CHAPTER 9
PRELIMINARY RETIREMENT INCOME CALCULATIONS (Step 3)
“An ounce of prevention is worth a pound of cure.” (Benjamin Franklin)
Preliminary retirement income calculations and forecasting are performed to primarily identify future problems before they happen or as early as possible. Once expenses and sources of income have been identified, projections are made to determine if you will have enough income to support your spending needs over time. This is when income software becomes critical and, as stated in Chapter 5, the following inputs are applied: inflation, investment rates of returns, sequence of return simulations, and estimated future income tax rates. These inputs will help you to understand if you will have adequate income to support your lifestyle. By changing these variables under different scenarios, essentially stress-testing them, you will understand how long your portfolio may hold up over time.
These preliminary projections will trigger more discussions and planning. Should a future shortfall exist, then some modifications may need to be made with your portfolio strategies, alternative sources of income, and future spending. However, rest assured, if corrective actions are necessary or desired, there will be plenty of time to implement them.
While investment rates of return, sequence of returns, and taxes are not in your control, your plan can take control over lifestyle inflation. Depending on your interests, lifestyle inflation can have a significant impact on your cash flow and your long-term income plan. For example, health care and entertainment (i.e., golf, travel, restaurants…) have higher inflation rates than those associated with food and clothing. Understanding that your choices about lifestyle can control how productive your income can be will help with retirement income planning.
As financial advisors, we have come to learn that not all retirement calculators are created equally. Each may use the same inputs and produce different outcomes. It is important to use comprehensive software that produces relevant results.
We find that retirement software programs are important, but, as you can imagine, limited in terms of long-term accuracy. Let us use the weather as an analogy. It is much easier for a meteorologist to predict current or short-term forecasts than long-term forecasts. The longer the weather forecast, the less reliable it becomes. The same holds true for long-term retirement forecasting. The projections are far less reliable over 30 years than over a 10-year period. For this reason, planning software provides useful guidance, but the continuous review of your plan is essential to the plan’s success.
On a final note regarding your preliminary calculations, if you are outside of the retirement risk zone, instead of using a budget to determine spending needs in retirement, you may look at calculating income replacement at somewhere between 60-80% of your average salary. Using one hundred percent of your income, as a gauge, is unnecessary since retirement savings and FICA among other expenses, are, likely, no longer applicable. This replacement ratio is a reasonable approximation of your future spending and income needs.
Word of Wisdom on Life
- Don’t try to be young. Just open your mind. Stay interested in stuff. There are so many things I won’t live long enough to find out about, but I’m curious about them. You know people who are already saying “I’m going to be 30 – oh, what am I going to do?” Well use that decade! Use them all! (Betty White)
- A trick is growing up without growing old. (Casey Stengel)