If you’re about to retire, you’ve got to be deadly serious about your retirement income security. All kinds of thoughts might be running through your head; “What if I need more income for some unexpected reason? What if my investments don’t do as well as planned? What if I live longer than I expect? Should I start looking into small business ideas once I retire?” These are just a few of the worries that are – or will – go through your head. Fortunately, there are solutions.
Keep in mind that if you’re concerned about having too little money in the future, the longer you delay taking action, the greater that fear should be. Every year you wait increases your risks of completely running out of money. The good news is, you can make relatively small adjustments now and they’ll pay off big time down the line.
In order to take that action, you need three very important things:
Your financial stability is a function of balancing three things; income, assets and spending. When you have a balance between these three, you’ve got a smooth retirement ride ahead of you. When any one of these are out of whack, you’re looking for trouble. Let me give you an example.
I met a man several years ago who was worth over $5 million and he earned over $400,000 a year. He had a great business and strong investments. When we met, he asked me one simple question: How much money do I need to retire?
I told him he needed about $20 million. After he put himself back up on his chair, he asked how I got to that number. He told me earlier that he was spending over $800,000 a year (pre-tax). Once he retired, he’d no longer have any business income so he’d need to replace that $800,000 somehow. If he could withdraw 4% on his assets, he’d need $20 million to produce that $800,000. He failed to understand the relationship between assets, income and spending.
Unfortunately, this person was spending down his assets even before he retired so each year he worked (and overspent) meant his retirement was further and further away. In other words, each year that he took out more than 4%, he was actually exhausting his account. When that happens, values decline. His $5 million portfolio was like a melting snow ball in mid-July. Soon, all he’s going to have left is a hand full of mud. In order to have income security, you have to stop the melting. Right?
Let’s move on to the second important ingredient for retirement income security.
In order to never worry about retirement income, you have to know what your income is going to be and how much it will cost you to live. It’s relatively easy to project your retirement income but it’s not so easy to forecast your spending. Of course things are going to change. Perhaps you’ll travel more. Maybe your mortgage will be paid off. And if you’re really lucky, maybe your children won’t be living with you.
These are all things that are very hard to predict. But you are far better of by making an effort and doing your best than to ignore this issue of spending. A great place to start is to track your spending now and then make adjustments. When I ask people what it costs them to live, they typically underestimate it by 30%. Track your spending for 12 to 24 months and get an average. That will be the best number for you to work off of. Without considering your cost of living during retirement, you’ll never have financial security. This is the number one most important step you can take.
You can see that if your expenses remain too high, you’ll be forced to spend down your assets. And as we saw above, once you do that, your income decreases because the asset base shrinks. Bottom line? Track your spending and match it to income.
3. Project and Adjust
Once you have a good idea about your retirement income and you’re retirement cost of living, you have something you can build on. Of course there will be inflation and changes. That’s why you’ll have to start creating a financial plan for yourself each year. The good news is it’s not hard to do and you can get this done for free. (If you are young when you retire and your income just meets your expenses, you’re going to have to make adjustments. Inflation is going to play a major part in your retirement life and it’s going to make things harder.)
Understand that balance between income, assets and spending. Track your spending, project out and make adjustments as needed. This will not be a perfect plan but if you take these steps you’ll be ahead of 90% of your peers. And you’ll have a lot less to worry about when it comes time to trade in your desk for some airplane tickets to visit your grandchildren.
What have you done to safeguard your retirement income?
This is a guest post from Neal Frankle, Certified Financial Planner in Los Angeles and the author of Wealth Pilgrim, a blog to help others make smart decisions about their finances.
Published or updated August 31, 2011.