Written by Lauren Vahey, Shepherd Financial Partners.
Financial independence is the point at which a person’s assets generate enough income to cover his or her expenses. Most people work toward and expect to achieve the goal of financial independence by the time they retire. However; only about 4% of Americans reach financial independence by retirement. (Source: US Department of Health and Human Services.) This means that potentially 96% of retirees may not have enough savings to last their whole retirement.
How to finance your goals in retirement? . Beginning with how much you currently spend, create a spending plan based upon the goals you value the most. You will gain a better understanding of how you can live the life you want to live with the assets that you’ve spent your life building.
Make Your Lifestyle Match Your Goals
Knowing where you’re spending your money is the first step toward reaching your financial goals. In retirement, your spending will change. A good way to maintain control during this period of change is to write down some of your expected changes and how much you think they will affect your finances. The following steps will guide you in creating a snapshot of your spending.
1) Break Down Your Expenses. Begin by writing down what you spend your money on each month. This will be your starting point. As you make your goals, think about which of your expenses you will want to reduce or increase in retirement.
2) Small Lifestyle Changes. In retirement, are you going to want to start new activities or go out to eat more? Activities like golfing may increase expenses, while hobbies such as landscaping may reduce an existing expense. Think about how your everyday life will change, and update your expected expenses accordingly.
3) Large Lifestyle Changes. Are you expecting grandchildren or the marriage of a family member? Do you plan to travel in your retirement? Large life events bring expenses and should be factored into your planning.
4) Potential Cash Inflows. This section of your plan should include expected income from Social Security and other pensions, as well as other sources of passive income, such as your investments. It could also include the projected income from a part-time job, if you plan to continue to work.
At this point, you should have a general idea of how much money you need to cover your expenses that your cash inflows will not pay for.
5) Emergency Fund. Once you know about how much money you will need each year to cover your expenses, you should move enough money from your retirement fund to your savings account to cover two to three years worth of expenses. This money should be liquid, meaning not invested in the financial markets and immediately accessible as cash. An emergency fund is important because risk is unavoidable, and, if the market crashes, you can leave your retirement fund in the market to recover without having to change your lifestyle too much. Additionally, it could be used to cover any other kind of emergency, including medical expenses or unexpected house repairs.
6) Medical Expenses. Most couples need approximately $240,000 to cover their medical expenses during their retirement. While you may be in good health now, keep this figure in mind when you plan your spending because sometimes unpredictable illnesses or accidents happen. Everyone has medical expenses, and, if you do not set money aside, you (or your children) will still be responsible for the bills. . By keeping this chunk of money in your fund, you are protecting yourself and your family from debt.
7) Ultimate Goal. Would you like to spend every penny of your savings or leave a bequest to an individual or charity? Consider what you would like to leave as an inheritance or legacy. This goal will help determine how much money you should be withdrawing from your retirement account.
Many retirees make the mistake of overspending in the beginning of retirement and then are unable to fulfill all of their retirement goals due to financial restrictions. Value bidding can help individuals prioritize their spending to work toward their goals. Value bidding is the idea that every dollar you spend has value, and, by spending your money, you are choosing, or bidding on, what you value. When you make your goals, think about which ones you will enjoy the most; those are the ones that you should spend the most money on.
Many times, people spend a great deal of money on small expenses like going out to dinner, Starbucks every morning, or expensive clothes. All of these small things add up and when you spend on these items, you are valuing them over your other goals. For example, $500 designer handbag could pay for a plane ticket across the country, and when you spend that $500 on the purse, you are valuing it higher than a trip cross country. . A four dollar coffee five days a week adds up to about a thousand dollars a year ($4 X 5 X 52 = $1,040)! . By making your own coffee in the morning, you can afford both the handbag and the trip!
Taking full control of your finances is as simple as prioritizing your goals. Consider what you are giving up by spending your money on small, inconsequential items. Spend your money on activities and items you will value the most.
Run the Numbers
You may have heard of the “4% Rule” that suggests a withdrawal rate of 4% of your retirement savings every year. This rule was designed to make retirement funds last up to 30 years and is a strategy that many retirees use. However, every household has different needs, and, while 4% may be too much or too little to support your lifestyle, it is a good place to start. Here are a few elements to consider when setting your withdrawal rate.
1) Stock Market Volatility. If the market declines early in your retirement, a decision to continue to draw out capital at the same rate, say 4%, could compromise your ability for gain when the market rallies. Consider changing your withdrawal rate as the market changes in order to get the best possible return on investment, at least in the early years of your retirement.
2) Goals. Each individual has different cash flow needs as well as differing levels of savings. While some people would like to have funds left over to pass on as inheritance, others would prefer to spend every penny. The 4% Rule does not take into consideration how much you would like to have leftover after a certain number of years, so you should adjust the percentage as time goes on to reflect your goals.
The amount you withdraw each year from your retirement savings should be based upon how much you wish to spend and how much you have saved. This is the reason why planning and setting financial goals is crucial. Knowledge is power, and writing out your goals and how you plan to achieve them is the first step towards having the financial success you’ve worked so hard for.
How Much to Rely on Social Security
Social Security benefits are highly variable from person to person, and it is difficult to make a general statement about how much you can expect to receive. The average monthly benefit from Social Security is around $1,300 Source: ssa.gov- 2015). Factors such as part time work, the age at which you begin to receive your benefits, the year you were born, pensions, and military benefits can all impact your Social Security benefit. Explore the website for Social Security retirement benefits for more accurate information based on your own personal financial situation. Another good resource on the basics of how Social Security works and some of its nuances is this BlackRock brochure .
Financial independence is most attainable and sustainable to those taking the time to make and adhere to a plan. Creating a retirement budget, an emergency fund, and defining your retirement goals are excellent first steps. Contact your financial advisor at Shepherd Financial Partners for guidance on these steps and for assistance moving forward. You worked hard to reach retirement, and you deserve a plan that will allow you to enjoy your retirement to its fullest.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.