As children, many of us feared the monsters that hide in the shadows or under our beds. And while such fears are usually relegated to humorous memories by adulthood, new anxieties often arise — like planning for retirement.
The nagging worry about “what’s missing” in our retirement plans can be very real. The good news is such fears can be managed.
When planning for retirement, we should consider risks such as an economy slowing down or outliving our money. But we should also not ignore the “inflation creep.” For many families, it is a common oversight when they are considering their financial futures.
We often see plans from other firms that have factored in zero inflation when calculating a future income stream. In other words, their investment plan generates a retirement income that never increases, even if they live 25 years or more beyond retirement.
Other folks project an inflation rate (3% is the norm) and then figure out how much they can spend today, with their income rising every year until they pass. Both approaches contain some inherent flaws.
Planning your retirement income should address what it takes to maintain your standard of living — not replace your current income — and it needs to allocate funds between two areas of expense.
The first is what we call fixed or essential expenditures, including shelter, phone service, insurance, etc. Fixed expenses are necessary expenses that will most likely increase over time with inflation.
The second type of expense is what we call “social” and includes fun stuff like travel, hobbies and those activities we might hope to do forever but might have to give up eventually as we age.
During the past 32 years as a financial planner I have seen families not adjust for inflation and run out of purchasing power or, perhaps even worse, use less money when they are younger (and healthier) and then find themselves older with plenty of money but little energy to spend it.
How can you create a revenue stream that provides adequate funding for the life you want to lead throughout your retirement years?
Make a careful budget going into retirement. Include all of the expenditures that you know will arise and add in the ones you anticipate enjoying, like travel or hobbies. Once the list is compiled, assign each item to a “fixed” or “social” expense category.
When calculating the income you’ll need for fixed expenditures during retirement, we believe you’ll be better served by using the inflation formula. You don’t want to have more life left than money when you need to eat and have a place to sleep!
When it comes to social expenses, our recommendation is to flatline the income, especially after age 68. This approach reduces the purchasing power of your social budget over time, even though you have the same income.
It will allow you to have more social income while you’re able and willing to enjoy the fun things in life.