When it comes to retirement planning, 1 in 2 people accurately know where they stand.*The other half are almost evenly divided between those who are over-confident and those who are under-confident about what lays ahead. If you are a member of either group it’s time to re-think your position – muy pronto. Here’s why.
If you mistakenly believe that everything is fine when it isn’t, you run a high risk of:
- Not investing wisely.
- Not saving enough and/or spending too much.
- Retiring too soon.
- Being forced back to work or working longer than you really want to.
If, on the other hand, you are unrealistically pessimistic about your retirement prospects, you may suffer the following consequences:
- Live in needless fear and uncertainty.
- Enjoy life less than you otherwise could.
- Possibly work longer than you really have to.
- Potentially invest too aggressively.
As you can see, both approaches are dangerous and they needlessly create negative outcomes. Yuk. The good news is that both these worries can easily be dispatched. Before we talk about how, I want to give you some very good news.
You Need Less Money Than You Think When You Retire
In order to get right-sized with retirement readiness it’s important to understand that you’ll probably need less money than you think once you stop working:
- Your mortgage might be paid off and other expenses will be lower.
- You won’t need to save for retirement anymore.
- The kids will be up and out. You’ll have fewer mouths to feed and people to support.
- Your taxes will (hopefully) be lower.
- You may be able to create more retirement income from your investments than you think.
While all this is true, it’s very important not to become complacent. Remember we talked about 25% of the people who are over-confident? They take the broad statements mentioned above, make generalizations, tell themselves it will all work out and go back to their lives without giving their future too much more thought. These are the people working at Flippy Burger in their 70s because they have to – not because they want to. Bad vibes.
Of course the people who are under-confident (25% of us) are equally skewed when it comes to the above. They ignore the fact that their cost of living will go down so they choose to be worried about something they really may not have to. Also, not a pretty picture.
An Example Of Clear Retirement Thinking
Let’s use a hypothetical example to illustrate how your cost of living might drop once you retire. Assume Phil and Fanny Flajwick gross $150,000 a year. They are in their 40’s and have 2 children; Frank age 12 and Felicia age 14. They aren’t saving much outside of their retirement plans at work and they are frightened to death. Sound familiar?
Without running a complete financial plan, let’s try to project out what Phil and Fanny are really going to need when they retire.
Currently they save $20,000 a year in their 401ks. They pay $41,000 in taxes and spend $10,000 on their children over and above their own cost of living. So the couple is living on ($150,000 – $20,000 – $41,000 – $10,000) $79,000 a year after tax.
That being the case, the goal is to replace that $79,000 after-tax and adjusted for inflation. Of course they’ll likely have Social Security and/or other retirement pensions. According to the Social Security Administration the average retirement benefit is $1249 a month. If Phil and Fanny each receive that amount, they’ll bring in about $2500 a month or about $30,000 a year before tax. If we assume they will be in the 30% bracket (very conservative) the $30,000 becomes $20,000 after tax. That leaves a balance of $59,000 to replace after tax or about $85,000 pre-tax.
I’ve written many times about how to create more income from investments so we’re not going to deal with that right here. The main point is, this couple will be able to afford their current lifestyle if they replace only 56% of their pre-retirement income ($59k/$150k) from investment income. That’s pretty cool and it’s a lot less than most people would otherwise believe they will need.
Time To Get To Work
The challenge for the over-optimistic folks is to continue this exercise to determine exactly how to generate that income from investments and how to save enough. The challenge for the overly pessimistic folks is to go through this exercise piece by piece. They need to prove to themselves that they’ll likely need less than they think. Then, they should also understand how much income they’ll be able to generate from their investments. If they see the numbers work, all they have to do at that point is chill out and order an extra-large orange juice to celebrate.
My experience tells me that our minds are the tallest hurdle that stands between us and financial peace of mind. Make sure you aren’t being over or under optimistic by running your numbers and being realistic.
Are you accurately assessing your ability to retire? How do you know?
Cyrel says
I think it’s harder when you don’t plan your retirement carefully. I think as early as, what 45-50, you’ve got to start planning. And I agree, you’ve got to be realistic.
Neal Frankle, CFP ® says
Agreed. Still, late is better than never…right?
Cyrel says
I think it’s harder when you don’t plan your retirement. I think as early as, what 45-50, you’ve got to start planning. And I agree, you’ve got to be realistic.