How Much Retirement Can You Afford?
Tiffany, Gordon, Government Finance Review
As retirement approaches, financial planning shifts from resource accumulation to resource use. A good retirement planning budget is the last piece of the retirement planning puzzle - one that deserves significant attention.
With the leading edge of the 77 million strong baby boomer generation within three years of Social Security and six years of Medicare eligibility, the press has been paying noticeably more attention to retirement issues. Numerous newspaper reports have been published recently on the viability of traditional pensions and of Social security. With the resulting awareness of retirement matters, people are beginning to take their pre-retirement planning more seriously.
Pre-retirement planning takes place during the working years, when the most important retirement planning questions concern how to accumulate sufficient resources to live for many years without a paycheck. As retirement looms closer, perhaps within the last five working years, the next planning step transitions from resource accumulation to resource use - what happens during the retirement years. By then retirement benefits and savings are pretty well determined. Making the most of savings and benefits moves to center stage.
Critical to that consideration is planning for retirement spending. It is the last piece of the retirement planning puzzle that can be controlled during retirement. It deserves significant attention in any serious retirement plan. This article offers advice on how to estimate retirement spending so that you can set appropriate savings targets. The advice is relevant to government finance officers at any stage of their career.
PREDICTING RETIREMENT SPENDING
Of course, it is hard to make predictions of spending needs for an untried retirement way of life. It is tempting to take the planning shortcut offered by simplistic retirement planning books and online planning systems - the spending replacement ratio. The appeal of the replacement ratio method is its simplicity. Just plan to spend 75 percent (or perhaps 80 or 85 percent) of your pre-retirement income and you will somehow maintain your preretirement lifestyle.
True, some expenses will be missing from your retirement budget: Social security and Medicare taxes, commuting costs, work wardrobe purchases, perhaps the mortgage payment. On the other hand, new costs may take their place: a work wardrobe is replaced by new leisure clothes, commuting probably costs less than retirement travel, and health care could cost as much as your old mortgage. A replacement ratio ignores individual differences. Some people retire with a significant mortgage payment. A lucky few can expect generous employer-paid health benefits. Some plan extensive international travel, while others look forward to a sedentary life.
Serious retirement planners reject the simplistic replacement ratio approach, seeking instead a thoughtful retirement budget. Even though future retirement spending needs cannot be exactly predicted, the deliberation that goes into planning an informed retirement budget provides the best foundation for your plan.
A good retirement planning budget is a prediction of actual future spending, not a document meant to control current costs. Those who do budgets often assume that budgeting necessarily means producing a tight and disciplined spending plan. It seems that budget and cut are words that always go together. It is prudent to make conservative estimates in planning, of course, but a conservative estimate for retirement spending should be realistic within means and not overly frugal.
FINDING THE BALANCE
Doing a useful retirement planning budget calls for another important planning step. Distinguishing between needs and wants reveals spending flexibility. It shows which expenses can be reduced if times get rough. Money budgeted for travel, for example, can be shifted to health care if needed. This planning step will also show the value of pre-retirement debt reduction to increase retirement spending flexibility by reducing or eliminating debt payments. …