, and savings commitments reduce in retirement.
Some financial planners recommend striving for a 100 percent replacement of preretirement income to maintain current lifestyle. If you don’t have much retirement income, make special efforts to reduce living expenses.
Consider Changes in Expenses
Some expenses in retirement will be lower than those expenses were before retirement. Others will stay nearly the same. Housing expenses depend on whether you have a mortgage payment or if there is a residence change that will require a mortgage. You might consider a reverse mortgage to supplement retirement income.
Work-related expenses are likely to decrease. Some of these expenses include transportation costs, license fees, meals away from home, gifts for coworkers, clothing, and so on. Also, there are no contributions made to a retirement plan. Payout for life insurance coverage is generally reduced by at least 50 percent or even eliminated if a spouse is fully provided for under a pension plan.
Some expenses may continue at their preretirement levels. Food, utilities, gifts, contributions, auto liability, and property insurance expenses will probably stay constant.
Some expenses will increase during retirement. Health expenses are the most likely to increase. Expenditures for leisure, entertainment, recreation, and transportation may also take a larger share of budgets, depending on retirement goals. The amount of money spent on food, clothing, housing, recreation, transportation, and other expenses should reflect the values and meet the goals of your retirement plan.
Calculate future expenditures using the following method:
- Determine current expenses (use checking account records and charge receipts if there is no written record of expenses).
- Estimate expenditures in retirement based on today’s prices.
- Record the calculations on worksheets 1 and 2.
Worksheet 1, “Estimated Monthly Living Expenses,” can help you calculate monthly expenses. The first column on Worksheet 2, “Estimated Annual Living Expenses in Retirement,” provides a summary of expected retirement annual expenses.
Consider the Inflation Factor
The expenses calculated for retirement on worksheets 1 and 2 are figured at today’s prices. Unfortunately, a dollar today may not be worth as much during retirement in 10 or 20 years. Loss of buying power due to inflation is what makes planning so important. To accurately estimate income needs at retirement, you must predict what inflation will be, which may be difficult. Estimate the number of years before retirement begins. Use table 1 and the following steps to estimate the effect inflation will have on income needs.
Step 1: Choose from the left column the number of years until retirement starts (subtract your current age from your age at the start of retirement).
Step 2: Choose an assumed rate of inflation. Keep in mind that it varies from year to year.
Step 3: Find the inflation and factor corresponding to the assumed rate of inflation and number of years to retirement. (Example: 20 years to retirement and 5 percent inflation gives a factor of 2.71.)
Step 4: Multiply the estimated total retirement expenses (worksheet 2) by the inflation factor to get the inflated retirement expenses. (Example: $28,000 x 2.71 = $75,880.) That means living costs would be about 265 percent higher during retirement than they are currently. Enter different inflation factors for different categories on worksheet 2. For example, medical prices may continue to rise more rapidly than food prices. Using worksheet 2, estimate future expenses by multiplying today’s dollar figures (column 1) by the inflation factors (column 2) and filling in column 3. With time, you can plan for a level of retirement income that will keep up with or stay ahead of inflation.
Table 1. The Inflation Factor: Average Annual Rate of Inflation
|Years Until Retirement||3% Annual Inflation Rate||5% Annual Inflation Rate||7% Annual Inflation Rate||9% Annual Inflation Rate||11% Annual Inflation Rate|
Calculating Net Worth
As retirement approaches, it is important to know your net worth, which is the difference between what you own and what you owe. Use worksheet 3 to determine your financial strength. Review your overall situation annually.
- Ask a real estate agent to estimate the value of your home. Do not use the purchase price.
- Check a used car price guide for vehicle values.
- Make a conservative estimate of the value of household items.
- Use the appraised value for antiques and art.
- Check newspapers and the Internet for the market value of stocks and mutual funds.
- Check insurance policies to find the cash surrender value of whole or straight life insurance policies.
- Use the current value of pensions as the anticipated amount if retirement began today.
- Use the mortgage balance that appears on monthly statements. If none appears, ask the lender for an amortization schedule of the mortgage.
- List the balance due on all charge accounts, installment accounts, and loans.
- Under current bills, include any doctor’s bills, current month’s water bill, phone charges, etc.
Subtract Total Assets from Total Debts
The difference in the two numbers is the figure to use for net worth and an idea of the nest egg that has been saved. The next step is to determine sources of income expected during retirement. Sources of future income are calculated by taking all anticipated sources of retirement income, including Social Security and pensions or retirement accounts, and then estimating monthly amounts to be received based on life expectancy.
It is never too late to begin saving for retirement. Take advantage of pretax retirement accounts offered by employers, or check with an accountant for available plans for business owners.
Worksheet 1: Estimated Monthly Living Expenses
|Expense Category||Current Cost||Retirement Cost|
Real estate taxes
Household operation and maintenance
Home repair, lawn care
Water, electric, gas, fuel, oil
Waste disposal, other
Home Improvement and upkeep
Furniture and fixtures
Garden, lawn equipment, supplies
Automobile and transportation
Food at home
Food away from home
Cosmetics and toiletries
|Hair stylist expenses|
Medical and health
Medicine and prescription drugs
|Doctor and dentist visits|
Eyeglasses, hearing aids
Movies, sporting events, concerts
Adult continuing education
|Pets: care, food, vet visits|
Taxes, debt repayment, insurance
Federal and state income taxes
|Credit cards and due bills|
Property insurance (not homeowner’s)
Banks, savings and loan
Company pension, profit-sharing plan
|Stocks, bonds, real estate|
Retirement: Keogh, IRA, SEP
Domestic help, day care
|Alimony, child support|
Professional and business expenses
Worksheet 2: Estimated Annual Living Expenses in Retirement
Multiply by 12 the total cost for each category in worksheet 1 to estimate your annual living expenses in retirement. Enter these amounts in column 1.
|(1) Estimated Annual Living Expenses in Today’s Dollars||(2) Inflation Factor||(3) Adjusted Annual Expenses|
Household operation and maintenance
Medical and health
Taxes, debt payment, insurance
Future irregular expenses (new roof, new heater, etc.)
Worksheet 3: Personal Financial Statement (Net Worth)
|Assets–What we own||Self||Spouse||With Spouse|
|Cash on hand|
Certificates of deposit
Government bonds and instruments
Affiliated business interests
|Life insurance and annuities|
Cash value, accumulated dividends
Vested retirement fund benefits
Accrued pension or retirement benefit
Home (current market value)
Other real estate
|Jewelry and rugs|
Art and antiques
Notes receivable to you
Liabilities – What we owe
Credit card accounts
Real estate mortgage
|Total amount owed:|
Revised by Rick Zapata, Human Sciences Regional Extension Agent, Auburn University. Originally written by Ruth Brock, former Regional Extension Agent.
Revised July 2021, Retirement Planning, FCS-2155