“Well, today people have to be self-reliant if they want a secure retirement income.” – Scott Cook
It is impossible to know exactly how much money you will need for your retirement but it is possible to get a good idea. So let’s talk about some practical ideas for getting this done.
There are four main components to a retirement plan: income, spending, investment return, and inflation. Start by estimating how much you will need to spend for the type of retirement you envision. With this approach, you start with what you currently spend and then make some changes for how you think your regular expenses will change when you are retired. For example, your car expenses might go down because you’re no longer commuting or they may go up because you’re planning to drive more. You then add in enough for your infrequent costs such as property taxes, insurance, buying a car every few years, etc.
On the income side, try running your plan with and without Social Security and/or your pension benefits included. That way you’ll know how important this income is to your success. Or, said another way, if your Social Security or pension benefits are changed, you’ll know what this means to your lifestyle and the changes you might need or want to make to your plans.
As for investment return and inflation, stay on the conservative side if you want to increase your chances of not running out of money. Consider the historical rates of return for the investments you’ll likely use and assume you’ll actually get a little less return. Consider what inflation has been over the past 30 years and assume it will be higher going forward.
These practical tips can make the important step of retirement planning a little easier and get you a more useful answer to the question of how much you can afford to spend in retirement.