“I want to know if I can retire,” Marie said, dropping her investment file on my desk and sitting across from me. It was typical of many early retirees everywhere trying to figure out when to stop working.
When I was a financial planner, many of my clients, like Marie, thought this was a simple question and expected a quick answer. Instead they got the Question you didn’t expect me to ask: How much will you be spending annually in retirement?
Empty states were a common response. Another was her current annual salary. Very few people can satisfactorily answer this critical question. They find it easier and more interesting to talk about investment returns and the stock market. However, spending is the secret factor that can carry you happily through retirement for decades.
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The forgotten ingredient for retirement
With inflation at its highest level in decades and recent stock market volatility, what’s the best way to prepare for retirement? Take a look at your spending now so you can plan for a brighter future.
Few early retirees (or their advisors) know how much they spend. Talking about spending isn’t as sexy as talking about the stock market. Recent increases in inflation and rising interest rates may work for and against you in your retirement years, but for the most part they are out of your control.
Your spending decisions, on the other hand, are in your control. If we don’t know how much we’re spending today, we can’t plan how much we can spend in retirement, especially on the two biggest expenses, housing and health.
Typical estimates of retirement expenses of 60% to 90% of current income are oversimplified as you approach retirement. The true number depends on your personal spending style.
Don’t feel overwhelmed by the thought of recreating this number. You can answer this question without putting everything you spend into a software program.
Set your issue number
Understanding where your money is going today is critical to being prepared for your retirement years. Focus on getting that number before the next time you check the stock market. As a certified financial planner, I’ve always answered my clients’ retirement question: “Let’s see what you spend.”
If you’re five to 10 years away from retirement, you can use your current expenses minus the large savings you’ve accumulated as a starting point. With a calculator in hand along with current tax forms, property bills, and investment statements, you’ll have a good estimate of what you need.
Get a pencil, paper and your tax returns
Here is my five step process:
Look at your most recent tax return using Form 1040. It shows a complete income picture that goes beyond your salary by including investment income, alimony, and retirement income. Line 9 shows the starting annual income number to use.
Line 16 is the amount you paid in federal taxes. Find the state taxes you paid on your state form or your W-2 if you are not filing a state income tax form. So deduct these amounts from your income for the time being. You’ll still pay taxes in retirement, although typically not as much – something we’ll get to in more detail later.
Find out your annual savings now. For retirement, these are on your W-2 or Schedule 1 of your 1040. If you save in a Roth or brokerage account, your financial statements will show that total for the year. Subtract any savings from the result in Step 2.
In step 3, deduct from your total savings any money that is in tax-deductible college savings accounts for your children or used to pay off student loans if they are paid out until you retire.
Finally, from the result from step 4, subtract any other large sums you spent on special occasions, such as holidays. B. a one-off trip or an anniversary celebration.
You now have a pretty good estimate of how much you spend annually, also known as your outflow.
If you own a home and intend to stay in it after paying off your mortgage, deduct your principal and interest payments from your monthly outflow. Don’t deduct taxes or insurance that may be included in the amount you send to the mortgage lender each month — you still have to make those payments.
Remember this number is the one starting point understand your expenses. This pre-tax number is your first point of reference for looking at your retirement assets and estimating how long they will support you. Don’t let the fact that last year was an unusual year put you off; We’re looking for an estimate. This is a starting point as expenses vary each year.
See also: Plan to live longer—and prepare to work longer
Income vs. Expenses
To see how much Social Security pays you, go to SocialSecurity.gov and click the My Social Security button to open or create your online account where you can see the monthly amount you will receive in retirement. You should familiarize yourself with this statement and check each year that your income information is accurate.
In general, it’s best to wait until you’re 70 — or at least as long as you can afford — before you start collecting Social Security, because the later you start, the more you’ll get each month . When you determine the age at which you want to retire and the amount you will receive each month, subtract that amount from your expenses.
If you have a defined benefit plan – ie a pension that guarantees you a certain amount of money each month – and/or have an annuity, deduct the amount you receive from your spending needs. Don’t deduct money from your spending needs that you expect from an IRA or 401(k) plan.
Now, in today’s dollars, you have an estimated spending number to plan for retirement. There are other ways to find out how much you’re spending, but this is one way to get you started and get a rough estimate to consider if you have enough to retire. This can be helpful whether you are speaking to a financial professional or entering information into a software program.
As you approach retirement, you can adjust the number with more specific information about where you will live in the future, the exact cost of health insurance, or any changes you want to make.
Read: Have retirees been fooled by the bull market?
secret of sustainability
Knowing your projected spending rate in retirement makes it easier to answer this nagging question if You can expect to retire without making any major lifestyle changes or outliving your savings.
For example, if you have $500,000 saved for retirement today and plan to retire next year at age 67, knowing that you’re spending $20,000 a year on top of your Social Security income means you’ll retire comfortably could. If you’re spending $50,000 a year in excess of your Social Security income, you might do well to postpone your retirement and increase your savings, or prepare to cut back on spending and lower your expectations of your golden years.
Success in retirement is living a connected and conscious life. Beyond spending, focus on all aspects of your plan: research has found that relationships, hobbies and lifestyle contribute just as much to a happy and healthy retirement as money.
Need to make changes? Now focus on the spending habits. You have the biggest impact on what you will spend in retirement.
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The less you spend, the more you can save and the more comfortable you’ll be spending less in retirement. Are you willing to compromise on your current lifestyle? For example, cut down on a car or only ski during the week when there are lots of discounts, adjust your living expenses and find a roommate.
Do this step-by-step approach annually, whether you’re preparing for retirement or already retired. You’ll get the information to motivate you to live with less and create a more sustainable retirement.
Retirement, like so much in life, comes with no guarantees, so make sure you understand all the factors that influence it. Your long-term safety depends on it.
Christine D. Moriarty, CFP, has over 25 years of experience coaching individuals, couples and business owners on their finances. Her focus is on the intersection of emotions, behavior and money. Living her dream in Vermont, she enjoys sitting down with a cup of Irish tea and a good book. For more see money peace.
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