For years, financial planners have espoused general formulas for determining the amount of income people will need in retirement. The most popular: the “70% rule,” which suggests that retirees will need to replace just 70% of their preretirement income to provide for their living needs in retirement. That may have been an effective guideline a few decades ago when the rule was established. However, relying on it today may be fraught with financial peril.
Why the old retirement formulas don’t work
It’s a very different world now, and old guidelines based on conditions that existed 30 years ago don’t necessarily reflect the realities of aging today such as these:
- A male turning 65 years old today can be expected to live another 19 years, on average, compared with 11 years in 1970; women can expect to live another 23 years
- The chance of a retiree or an elder family member requiring some form of long-term care is now 7 in 10.
- Many of today’s retirees carry debt into retirement, including mortgages, consumer debt and student loans.
- Although inflation has moderated somewhat since the 1970s, lifestyle costs such as housing, food and transportation consume a larger portion of a retiree’s budget today.
- Although health care cost increases have slowed, their rate of increases continues to be well above the general rate of inflation.
For many retirees, the 70% income replacement rule might be an acceptable baseline for planning; however, with the risk of inflation compounded by the longevity risk now confronting retirees, it’s not inconceivable that, for some retirees, their income replacement need could be as high as 100%.
5 steps to enhance lifetime income
So here are five essential steps to take within 15 years of retirement to enhance your lifetime income sufficiency:
1. Track your expenses now. You should begin to track your living expenses and gradually adjust your budget to smooth out your consumption between your living requirements now and your requirements in retirement.
2. Start living like a retiree now. Taking it a step further, you could take the approach of changing your lifestyle now to reflect how you expect to live in retirement. That might mean downsizing your home now, reducing your leisure travel, driving more efficient cars and generally adopting a more frugal mind-set.
3. Increase your savings. Any combination of the first two steps should generate a steady increase in excess cash flow which should be saved for retirement. Preretirees within 15 years of retirement ought to aim to contribute to their retirement fund a minimum of 15% of their earnings annually.
4. Start exploring your Social Security options. Retirees who are able to postpone their Social Security benefits until age 70 can significantly boost their lifetime income because Social Security increases the size of the benefits each year you delay claiming up to that age. Additional Social Security planning for spousal benefits could increase your Social Security income even further.
Read: How Social Security has shortchanged widows and widowers out of millions
5. Don’t invest too conservatively. Although the natural inclination is to reduce your exposure to risk-based investments like stocks the closer you are to retirement, reducing your exposure by too much, too soon could stunt the growth of your capital. To ensure lifetime income sufficiency, today’s retirees should always have some exposure to equities. A broadly diversified, well-balanced portfolio of stocks, bonds and cash offers the best opportunity to maintain the necessary growth of capital needed while minimizing volatility over the long term.
Regardless of your planning method or process, it would be a mistake to succumb to standard formulas or a generalized approach to retirement planning.
Also see: How much do we spend on long-term care?
Right now, your retirement vision — formed by your specific needs, wants, attitudes and beliefs — rests in your mind, and it will undoubtedly change as your outlook and priorities change. But you should always base your income needs on realistic assumptions.