Understanding your Retirement Needs

Many Americans these days have made no real retirement plans for the future, and seem to have a “go with the flow” type mentality. While this may have worked earlier in life, it may hurt you in the end. Planning for retirement is one of the most important steps you can take in your life, so it shouldn’t be taken lightly by any means.

These days, planning for retirement has become known as a “do-it-yourself” activity, either because people don’t feel like consulting with a financial planner, or because the more traditional sources of retirement income are now less reliable than assumed in the past, and therefore seen as less important.

Lately, it seems that employers are moving away from “defined-benefit” retirement plans where the risk is on them and are moving more towards “defined-contribution” plans, where the investment risks fall on your shoulders. Social security cannot be relied on anymore as the only source of retirement income. For the most part, it just simply is not enough.

How Much Is Needed For Retirement?

The most generalized rule to abide by seems to say that you’ll need at least 70% of your pre-retirement income in order to live as comfortably as you currently are. If you are a lower earner, you may need up to 90% or more. These numbers also assume that you will eventually be paying a lower level of taxes because of not receiving earned income, and assume that all of your major debt has been paid off.

The most generalized rule says 70% because when Social Security and pension plans were first introduced, 65 was considered old and people weren’t expected to live much longer. Given that the life expectancy has now gone up significantly, most people should plan for at least 15 years of retirement. Because people who retire are also generally much healthier these days, they often travel much more frequently and enjoy various forms of entertainment, so it’s best to try and retire as close to your pre-retirement income as possible.

Determining How Much Is Needed

There are many different factors and calculators to go by, but this is one of the best out there. Assuming the average rate of inflation is around 2.5% per year, we shall assume that:

1 (your estimated annual income at the time you retire) x 1.025 (inflation factor) = what you’ll need to maintain your current lifestyle

This formula will show you a rough estimation of how much you may need as you enter your first year as a retiree. Be sure to repeat this formula 15 to 20 times to determine how much you may need to retire comfortably.

For instance, if you retire with an income of $50,000 per year, you will need $51,250 to allow you to live the same in your first year as you did before you were retired. In year five, you will need $56,570. As you can see, inflation must be taken into consideration, as it compounds over the years and slowly takes away the power of your money.

Are You Ready to Retire?

If you are able to potentially receive up to 70% of your current income consistently over the next 15 to 20 years after retirement without ever having to do work, you should be able to retire. Every type of debt that you have should be paid off, and you should be well-prepared in case any sudden medical issues come up. Follow these guidelines and you should be able to ease smoothly into retirement.

Tapping your Equity

In addition to pensions and retirement accounts, many people overlook the equity available in their homes. While the United States’ housing market has taken a beating in recent years, most retirees still have considerable equity in their real property. Borrowers have spent their lives building that equity, and they can spend their retirement living off it.

While many individuals look to their home equity as a last resort, which it certainly can be, it should always factor into asset considerations. Many mortgage lenders offer “cash-out” refinances, which can be executed at historically low interest rates. This cash is generally tax-free, though check with your accountant, financial adviser or with the IRS directly for verification.