Do you think you can retire when your savings hit some magic number? It seems that some people make this mistake, based on the articles youâll see with titles like âHow to retire on $1 millionâ or ones that advocate accumulating a specific target multiple of your pay.
When youâre in your 30s, 40s, and even early 50s, it can make sense to determine a target retirement asset amount and then develop a savings plan to hit that target at some age in the future. But retirement planning becomes much more complicated when you reach your mid to late 50s, retirement is on your radar, and you need to decide exactly when and how youâll retire.
The trouble with a magic retirement number is that it doesnât give you a framework for deciding how to manage your finances in retirement. Nor does it help you make critical decisions, such as when and how to retire, when youâll start your Social Security benefits, exactly how youâll invest and draw down your retirement savings, how to protect yourself from stock market crashes in retirement, and whether you need to reduce your spending in retirement or work longer.
Fortunately, thereâs a better way.
The âmagic formula for retirement income securityâ
Instead of focusing on a target savings amount, you should manage the magic formula for retirement income security:Â I > E
To translate, your income (âIâ) needs to exceed your living expenses (âEâ) for the rest of your life. As you can see, this formula really isnât magic; itâs just plain common sense.
But to the detriment of older workers and retirees, retirement planners often focus only on the income aspect of retirement, wanting to talk to you solely about how you can generate retirement income. You might hear them say, âYou need a retirement income equal to 70% to 80% of your salary just before your retirement.â
The problem with this rule of thumb? It ignores the element of living expenses, which can change significantly in your later years. It also assumes you want the same life in retirement that you had while you were working and that you wonât change your spending habits. For many people, however, thatâs not the case.
Instead, youâll want to take a closer look at your expenses and determine how you might cut back. Youâll also want to focus on buying just enough to meet your needs and make you happy.
Since most older Americans havenât saved enough to continue their current standard of living in retirement, theyâll need strategies for managing both sides of the magic formula for retirement income security.
Once youâve got these financial basics down, youâll also want to focus on other key financial decisions youâll need to make as you transition into retirement. These include obtaining the right medical insurance, making smart choices for Medicare, and protecting yourself against the risk of high expenses for long-term care late in your life.
Spend the time it takes to make choices that allow you to feel comfortable that you wonât go broke in retirement and that youâve done all you can to plan for a secure future, then go enjoy your life.