Preretirement is the stage of life before retirement and offers an opportunity to plan and save solely for your retirement years. Determining your retirement income needs when retirement is still in the future is not an exact science. You need to spend some time thinking about what sources of income you will have. After you’ve done that, you’ll need to estimate your retirement income needs. The further away retirement is, the harder it will be for you to get an accurate picture. The sooner you start thinking about it, however, the greater the opportunity you have to achieve the retirement lifestyle you want.
Sources of Retirement Income
Generally, retirement income comes from three major areas: Social Security, employer-sponsored retirement plans, and personal savings and investments. You should plan to have all three of these sources of retirement income securely in place before you retire.
The following table will help you identify your sources of retirement income:
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Retirement Benefits
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$
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Social Security
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$
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Personal Savings and Investments
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$
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Wages (if you work post-retirement)
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$
|
|
TOTAL
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$
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Analysis of Current/Projected Expenses
After you determine your sources of retirement income, you should estimate your retirement income needs. The method you use can vary and depends on the time you have left before you retire. The closer you are to retirement, the easier it will be to determine what your income needs will be during retirement. If you are nearing retirement, an analysis of your current income needs is a good way to estimate your retirement income needs. However, if you are a long way from retirement, determining your retirement needs will be more difficult. If retirement is far into your future, you’ll need to do an analysis of your projected income needs to estimate your retirement income needs.
The average rate of inflation is 3% to 4%. For certain retirement expenses (e.g., health care), however, the rate could be higher.
Replacement Percentage Method
The further you are from retirement, the more difficult it is to determine your retirement income needs. Many financial planners believe that the best way for younger clients to estimate retirement income needs is to use the replacement percentage method. This method determines your retirement income needs based upon a ratio of retirement income to preretirement income. Most financial planners estimate that you need approximately 70% to 80% of your present income to maintain your current standard of living during retirement.
Caution: Keep in mind that when you determine your retirement income needs, it is only an estimate. There is no way to determine your exact income needs due to inflation, life expectancy, and other variables.
Capital Utilization versus Capital Preservation
Capital Utilization
After you estimate your retirement income needs, you should determine how you would like to use your sources of retirement income to fulfill those needs. Your first option, known as capital utilization, is to consume the principal on an as-needed basis in order to fulfill your retirement income needs. Consequently, capital utilization depletes your retirement assets even as it meets your retirement income needs.
Capital Preservation
Your second option, known as capital preservation, is to live off of the income (interest and dividends) that your retirement assets generate. This may allow you to leave the remaining principal to your heirs or preserve the assets in case additional finances are needed later in retirement. The capital preservation approach does not deplete your sources of retirement income since it does not require you to live off of the principal.
Preretirement not a Static Time
The term “preretirement” generally refers to the working years before retirement, when you are focusing primarily on retirement and planning for it more actively than before. For most people, this period begins in their late 40s or their 50s and spans anywhere from 5 to 15 years. Even over such a relatively short time, a lot can happen in your life. While you should be constantly planning for retirement during your preretirement years, such variables as your risk tolerance, your ability to save, and the priorities you set for retirement may all change throughout your preretirement years.
Example(s): You might start giving more serious thought to retirement when you turn 50. At that point, you may still be burdened with your children’s college costs and unable to save as much for retirement as you’d like. Ten years later, assuming you’re still working and your children have finished college, you might be able to save considerably more. The point here is that preretirement is not a static time. As your financial and life circumstances change during preretirement, so too may your retirement goals and the strategies you use to reach them.
At Henssler Financial, we believe you should Live Ready, and that means understanding when and how you plan for retirement changes as your circumstances change. We suggest you take the opportunity now to speak with a financial planner to help define your retirement goals ensure you are on track to meet them. If you need a financial adviser, give the experts at Henssler Financial a call at 770-429-9166 or experts@henssler.com.