Like everything else in life, retirement can creep up on you – whether you’re prepared for it or not. It’s wonderful to contemplate what you can do with all that extra free time, how to stay healthy, etc…..but many of you put off the “roll up your sleeves, look at the numbers” part of retirement. Why? You either underestimate how much you need, you don’t know how to calculate it and/or you fail to go to a financial planner for help. Finally, some of you stick your heads in the sand, hoping problems will go away. Establishing your preparedness for retirement is critical since you don’t want to outlive your assets. So far I haven’t met anyone who wants to rely on friends and family for a bail out!
How acute is the lack of retirement preparedness? Very. A recent survey by HRconsulting firm Aon Hewitt says 4 out of 5 Americans are not adequately prepared to meet their needs in retirement. The average worker needs 11x his/her final pay in retirement to meet retirement needs (note: this includes social security). Unfortunately, the average pre-retiree socking away money in defined contribution plans (e.g. 401(k) or 403(b) plans) has far less. Recent market volatility is increasing this gap. Another worrisome trend is the rising number of pre-retirees who have suspended 401(k) contributions and/or no longer receive an employer match.
Esssentially, there’s a mismatch between 1) sources of income and 2) how much folks need in retirement. The resulting gap is the problem. Let’s take a simple look at each area:
Step 1 -Sources of Income: A simple retirement planning is the 3-legged stool. The 3-legged stool refers to the 3 major sources of retirement income: 1) your regular savings 2) your pension (if you have one) – or your 401(k) & other tax-deferred savings plan and 3) social security. You have control over all 3 areas – including how much social security you receive!
- How much do you save in after-tax and tax-deferred accounts? Is it the right amount and allocation, given your risk tolerance, savings amounts and investment targets?
- Do you plan on taking social security at age 70 (recommended) or will you settle for a much lower annual amount if you rush to take benefits at 62 or 65/66?
Finally – are you planning on retiring at age 60? 65? 70? Phase retirement in steps, if you can? If you end up living to 95 (a growing possibility), will you have enough money coming in each month?
Step 2 – How Much You Need in Retirement: Here’s the other side of the ledger – the amount you need each month or year in retirement, including covering rising medical expenses.
- Are your financial goals realistic – given your 3-legged stool? Goals include living expenses, car purchases, travel, insurance and medical.
- Can you scale back some of these areas – if needed – to close the gap with your 3-legged stool sources of income?
Outdated financial planning conventional wisdom said folks spent 20% less in retirement. The new, harsh reality is that folks spend up to 120% or more vs. pre-retirement expenses – in part due to rising medical.
Here are the 3 critical steps to eliminate the gap between income and expenses:
- Retire later
- Save more
- Seek professional help (including help with your investments)