Get Your Retirement Income Plan on Track
How much can you afford to spend each year of retirement? Will your savings last as long as you do? What if your needs or the markets change? It's tough to answer questions like these if you don't have a plan.
"With some planning, you can set up a sensible, sustainable retirement income stream that can be adjusted over time," says Rob Williams, managing director of financial planning, retirement income, and wealth management at the Schwab Center for Financial Research.
Here are five steps to help you put your retirement income plan in place.
Step 1: Estimate your expenses
Once you retire, costs such as commuting and retirement contributions will go away. But others—such as health care and travel—are likely to increase.
To understand how these changes balance out, Rob recommends first tracking your expenses to know what you're spending and then creating a budget. Include essential items, like food, health care, and housing, as well as nice-to-haves, like entertainment, travel, or a new car every few years.
Pay special attention to your health care spending, as your expenses may rise in retirement. "Most retirees can expect to spend $450-$600 a month on routine health care," Rob says. "However, before becoming eligible for Medicare, most working people already pay for health insurance, whether directly or through payroll deductions, so such monthly outlays may not represent a new expense, even if the amount differs."
If you expect major one-time expenses such as home improvements, relocation, or gifts, be sure to factor those in, as well.
Step 2: Calculate your retirement income
Next, determine if you'll have enough income to cover your projected expenses.
Start by adding up the income you expect from predictable sources outside of your savings, such as Social Security, a pension, a rental property, or an annuity. Then, subtract that amount from your estimated expenses to determine how much—if any—you'll need from portfolio sources like a 401(k), IRA, or other retirement or investment accounts.
For example, let's say you need $90,000 a year to cover your expenses. If you receive $40,000 a year from Social Security and a pension, you'll need to pull another $50,000 from your portfolio.
Step 3: Determine your withdrawal rate
The next question is whether and how long you can afford to withdraw that amount.
Say you want your portfolio to support 30 years' worth of withdrawals, including adjustments for inflation each year. How much would you need? Research by Rob's team found that an appropriately diversified portfolio of cash, bonds, and stocks would need to be roughly 25 times the size of your first-year withdrawal for you to be "highly certain" your portfolio will go the distance. (These results are based on Schwab's current long-term capital market expectations.) For example, if you planned to withdraw $50,000 in your first year and wanted to be highly certain your portfolio would last 30 years, you'd want to have a portfolio of $1.25 million ($50,000 x 25).
"Make sure you build in some wiggle room for emergencies and other potential increases in your expenses," Rob says. "And don't fret if you haven't saved this much. Depending on how long you live and how your investments perform, the 25x rule could be on the conservative side. For a more personalized spending rate and savings target, work with a financial planner to complete a retirement plan.
Step 4: Adjust as necessary
If you find your current savings are out of sync with your required portfolio balance, there are several ways to bring your savings—and aspirations—in line:
- Increase your savings: If possible, make sure you're contributing the maximum to your 401(k) account—which in 2022 is $20,500, plus an additional $6,500 if you're over age 50—and consider funding a separate individual retirement account (IRA), as well. You might also consider earmarking bonuses, raises, and tax refunds for retirement.
- Consider delaying retirement: Every extra year you work gives your retirement savings more time to grow. Plus, if you work until you're eligible for Medicare, you can avoid paying for private health care coverage. Waiting to collect Social Security can also help stretch your retirement savings. Once you reach full retirement age—between 66 and 67 for today's retirees—every year you wait to collect (up to age 70) increases your benefit by 8%.
- Reassess your expenses: If your retirement budget includes nice-to-haves, like dining out, travel, or other non-essential purchases, consider reducing or delaying these costs. "That doesn't mean you have to cut out all the fun stuff," Rob says, "but it helps to know how much of your budget is flexible in case you need to make a change."
- Allow flexibility: Expect to adjust your plans annually when you retire. "Flexibility is important for all investors, but especially for those who feel they haven't saved enough," says Rob. In retirement, your income isn't truly "fixed." Social Security can rise with inflation, and if you have a good handle on your expenses you may be able to spend more or less as needed. For most retirees, spending isn't a straight line that never varies.
Step 5: Plan for the unexpected
As you move through retirement, you may find your income or expenses fluctuate from year to year, requiring you to spend more or less than you planned. Likewise, market volatility may necessitate a change to your withdrawal rate to help extend the life of your retirement savings.
"Changes are inevitable," says Rob. "But you can better navigate the ups and downs by creating a plan early and revisiting it often. Regular monitoring for both your plan and portfolio can help ensure you're on track, and allow you to adjust more quickly if you're not."
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