This is the ninth article in a series on retirement. In this piece I will answer questions 17, 18, 19 and 20 of 32 questions everyone must answer before deciding on retirement.
- What expenses don’t I know about in retirement?
I have talked about estimated retirement expenses in question 13. However, there are some things that require repeating and more explanation. Many folks under-estimate the amount of money that will lavish upon kids and grandkids. If you don’t have grandchildren, you have no clue what is coming and how much it will change your life (and your checkbook). Talk to some friends who are retired and have grandchildren to get an idea. If you don’t put this number in your retirement budget, you will regret it. If you have grandkids before you retire, you have a pretty good idea of the money involved. You will likely under-estimate the number in retirement because you will have more time to spend with grandkids, and that will require more money. Be careful! People have been known to under-estimate other discretionary retirement expenses such as dining out, travel and vacations. Do your homework on these please.
Also, there may be some un-anticipated expenses pop up in retirement such as financially struggling children, major home or grounds expenses, dental work, large medical expenses and any number of other things. If possible, try and set up a pot of money in retirement available for such emergencies.
- What do I use for an expense inflation number?
In our practice we use 3% as an inflation assumption and hope that we are high. Inflation has been well below that for the last 10 years, but there have been some much higher numbers. We work with some folks who have some strong feelings about inflation and use their own estimate, which is fine with us. We also might use a higher inflation estimate for things such as medical expenses. Inflation could be a big variable in your retirement plan. Guess too high and maybe you could have had more fund or left your kids more than planned. Guess too low and you might not have as much fun as planned.
- What will my guaranteed income be in retirement?
Guaranteed income sounds great and usually comes in the form of a Social Security or a pension check. It might come in the form of an annuity, but I will get to those in a minute. I work with many motivated clients, and very few can retire just on a pension (unless both spouses are on a pension, and then that is a maybe). Nobody I know can retire on Social Security alone. The point is that if that is your situation, please be very diligent in planning for retirement, the odds are against you.
For most folks, you add up your Social Security income, subtract some taxes (see next question) and match the number against your expenses. There is a really good chance they don’t match and you are going to have to go to your nest egg to make up the difference. May your nest egg be big, or the money you have to take from it yearly be small.
Your nest egg may consist of mutual funds or annuities. Mutual funds aren’t guaranteed. Annuities are. Be careful of investments with guarantees. There is no such thing as a free lunch. Variable annuities that guarantee income or capital are very expensive, and that cost can significantly detract from your anticipated investment return. If you trade a chunk of money for a guaranteed income stream for the rest of your life (such a deal), that is called an immediate annuity. You will be a winner if you live to a ripe old age. You will be a loser (and pay for some other persons retirement) if you die early. Make sure you clearly understand any investment before you commit.
- How much of that income will be left after taxes?
How much did you pay in federal and state income tax last year? What was your total bill in dollars, not how much you had to pay in April? If you can answer this question, you are in a very small group. My point is that most people don’t have a clue what their “tax expenses” are. This is a very important number in retirement expense estimates. Have your CPA do a hypothetical tax return for you with your anticipated guaranteed and investment income in retirement. Or do it yourself with that tax program you use. Plug that federal and state tax bill into your retirement expenses. You could be unpleasantly surprised if you don’t.
In my next article I will answer the following questions:
- How much income, before and after taxes will I need from my nest egg?
- How big does my nest egg have to be to last for my lifetime?
- If my nest egg is not big enough, what do I do? 24. What do I do about “sequence risk”?
If you have a question for me, I can be reached at mike@McNamaraFinancial.com. I promise that I will respond. If you missed any of the previous articles in this series, they can be found at my website McNamaraFinancial.com
Michael J. McNamara, Ph.D., CFP®
CERTIFIED FINANCIAL PLANNER™
*Any financial advice in this article is intended to be generic in nature. Readers should consult with their own financial advisors before implementing any advice or suggestions above.