Calculating Your Retirement Needs
by Jim Winslow, CFP®, Vice President, United Investment Services, LPL Financial Advisor
When retirement was years away, calculating how much income you may need may have involved a lot of estimates. Now you can be more accurate. Consider the following factors:
- The length of your retirement. The average 65-year-old man can expect to live about 17 more years; the average 65-year-old woman, 20 more years, according to the National Center for Health Statistics. Have you accounted for a retirement of 20 years or more?
- Earned income. Working during retirement, even on a part-time basis, can reduce your need to tap retirement assets for ongoing living expenses.
- Your retirement lifestyle. Your lifestyle will help determine how much income you'll need to support yourself. A typical guideline is 60% to 80% of your final working year's salary, but if you want to take luxury cruises or start a business, you may need 100% or more.
- Health care costs and insurance. Most Americans are not eligible for Medicare until age 65, and even then, Medicare doesn't cover everything. You can purchase Medigap supplemental insurance to cover some of the extras, but even Medigap does not pay for long-term custodial care, eyeglasses, hearing aids, and other ongoing essentials. For more on Medicare and health insurance, visit www.medicare.gov.
- Inflation. Because the rate of inflation can vary over time, it's a good idea to tack on an additional 4% each year to help compensate for increases in the cost of living.
Running the Numbers
The next step is to identify potential income sources, including Social Security, pensions, and personal investments. Also review your asset allocation -- namely, how you divide your portfolio among stocks, bonds, and cash.1 Are you tempted to convert all of your assets to low-risk securities? Such a move may place your assets at risk of losing purchasing power due to inflation. You may live in retirement for a long time, so try to keep your portfolio working for you both now and in the future.
A New Phase of Planning
Once you've assessed your needs and income sources, it's time to look at tapping your nest egg. First, determine a prudent withdrawal rate. A common approach is to liquidate a maximum of 5% of your principal each year in retirement; however, your income needs may differ.
Next, you'll need to decide when and how much to withdraw from your tax-deferred and taxable investments. Investors are required to take annual withdrawals from employer-sponsored retirement plans and traditional IRAs after age 70 1/2. Be aware that these withdrawals are subject to federal income tax.2
The advantage of maintaining tax-deferred investments for as long as possible is their ability to compound on a pre-tax basis and thus offer greater earning potential than their taxable counterparts. In contrast, long-term capital gains from the sale of taxable investments are currently taxed at a maximum of 15%.
1Asset allocation does not assure a profit or protect against a loss in a declining market.
2Withdrawals from tax-deferred accounts made prior to age 59 1/2 may be subject to an additional 10% penalty. In the case of employer-sponsored plans, there are special rules that apply to plan participants aged 55 and older who separate from service.
© 2011 McGraw-Hill Financial Communications. All rights reserved.