How to set a retirement budget

October 14th, 2011 madmin

This material was prepared for Lee Curry, LPL Financial Advisor, use.

If you’re approaching retirement, you’ve probably had several meetings with your financial advisor, toyed with some online retirement calculators and possibly even mapped out some planning documents. Despite all this, you’ve probably also wondered whether you really do have enough savings to retire.

Creating a retirement budget will help you answer that question. What’s more – it also requires you to visualize the specifics of your retirement, which will help you determine if your dreams are realistic given your financial situation.

We’ve put together some simple tips to help you develop a retirement budget and stick to it throughout your retirement.

Identify your retirement expenses.

What will your expenses be when you retire? Is your home paid off, or will you have to make ongoing mortgage payments? Are you planning on traveling when you retire? How will you manage health care expenses? Some of your existing expenses may reduce when you retire (such as taxes) while others will likely increase.

When you’re going through this exercise it’s important to realize that there are different types of expenses.

Committed expenses – these are expenses you can’t live without or expenses that you can’t afford to miss, such as mortgage payments, insurance premiums, property taxes, income taxes, car payments, etc.

Discretionary expenses – as opposed to necessities, these are expenses that you could theoretically live without. Examples include dining out, massages, manicures, vacations, etc. The purpose of tracking discretionary expenses separately is so that you are able to determine where and to what degree expenses can be reduced.

Knowing exactly how much money you will need is critical in establishing a retirement budget.

Determine the amount of income you’ll need.

Next, you will need to figure out exactly how much income you’ll need to cover those expenses and sustain the lifestyle you’d like to maintain during retirement.

Just like your expenses, your income sources will probably rise and fall as well. Analyze your current expenses to get a precise measurement of what you’re spending. Then, determine what will change when you retire, such as housing, taxes, travel, health care needs and other things. This will represent your necessary retirement income.

In retirement, it’s ideal to have enough fixed income to cover your committed monthly expenses. That way you can use your interest, dividend or investment income to cover your discretionary monthly expenses.

You will also need to determine the level of distributions you want to take from your investment accounts. Many people recommend the 4-percent strategy. Here’s how it works:

Withdraw 4% of your retirement savings in the first year. In the subsequent years, take the dollar figure from the first year and increase it by the inflation rate. Let’s say, for example, that you retire with $900,000. That means you could spend $36,000 in your first year of retirement ($900,000 x4%=$36,000). Assuming inflation during the year is 2%, you could then spend $36,720 in your second year of retirement ($36,000 + ($36,000 x2%)=$36,720).

The advantage of this approach is that you continue to grow your spending each year by the prior year’s inflation rate, regardless of what is happening to your investments.

Keep in mind, however, that this may not be the best solution for you. Work with your financial advisor to determine an appropriate strategy for you.

Don’t rely on conventional wisdom.

Many people claim that you will need roughly 70 to 80 percent of your pre-retirement income when you’re retired. Realize that this range is a rule of thumb that you’ll need to take with a (very large) grain of salt. Everybody’s situation is unique. Some people enter retirement debt-free, while others carry large amounts of debt when they stop working. The bottom line is: the larger you plan to live, the more income you’ll need. Try to come up with a percentage that is reasonable within your judgment. You can then plug this figure into retirement calculators to get a sense of what you need to save in order to hit that target.

Understand your income sources.

Take the time to truly understand your income sources. Sit down with your financial planner and make a list of all your fixed income sources, including pensions, social security, part-time work, interest/dividend income, and more.

Address any questions you may have and make sure you aren’t miscalculating income streams. For example, many people misunderstand the impact of drawing Social Security at age 62 instead of waiting until later. Also, make sure you’re factoring all sources of income, including 401(k)s from earlier jobs.

Seek out help.

Planning for your retirement can be a daunting and intimidating challenge. Realize that you don’t have to do it all yourself. Talk to a financial advisor. Utilize money management tools that will make the budgeting and planning process more efficient. The more help you can get, the better.

Be flexible.

Once you’ve established a retirement budget, try to live on it for a few months. If you realize that your money doesn’t stretch far enough, you will probably have to make some adjustments.

Lee Curry is a LPL Financial Advisor at MidWestOne Bank. He specializes in investments and retirement planning.

Securities offered through LPL Financial, Member FINRA/SIPC. Insurance products offered through LPL Financial or its licensed affiliates.

MidWestOne Bank and MidWestOne Investment Services are not registered broker/dealers and are not affiliated with LPL Financial.

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