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Get Four
|  | MARCH 11, 2005
By Ellen Hoffman Time to Abandon the 70% Solution The one-size-fits-all approach to estimating your future retirement spending is obsolete. Try this four-step strategy instead Financial planning for retirement consists of three basic steps: estimating your financial needs and goals, creating a plan to meet those goals, and implementing the plan. If you don't complete the first step, your chances of succeeding at the other two diminish significantly. For many years the rule of thumb said that to maintain your preretirement lifestyle, you needed 70% of your preretirement income. An Internet search of retirement-planning Web sites turns up this guidance over and over again. Don't believe it. Instead, consider newer advice offered by many financial planners: Start by analyzing your preretirement expenses and then making adjustments on a line-by-line basis. That's the most effective method, says Patrick Doland, a financial planner in Northbrook, Ill. With this method, you're more likely to get a result that makes sense for you. TOUGH CHOICES. The closer you are to retiring, the more detailed you should make your list of anticipated spending. But that doesn't mean you have to -- or should -- wait until retirement to start. Lauren Klein, a financial planner in Newport Beach, Calif., recommends doing your estimates now, before you're preparing to leave the workforce. Remember to update your estimates periodically. Keeping an eye on retirement can also help you make day-to-day decisions. Take a couple in their 50s who had "marginal" financial resources for their retirement, although they were hoping to retire soon. They asked Klein to help them figure out how to pay for their third child's college education and for a new, $50,000 kitchen they "needed." After talking to Klein and calculating the impact of these other expenses on their retirement, the couple started looking into loans to pay for college, put the kitchen project on hold, and gave up on the idea of an early retirement. Decisions like this are tough, but if you take the time to go through the following four-step process, you'll have a better idea of what you really need. 1. Itemize and add up your current expenses. Make the list as complete as possible, covering housing, utilities, health care, transportation, insurance, entertainment, vacations, taxes, and even contributions to retirement or college accounts or other savings. Checking-account records, credit-card statements, and tax records can help you come up with a complete list. It may help to break the list down into routine monthly expenses (mortgage payments, utilities, etc.) and annual ones (income taxes, property insurance, etc.). The Internet offers many budget planners and expense calculators you might find useful, but be forewarned that many have categories so broad that you could easily leave out key expenses -- such as taxes. One of the best I found is a budget form offered by a retirement fund in Tasmania, Australia. Once you can translate a few such Australian terms as petrol (gas) and chemist (pharmacist) into American English, you should find the detailed breakdowns quite helpful. 2. Estimate which expenses will disappear. These may include commuting costs, your "dress for success" wardrobe, lunches, and contributions to retirement accounts. Tally these disappearing expenses, then subtract that amount from your current spending total. 3. List what expenses you'll add. Be sure to consider the cost of your ideal lifestyle, which may include more travel and entertainment, or large gifts to your grandchildren. And don't forget to add on potential health-care costs. These include premiums and co-payments you'll need for Medicare. If you're retiring before age 65, include what it will cost to pay for health insurance out of your own pocket. Add this list of new retirement expenses to the total from the second step. 4. Decide what you can live without. Until you do, the dollar figure that you've come up with lacks authenticity. Separate out the essential expenses from discretionary ones. Essentials will include food and health-care, plus housing and such related costs as property taxes, utilities, and homeowner's insurance. Travel, entertainment, and maintaining two vehicles instead of one are examples of discretionary areas you may need to reduce or eliminate. The calculations I've described appear pretty straightforward, but experts caution that overlooking or miscalculating just one or two items can make a big difference in whether your retirement budget will succeed or fail. A recent study by Barbara Butrica and other Urban Institute researchers found that the biggest retirement expense for most people is housing, which amounted to 37% of expenses for married couples and 42% for individuals with an aftertax income of at least $49,000. If you need to look for costs to cut, concentrate on housing. Health care gets tricky due to the difficulty of predicting both your health and the price of medical care. Probably, the best you can do is to learn how Medicare works so that you're aware of at least the minimum costs you'll face after age 65, and include them in your budget. The biggest remaining issue: inflation. Try this calculator for an idea of past inflation rates. It shows, for example, that if you were living on an income of $60,000 in 1990, you needed nearly $85,000 by the end of 2003. If you use a financial adviser, you can also ask him or her for software that helps calculate inflation's impact on your retirement expenses. No amount of preretirement calculation can predict your expenses with complete accuracy. But taking the time to start now offers the best hope that you'll have adequate resources not only for what you need but also for what you want. In the next Your Retirement column: A look at how much money you can count on once you stop working.  In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement With Help From Uncle Sam. You can contact her via www.retirementcatchup.com Edited by Patricia O'Connell
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