How to Financially Prepare for Retirement: A Realistic Guide

TRICKS OF THE TRADE

How to Financially Prepare for Retirement: A Realistic Guide

Prepared by Michael Menninger, CFP®

Retiring from your job may be one of the most important decisions you will make during your lifetime.  This decision impacts you both emotionally and financially.  As for emotionally, many folks identify themselves by their role at work and/or most of their friends and acquaintances are at work.   Once you retire, those two mostly go away, thrusting you into a new life.  However, the focus of this article is on the financial preparation.

The Financial Reality of Retirement: Where Will Your Income Come From?

To most, the thought of not getting a paycheck is very worrisome and brings on angst, because retirement takes on a new paradigm. These are the most common questions financial planners hear when folks are considering retirement.  

• Where will my money come from?
• Will I have enough to live on?
• How much can I realistically spend each month?

These are very valid questions, and we believe that folks should be carefully considering this at least 2 – 3 years before they retire.

Step 1: Determine Your True Cost of Living in Retirement

We have run hundreds of retirement income models, and interestingly, the most important item to consider is your cost of living in retirement.  Most people will create a budget of their expected costs, including their mortgage, utilities, car loans, and other necessary items.  

Pro Tip: Add approximately 30% to your estimated monthly expenses to better reflect real-life spending.

Step 2: The Easiest and Most Accurate Way to Calculate Spending

So, how do you arrive at your cost of living?   I jokingly follow by asking two questions.  

1. Do you want the easy way or the hard way?  
2. Do you want the accurate way or the inaccurate way? 

Obviously, everyone answers those questions the same way, but I’m here to tell you that the easy way is miraculously the most accurate way.   How can that be?

We recommend starting the easy way, which is effectively looking at your bank statements at the beginning and end of a 12-month period.  By doing so, it includes anything that may be an annual payment (insurances, property taxes, etc.) and also eliminates the normal fluctuations we all experience.   So, when using those starting and ending points, go see how much your bank balances have gone up or done over that year, and then compare that to your take-home income.  If you deposited $120,000 over the year and your bank account balances went up by $12,000, then you spent $108,000, or $9,000 per month.   Yes, it’s that easy, and trust me, it’s the most accurate and often eye-opening.  The problem is that it includes all the discretionary spending that is easily forgotten.

Step 3: Break Down Your Spending

Now that you have developed your actual cost of living, it is appropriate to figure out where it went.  You should carve out any extraordinary one-time income or expenses, such as an inheritance or paying for a wedding or college.  I caution you not to exclude maintenance items such as car repairs, home repairs / maintenance, because while they may be “one-time” costs, you will find that you have these one-time costs each year, but just different ones.  

How Financial Apps Can Help You Organize and Track Your Spending?

Here comes the hard part.  Where did I spend that money?  You can do it the tedious way that I did several years ago by tracking all my expenses on a spread sheet.  Or else, there are financial apps that allow you to track and organize your expenses.  These apps typically will connect to your bank accounts and credit cards, and will often help you categorize those expenses.  You can also “train” those apps to know your expenditures, and I use the Wawa example.  For me, if the Wawa expense was about $50, then it was likely for gas, but if it’s for $10 or so, then it was likely for incidentals I purchased inside the store.   The first time I did this exercise, I had categorized every expense, such as my mortgage, each car payment and maintenance item, gas, utilities, insurance, groceries, dining out, kids’ activities, donations, etc., and then I had one final column called “miscellaneous”.   And would you believe that was my biggest column, almost equalizing my mortgage?  Those are the unanticipated and uncounted discretionary expenditures that most people don’t consider, but they are real.

Once you have accomplished this task, then it’s time to figure out what expenses may go up or down in retirement.  Be careful, because once you’re retired, that pesky thing called “work” no longer gets in the way of that desirable thing called “fun”.   Plus, you’re likely spending less money while you are working.  

Can You Afford to Retire?

Important Questions to Ask Yourself

If your expenses are still too high to live on with your retirement savings, it forces you to make some difficult decisions.  

• Do you delay your retirement?
• Do you get a part-time job in retirement? 
• Do you save more now to build your nest egg?
• Do you increase the risk of your investments so they grow more?  
• Should you figure out a way to lower your expenses in retirement?

Only you can answer those questions because they are a function of prioritizing your retirement goals. 

Practice Retirement and Start Planning Your Retirement Now

This represents one of the most important facets of what we do to help our clients, which is also why we suggest that they “practice” for retirement to see if they can adjust any of those numbers above.  We hate to be the bearer of bad news if the nest egg doesn’t support their retirement, but it’s much better to learn before you retire than after you have made that commitment and are likely unable to earn the same amount of money again.  Conversely, there is nothing more satisfying than showing a client that they are able to retire when they thought they couldn’t.  So, if you’re thinking of retiring within the next few years, we encourage you to begin these exercises, and if you are seeking assistance with it, please feel free to contact us. 

Need Help with retirement financial planning? Reach Out To Menninger Today

^{Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.}

^{This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.}