The old adage ?out of sight, out of mind? is never truer than when it comes to budgeting for retirement. Starting young is the best strategy. But typically, nothing is further from a young person's mind, especially when they?re just starting a new career or forming a family.
That's probably the biggest mistake most people make when it comes to retirement planning, experts say. While it's hard to give much thought to something that's 20 to 40 years away, developing a budget geared toward retirement is the best way to help make sure you?ll have the kind of retirement that you want.
?Textbooks will tell you that once you retire, your living expenses will drop by 20% to 25%,? says Barbara A. Patton, Director of Planning for Lincoln Financial Advisors in Deerfield Beach, Fla. ?The rationale is that children will be out of the nest, you won't have expenses associated with working and so on. But generally, it's been my experience that this is no longer the case.?
People are simply more active now, says Patton. They want to take vacations, they may want to have a second home, or they want to pursue hobbies they didn't have time for when they were working. ?In some ways it's a good problem to have, so we plan that their current living expenses will remain constant throughout their lives.?
At first, that may sound like a tall order. The average American today has nowhere near the retirement savings needed to make that happen. But by budgeting properly, reaching your retirement goals can be easier than you think. The key is to start planning early.
While there is no one set scenario, here are some general rules of thumb for calculating your retirement nest egg. First, to avoid exhausting your assets, you should withdraw no more than 4% or 5% a year, adjusted for inflation, from your portfolio. That means you?ll need $20 to $25 in assets for every dollar you want to spend in retirement. So, to generate $50,000 in retirement income, count on having $1 million to $1.25 million in your nest egg.
Social Security benefits can cover some of that amount, but Patton says many of her clients aren't banking on Social Security. ?They want it to be a cushion, not necessarily a requirement of retirement,? she says.
Assess Your Expenses
For many individuals, then, the question becomes how to get from here to there. Again, it's not as hard as it seems, especially if you start young. At age 25, for example, saving even 3% of your total pretax salary a year can help accumulate a sizeable nest egg you will need by age 65, since time is on your side. But as you get older, the annual savings rate needed increases dramatically to accumulate a sizeable nest egg by age 65?18% at age 45 and up to 28% of pretax income at age 50, according to some experts, since there is less time to accumulate savings until retirement.
?For people who are closer to retirement, it is possible to catch up. But they may have to sacrifice some of their current lifestyle. And really, budgeting becomes very important,? says Patton.
Patton advises her clients to start by identifying their core, or fixed, expenses, such as mortgage payments, utility bills, insurance, etc. Basically, it's the money you must spend every month to maintain a household. Expenditures beyond that, she says, can be considered ?fun money.?
Most people have a good understanding of their core expenses and their fun money, Patton says. ?But it's really a challenge for many people to put pen to paper and figure out how much they spend on dining out and other [discretionary] activities.?
Patton usually starts with core expenses. Then she adds in the cost of going to the movies, dinners, magazine subscriptions?and they quickly add up, she says. ?I get an expense sheet and run the numbers and usually come up with a large surplus,? says Patton. ?The client will typically say it's not accurate. They must go back and account for every trip to the convenience store, every visit to the local mall, etc. Little out-of-pocket expenses add up.?
Once that's accomplished, the next step is to invest your money wisely. A diversified portfolio of stocks may still be the best bet, depending on your time horizon. ?I always encourage having money directly deposited into a separate account, so you don't feel the savings. If the money wasn't in your pocket to begin with, it doesn't hurt to go somewhere else,? says Patton.
The idea is to learn how to begin a savings regimen. ?When clients see their money build up, it gets them into the habit of saving,? she says.
Talk to Your Financial Planner About:
- Your retirement objectives.
- Identifying your expenses and mapping out a budget.
- Investment and savings strategies to help you reach your goals.