Retirement Income: Why Personalization Is Key
23 Aug 2024
When planning for retirement, many people turn to the so-called “rules of thumb” as a guide for how much income they’ll need. One of the most common rules is that you should aim to replace 70% to 80% of your pre-retirement income. While this rule can provide a quick estimate, relying on it too heavily can lead to a retirement plan that doesn’t align with your actual needs and desires. Instead, you should develop a personalized strategy based on your desired lifestyle in retirement. Here’s why.
The Problem with Income Replacement Rules
Income replacement rules are appealing because they offer a simple way to gauge how much you need to save for retirement. However, these rules are based on averages and assumptions that may not apply to your situation. They don’t account for your specific spending habits, health care needs, or personal goals. For example:
Spending Patterns: Some people may spend more in retirement, especially in the early years, as they travel or engage in hobbies. Others may spend less as they downsize or reduce their discretionary spending.
Healthcare Costs: As you age, healthcare costs can become a significant part of your budget. If you anticipate high medical expenses, the 70%-80% rule may leave you underfunded.
Debt and Obligations: If you enter retirement with outstanding debt or financial obligations, such as supporting a family member, your income needs could be higher than the standard rule suggests.
Because of these factors, basing your retirement plan on a generic percentage can lead to a mismatch between your retirement income and your actual needs.
Designing Your Retirement Lifestyle
Rather than relying on broad rules, start by envisioning your ideal retirement lifestyle. This involves thinking deeply about how you want to spend your time, where you want to live, and what activities and experiences are most important to you. Here’s how to begin:
Identify Your Priorities: What does a fulfilling retirement look like for you? Do you plan to travel extensively, pursue new hobbies, or perhaps volunteer? Your answers will help determine your spending needs.
Consider Your Location: Where you live can significantly impact your cost of living. Are you planning to stay in your current home, downsize, or move to a different city or country? Research the cost of living in your desired location to get a realistic sense of your expenses.
Estimate Healthcare Costs: Consider your current health status and potential future healthcare needs. Research insurance options and out-of-pocket costs so that you have a plan that covers these expenses.
Factor in Inflation: Remember that the cost of living will likely increase over time. Make sure your plan accounts for inflation, especially in areas like healthcare and housing.
Plan for Longevity: With people living longer, your retirement savings may need to last 30 years or more. Your financial plan should account for a potentially extended retirement period.
The Power of a Retirement Vision
Having a clear vision for your retirement does more than just guide your financial planning; it provides motivation and focus. When you know what you’re working towards, saving and investing becomes more meaningful. You’re not just amassing money for some vague future need; you’re building the foundation for a specific, desired lifestyle.
Your retirement vision can also help you set more accurate financial goals. For example, if your dream is to travel the world, you can research the costs of long-term travel and plan accordingly. If you want to stay close to family and engage in local community activities, your financial needs might be different.
Building a Personalized Retirement Plan
With your lifestyle vision in place, you can start to build a retirement plan that reflects your actual needs. Here’s how to begin:
Create a Detailed Budget: Estimate your expenses based on your retirement lifestyle. Include categories like housing, food, travel, entertainment, healthcare, and insurance.
Assess Your Income Sources: Consider all potential income sources, including Social Security, pensions, investments, and any part-time work or passive income. Determine if these will be sufficient to cover your estimated expenses.
Identify Gaps and Adjust: If there’s a gap between your estimated income and expenses, look for ways to adjust. This might involve saving more, working longer, or reducing your spending expectations.
Consult a Financial Professional: A financial planner can help you fine-tune your plan, taking into account factors like taxes, investment strategies, and estate planning.
Review Regularly: Life changes, and so do your financial needs. Review and adjust your retirement plan regularly so that it remains aligned with your goals.
The traditional rules of thumb for income replacement in retirement are not a one-size-fits-all solution. Remember, it’s not just about the money; it’s about creating the life you want to live after work.
Important Information:
Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.
