In reality, your retirement plans are based on a plethora of assumptions. You have to set an expectation on how long you will live, what kind of long-term returns are plausible through the stock market, what your medical bills or long-term care expenses might be and the lifestyle you want to have in retirement. And frankly, those things are all incredibly hard to predict. In addition to these guesses, you’ll also need to make an educated guess about what age you’ll stop working, and when you want to begin collecting your Social Security benefits.
With that said, it is also important to understand that not all retirements are voluntary. Things like disabilities or illnesses might impact your ability to work, and then there is always the possibility of a layoff or termination at any point in your career. And when things like this happen, it can be difficult for seniors approaching retirement to secure new employment.
So what’s the right answer? While the “right” answer is little different for everyone, there are some basic retirement planning tools that work for just about anyone.
Create a rough estimate
Estimate how much you’ll want to spend in a given year during retirement. Use your current budget to come up with a number and adjust for inflation.
It is important to point out that some of your current expenses will no longer be needed when you retire. For example, you might plan to have your house paid in full by the time you stop working. However, some expenses go up when you are a senior citizen. Your car insurance rates will rise, you may need to make your home handicapped friendly due to limitations or disabilities, or there might be some other financial considerations due to extended illnesses or chronic conditions post retirement. Pad your budget appropriately and adjust your estimate as needed.
From here, multiply your estimated annual expenses by 25 to 33 times. The sum is the rough amount you will need to retire on.
For example, if you need $60,000 to cover your annual cost of living your formula would look like this:
$60,000 x 25 = $1.5 million
or
$60,000 x 33 = $1.98 million
Doing this will give you a rough estimate of how much money you will need at retirement, but there is always room for improvement with anything monetarily related. For best results, hire a certified accountant or financial planner to help you.
Drawbacks to using only a rough estimate
Some retirees will spend most of their money in the first few years of retirement. They will travel, enjoy life, improve their homes and maybe even take up a hobby because they feel like they have the money to do these things. However, this usually leads to outliving retirement savings, requiring the senior to get a job instead of enjoying their golden years. When planning for retirement, it’s equally important to plan your spending now and in the future.