In my last blog about retirement, I talked about rethinking your definition of retirement and shifting to creating a plan for financial freedom. I am on a mission to get as many people as possible to rethink and redefine their plans for their future. To do this, I’ve provided comprehensive tools to help you achieve financial freedom, both in my book, Money Smart and on www.MoneySmartOnline.com.
For openers, I suggest using the Money Smart Financial Freedom Calculator to insure that you have a good understanding of how your current plans are likely to unfold. The Input Worksheet will walk you step by step through the process of gathering the information you need for the calculator. We put a lot of work into the Money Smart calculator to ensure that the results are both complete and accurate.
The following is the input you will need for your plan. These instructions can also be found as pop-up instructions on the calculator itself. For simplicity sake I have used the word retirement rather than retirement/financial freedom below. As explained in my previous blog, financial freedom, not retirement, should be the goal for most people.
Identify your employee retirement benefits, if any.
If your employer or ex-employer offers any retirement benefits, find out the amount you are likely to receive. Most employers will provide a projected benefit statement on request. If you are married and your spouse will also be receiving retirement benefits at some point, find out about theirs as well. If you are divorced, find out if you are entitled to any benefits from your ex-spouse’s plan.
Estimate your Social Security benefits.
For the average retiree, Social Security has been providing about 35%–40% of their pre-retirement earnings. Provided you’ve been working for enough years, you can go to www.ssa.gov/estimator to get an estimate of your benefits. If not, call the Social Security Administration at 1-800-772-1213 to see if they can provide a free statement of your estimated benefits, and then learn the rules involved by going to www.socialsecurity.gov. If you are married, enter the information for each of you separately. If you are divorced or your spouse is deceased, and you were married for enough years, you may have a choice between your own benefits or 50% of your ex-spouse’s benefits, which may be higher.
As to when you expect to begin drawing Social Security, I would, for now, use the age at which you are entitled to full benefits. As you approach the date at which you can choose to take partial benefits early, you can make your final decision whether to start collecting then, to wait for full eligibility, or even to delay past that date. Most people will find that starting on the date of full eligibility is probably the best way to go.
Lastly, I repeat my caution that you should expect Social Security benefits to be tied to (indexed to) your income in the not-too-distant future. If you expect to have a substantial retirement income, I would depend on little-to-no money from Social Security. If you’re unsure what number to use, consider using half the amount that you are currently expecting to get.
Identify your current retirement savings.
List the current total of all of your retirement savings and the amount you plan to save/invest each month from this point on, including any company matching dollars. The retirement calculator on this site will assume that you will increase the amount saved annually at the rate of inflation. If you expect to substantially increase the amount you are now saving to a much higher number within the next couple of years, use that higher number. The error introduced by doing so is likely to be quite small, so I wouldn’t worry about it. As for the expected rate of return, I will again recommend using 8% for your expected rate of return from the stock
market and 5% for fixed income. If you have a mix of stocks and fixed income, calculate the average rate of growth expected. For example, if you have 50% of your assets at an expected return of 8%, and 50% at 5%, your expected growth rate would be 6.5% percent. If some of your savings are not tax-deferred, be sure to subtract the percent of the return lost to taxes to get an after-tax rate of return for this portion of your savings. As for your rate of return after retirement, it should be a more conservative number, probably no more than 6%.
Estimate your earned income in retirement.
Decide whether either you or your spouse will continue working in retirement on a full- or part-time basis, for how many years you expect to do so, and the amount you expect to make per month. For the retirement calculator, enter the information in today’s dollars; the retirement calculator will automatically adjust that number for inflation. As you look at this option, don’t limit your thinking to working only for others. Take some time to look around you. You will find the world is full of opportunities to make some money on your own. Understand that things have changed when it comes to retirement. The old pattern of go to school, work, and retire is disappearing for most people. The new pattern is more likely to be go to school, work, and change jobs (maybe a lot), go back to school, work, retire, go back to work, and then maybe retire again. The truth is that this very often makes for a better quality of life.
Estimate your cost of living in retirement.
Most people should plan on needing about 70%–80% of their current spending level after they stop working. Again, enter the amount per month in today’s dollars; the retirement calculator will automatically adjust that number for inflation. To assist you in the estimation of your
future cost of living, refer to the Spending and Saving Plan Worksheet and consider how each of the items in your current budget will change in retirement. Be especially careful when estimating the cost of your health care insurance. To estimate your future health insurance costs you need to understand the benefits you are likely to get from Medicare and the costs involved. Go to www.medicare.gov, which will give you a pretty good rundown. You should expect Medicare costs to rise far faster than inflation over the years to come. I would use at least 40%–50% more than the premium amounts people are currently paying under Medicare as your input (“today”) cost.
Financial freedom is achievable, but to get there you need a good plan and to be money smart in how you spend, save and invest your hard earned money. My aim through the Money Smart project is to support you at each step along the way with education, advice and financial coaching.
Also see: Why Wait for Retirement?