Here's how you can determine the amounts needed for your retirement income funds. These are the funds that will provide your income during retirement.
Another way to look at this, how to determine how much money you need for retirement and then how to use it.
The starting point for this process is the pre-retirement budget.
In this example budget, many categories are left out, but you need to take the time to develop your actual budget.
To make it real, just take the example and expand it to fit your own situation. To find pre-formatted spreadsheets, see this page.
As mentioned on the financial planning pages, the starting point is the budget from life before retirement.
Here is an example budget to use as a starting point for determining your savings goals and retirement income funds needed.
The next step is to convert this pre-retirement budget to your retiree budget based on the life you plan for retirement. (Keep in mind, many categories are missing, such as clothes, insurance, etc)
In your retirement plan, you may want to start your retirement after your house is paid off, and with a new car bought with cash.
You won’t be commuting so your gas expense should be lower. For now, you decide to keep your misc category as is since you still plan to go out for lunch or dinner with your friends occasionally, for example.
Here is a scaled-down example of a retirement budget:
On top of these basic living expenses, you may want to add a category for your favorite hobby. For this example, let’s figure that you want to take a class to learn oil painting, and purchase supplies, which comes to 160 per month. That gives us a nice round figure of $2000 per month, so far.
Next, we need to find out if you have enough money to support this income goal, so let’s do the math. $2000 per month for a year is $24,000.
You want to retire early, at age 57, so you need to cover the full amount of your income from your savings. Your full retirement age will be 67, so you need to cover 10 years from your income funds before you begin taking Social Security retirement benefits. That comes to $240,000.
That covers your basic living expenses with a little extra for hobbies, but what about the dream vacation trip to Australia you and your husband/wife have always dreamed of?
You can’t give that up, because it has been a huge dream for both of you. So, how much does that cost?
Let’s brainstorm that for a moment. Airfare these days is about $2000 each, and the hotel/lodgings should run about 200 per night for the 2 week stay you were planning. We’re up to $6400, and we need to add meals, ground transportation, sight seeing. I suggest $300 per day for food and taxis, plus things to do. Let’s allow $500 per event and 3 per week, 6 for the two weeks equals $3000. $4200 for meals, and $3000 per week for fun things.
This dream vacation grand total is close to $20,000.
We’re now up to $260,000. But we also need to plan for a new car after 10 years, so add another $30,000, taking us to $290,000, or round up to $300,000.
So, this $300,000 covers our income fund needs for 10 years, until we are ready for Social Security at age 67. This example plan doesn’t include money for home repairs or other unexpected expenses, so make sure you address these in your actual plan.
In planning for your retirement, another consideration is how you will invest or hold your retirement income funds. If you are not comfortable with the risks of the stock market, you may want to consider more conservative investments such as annuities (which may have much lower returns), but this gets into another topic. Just take note that you need to think about this, too. Learn more here then consult a fee-only financial advisor for more detailed advice.
I would not be comfortable spending all of my nest egg savings on this early retirement plan for the 10 years between age 57-67, so my income funds will include another “bucket” of savings to carry over into the full retirement period, even if my living expenses are already covered.
What about the years after age 67? We also need to do a budget for those years and take social security income into account. If there is a gap between what we need and what social security will provide, we need to set aside retirement income funds for those years, too.
Let’s say we’re short by $4000 per year, and we are counting on 30 more years of retirement, being healthy and optimistic. For these years, we need to set aside $120,000.
We also want a cushion for unexpected expenses, and $200,000 should cover it. That brings us to a total savings need of $420,000 for the budgets plus $200,000 for good measure which gives us a grand total of $620,000. We may need more if we don’t expect the investments to keep pace with inflation. In this example, we assume they do.
For each step above, you will need to adjust the budgets to fit your circumstances, needs, and plans. After that, you have a savings goal. Are you on track for reaching the goal on time? Have you considered all income sources available to you?
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