“I want to know if I can retire,” Marie said, dropping her investment file on my desk and sitting down across from me. She was typical of many preretirees everywhere, trying to figure out when they could stop working.
When I was a financial planner, many of my clients, like Marie, thought this was an easy question and expected a quick answer. Instead, they got the question that they did not anticipate from me: How much are you going to spend annually in retirement?
Blank states were a common response. Another was their current annual salary. Very few people can satisfactorily answer this critical question. They find it easier and more interesting to talk about investment returns and the stock market. Yet, spending is the secret factor that can carry you through retirement happily for decades.
The forgotten retirement ingredient
Amid the highest inflation rate in decades and the stock market’s recent gyrations, how can you best prepare for retirement? Look at your spending now, to help you plan for a better future.
Few preretirees (or their advisers) know how much they spend. A conversation about spending is not as sexy as a conversation about the stock market. The recent spike in inflation and rising interest rates can work for and against you in your retirement years, but they are largely out of your control.
Your spending choices, on the other hand, are in your control. Unless we know how much we spend today, we cannot plan for how much we will be able to spend in retirement, especially for the two biggest expenses, housing and healthcare.
Typical retirement spending estimates of 60% to 90% of current income are too simplistic when you are nearing retirement. The true number depends on your personal style of spending.
Do not feel overwhelmed at the thought of re-creating this number. You can answer this question without entering everything you spend into a software program.
Establish your spending number
Understanding where your money goes today is critical to being prepared for your retirement years. Focus on establishing that number before you next check the stock market. As a Certified Financial Planner, I always answered my client’s retirement question: “Let’s see what you spend.”
If you are five to 10 years from retirement, you can use your current spending less the large savings you accumulate as your starting point. With a calculator in hand along with recent tax forms, real estate bills and investment statements, you will have a good estimate of what you need.
Get a pencil, paper and your tax returns
Here is my five-step process:
- Look at your recent Form 1040 tax return. It will show a complete income picture, beyond your salary, by including investment income, alimony, and annuity income. On line 9 will be the starting annual income number to use.
- On line 16, find the amount you have been paying in federal taxes. Find the state taxes you have been paying on your state form or your W-2, if you do not file a state income tax form. So, for now, deduct those amounts from your income. You still will pay taxes in retirement, although typically not as much — something we will consider in detail later.
- Now find your annual savings. For retirement, these are on your W-2 or Schedule 1 of your 1040. If you save in a Roth or brokerage account, your annual statements will show that total amount for the year. Deduct all savings from the result in step 2.
- From your savings total in step 3, subtract any money that is socked away in tax-deductible college savings accounts for your children or that will be used to pay off student loans, if they will be paid by the time you retire.
- Finally, subtract from the result of step #4 any other large sums you spent for special events, such as a once-in-a-lifetime trip or an anniversary party.
You now have a pretty good estimate of how much you spend annually, which is also called your outflow.
If you own a home and intend to stay in it after paying off your mortgage, subtract your principal and interest payments from your monthly outflow. Do not subtract any taxes or insurance that may be included in the amount you send to the mortgage company each month — you will still need to make those payments.
Keep in mind that this number is the starting point of understanding your spending. This pretax number will be your initial guide to view your retirement assets and estimate how long they will sustain you. Do not let the fact that last year was an unusual year stop you from this process; we are looking for an estimate. This is a starting point, as spending varies every year.
Income vs. spending
To see how much you will receive from Social Security, go to SocialSecurity.gov and click on the “my Social Security” button to open or create your online account, which will let you see the monthly amount you will receive in retirement. You should be familiar with this statement and verify that the information on your income each year is correct.
In general, it is best to wait until you turn 70 years old — or at least as late as you can afford to wait — before you start to collect Social Security because the later you start, the more you receive each month. When you decide the age at which you want to retire and the amount you will receive each month, deduct that amount from your spending.
If you have a defined-benefit pension plan — that is, a pension that guarantees you a certain amount of money each month — and/or an annuity, deduct the amount you will receive from your spending needs. Do not deduct from your spending needs any money you expect to receive from an IRA or 401 (k) plan.
Now you have in today’s dollars an estimated spending number to plan for retirement. There are other ways to discover how much you spend, but this is one way to get you started and have a rough estimate to consider if you have enough to retire on. This may help whether you are speaking to a financial professional or entering information into a software program.
When you get closer to retirement, you may fine-tune the number based on more specific information about where you will live, exact costs of health insurance or changes you want to make.
Secret to sustainability
Knowing your anticipated spending rate in retirement makes it easier to answer that nagging question of when you can expect to retire without significantly altering your lifestyle or risk outliving your savings.
For example, if you have $500,000 saved for retirement today, and you want to retire next year at age 67, knowing that you spend $20,000 a year beyond your Social Security income means you could retire comfortably. If you spend $50,000 a year beyond your Social Security income, then you would be well advised to postpone your retirement and increase your savings or prepare to reduce spending and lower your expectations for your golden years.
The success of retirement is to have a connected and conscious life. Focus on all aspects of your plan beyond spending: Research has found that relationships, hobbies and lifestyle make for happy healthy retirement as much as money.
Need to make changes? Focus on spending habits now. They have the biggest impact on what you will be spending in retirement.
The less you spend, the more you can save and the more comfortable you will be in spending less in retirement. Are you willing to make trade-offs from your current lifestyle? For example, downsize to one car or ski only during the week when discounts abound, adjust your living expenses, and get a roommate.
Enact this step-by-step approach annually whether you are preparing for retirement or already retired. You will have the information to motivate you to learn to live on less, creating a more sustainable retirement.
Retirement, like so much of life, has no guarantees so be sure to understand all the factors that influence it. Your long-term security depends on it.
Christine D. Moriarty, CFP, has over 25 years of experience coaching individuals, couples and business owners on their finances. Her focus has been the intersection of emotions, behavior and money. She is living her dream in Vermont and delights in sitting down with a cup of Irish tea and a good book. Find more at Moneypeace.
This article is reprinted by permission from NextAvenue.org, © 2022 Twin Cities Public Television, Inc. All rights reserved.
More from Next Avenue: