A general rule of thumb often quoted in the investment industry is that retirees will need approximately 70% of their preretirement salary to live comfortably in retirement.
This is based on the assumptions that retirees will have fewer expenses (i.e., paying FICA taxes, contributing to 401(k)s and IRAs, and mortgage payments) and as a result, will need less money in retirement. But what you save in those expenses can be replaced by other expenses. The following are three often overlooked and underestimated expenses to consider during retirement.
1. Free time
Many individuals fail to factor in the amount of free time they will have in retirement. When you are working eight hours a day, five days a week, you are making money not spending it. However once you retire, you now have an additional 40 hours a week of free time to fill every week for the rest of your life. As a result, one could easily spend an extra $50 a day which over the course of a year could be an additional $15,000 of expenses and on an annual retirement income projection of $75,000, spending an additional $15,000 would increase your annual expenses by 20%.
Inflation can be a silent killer in a retirement because it has the potential to erode your savings and your income over time. At the historical average inflation rate of 3.5%, a person retiring today on an annual income of $50,000 would need $70,000 of income in 10 years. Without factoring in the effects of inflation, a retirement income plan based on $50,000 of income in today’s dollars will only purchase approximately $35,000 of goods and services in 10 years.
If all or most of your money is in retirement plans (i.e., 401(k) and IRAs) it is important to factor in the effect that taxes will have on withdrawals from those accounts. Any income withdrawn from these accounts will be taxed at your federal tax rate. For example, you have determined that you will need $40,000 of annual income in retirement. As a result, your goal is to have $1,000,000 in retirement savings and a 4% withdrawal rate will provide you with $40,000 of annual income. However, that amount doesn’t include taxes. If you happen to be in a 20% tax bracket, you will pay $8,000 in taxes, reducing your annual income to $32,000. To have $40,000 of after tax income means you would need to withdraw approximately $50,000 from your savings. This increases your withdrawal rate from 4% to 5%, which can significantly increase your chances of prematurely running out of money.
One of the biggest reason retirees spend less money in retirement isn’t because they want to live on less money, it’s because they have to. When it comes to developing a plan for retirement, it is important to consider all of the potential expenses you may encounter during your retirement. And the best time to develop a plan is before rather than after these expenses occur.
Check out our free upcoming presentation, “Investing During Inflation.” For more details visit our website at www.capitalwealthmngt.com.
Martin Krikorian, is president of Capital Wealth Management, a registered investment adviser providing “fee-only” investment management services located at 9 Billerica Road, Chelmsford. Martin can be reached at 978-244-9254, Capital Wealth Managements website; www.capitalwealthmngt.com, or via email at, firstname.lastname@example.org.