Retirement planning specialists often use rules of thumb when discussing saving for a comfortable retirement. Broad generalizations about retirement planning are a great starting point to help you conceptualize the task at hand. Yet they can often create a false sense that you’ll meet specific goals by following rough guidelines. You need more to ensure you will have saved enough to attain the kind of retirement you want. Still rules of thumb can get you thinking the right way about retirement planning. So, before you get more specific about your plans look at the big picture.
Rules of Thumb for Retirement Planning
The consequences of having insufficient retirement assets can be tragic. So, while your retirement plan should not be based on general rules of thumb, understanding the logic behind them is a great starting place. In the end, however, your retirement plan should be unique to you and based on a more comprehensive financial plan.
Retirement rules of thumb tend to offer general guidelines like:
- Save 10 to 15 percent of your income
- You’ll spend 20 to 30 percent less in retirement
Ranges like these have no real connection to what your specific retirement might look like. The point is to get you thinking about the magnitude of retirement planning.
Sometimes Rules of Thumb are Very Helpful
Rules of thumb are better than nothing. For example, you should be able to see that saving two percent of your current annual income will likely be insufficient to fund your current lifestyle in retirement.
So, the benchmark that you should save 10 percent can get you moving in the right direction. But it is just a guess and actually may not produce the results you will actually need to be successful.
Sometimes the Rules Aren’t at all Helpful
General retirement planning rules of thumb can be based on some very big assumptions.
The first of these is that your expenses will be lower when you stop working. Yet you will be responsible for your own health insurance, including long-term care and potentially nursing home coverage. As you age, the cost of prescription drugs is likely to go higher. And retirees typically don’t stop traveling when they stop working.
Many plan on traveling more in retirement. This represents an incremental increase in expenses. If you entertain more or have more leisure activities, you will likely spend more than pre-retirement levels. And inflation will raise the cost of all of these.
So, the general rule of thumb that you’ll spend less clearly has some exceptions.
The Mathematics of Retirement Income
Understanding your saving and spending habits is the basis of sound budgeting. It is also helpful when you start thinking about retirement planning.
If you take your current earnings and subtract taxes and savings, the difference is your disposable income. This is what you actually live on. Subtract your mortgage, and you arrive at your current lifestyle. Many seek to spend the rough equivalent of this in retirement.
As you consider your retirement lifestyle, you may eliminate some of your working lifestyle expenses. These may include a car payment, business lunches or other work-related costs, but not much more. Then, you need to consider those future expenses that you don’t have now.
Add to your current lifestyle number the cost of health insurance and long-term care. Also include the cost of the things you want to do in retirement. But only to the extent that you are not already doing them. In other words, the incremental cost of these things…whatever they are.
If you are doing all the travel you want, that’s in the equivalent number. If you want to travel more, you need to add in the amount of that increase.
Also consider adding in your bucket-list goals. If you have always wanted to learn to fly or join an exclusive country club, add those into your calculation. Finally, think about what you want to leave for loved ones, if that’s one of your goals. If it is, add it in.
The total of these additions and subtractions will give you an idea of the cost of your desired retirement lifestyle. Add to this your estimated tax liability, which you can get from the IRS’s published tax tables. Now it’s time to see if you can afford all of this.
You can estimate what Social Security will provide. Benefits are posted online. If you expect a company pension, add that in too. If those two sources of income don’t cover your annual expenses, you will have to make up the difference with savings and investments.
Working backwards, you can calculate the amount of capital you'll need to cover whatever gap exists between your expenses and the pension income you expect (including Social Security). After you do that math, you will see whether or not those rules of thumb will work for you.
Proper Planning Beats any Rule of Thumb
It is unwise to take chances with your retirement. That’s why proper planning – as soon as you can do it – is a much better strategy than following a rule of thumb.
Still if you are young and early in your career, a rule of thumb can at least get you thinking about retirement planning. If an income-based rule (e.g., save “X” percent) motivates you to start putting money away, that’s a great start. But you’ll need to get more specific at some point later in your career.
As retirement looms, it becomes more necessary to be detailed in your planning. And your retirement goals will drive your savings requirements. This is an important point because either your planning will allow you to afford your desired lifestyle in retirement. Or your savings will dictate what you can afford. If your retirement lifestyle is important, then you need to be specific about how much you save. The risk if your savings plan falls short is that you could be spending your golden years back at work.
The Member Service Representatives at Victory Capital Management can help answer many of the most common retirement planning questions. They are here to help when you’re ready to start planning. To help jumpstart that process, use our Retirement Planner Calculator to see how far your current investments might last in retirement.