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How Much Money Do You Need to Retire?

by Jan Cullinane and Cathy Fitzgerald
Published by Rodale; June 2004

The following is an excerpt from the book The New Retirement: The Ultimate Guide to the Rest of Your Life.

In a way, this is a trick question. One rule of thumb says you need only 60 to 80 percent of your current income to retire, since it costs money to make money -- workers pay for transportation, a work wardrobe and meals, plus they pay Social Security taxes and invest in retirement funds. In addition, many retirees have already put their kids through college and plan to downsize their homes. Some experts, however, suggest you may need 100 percent or more of your current income (especially when you first retire) if you still have kids in school, have parents who rely on you for some financial support, have to pay a larger share of your health insurance, plan on traveling extensively or pursuing new interests, would like to eat every meal out, or want to relocate to a more expensive resort-type setting. The real answer to "How much do you need?" is that you can't rely on anyone's rule of thumb -- you need to make your own judgments after considering your own retirement plans.

Each of us is different. Some of us are eternally optimistic, while others have a dim view of the world. Some people save money to a fault, while others seem never to have a spare dime. Here's another catch-22: The earlier you start planning for retirement, the better. The earlier you start, however, the less you will know what your specific needs will be down the line. Will you need long- term care insurance? Will you have to move to a home with your bedroom on the main level for mobility purposes? As you grow older, you will have a much better idea of how you want to live in your retirement years, but if you wait until you are older to start planning for retirement, you will have less time to prepare for it.

The best way to start thinking about retirement is to think about the choices you'll be making. If you are within 5 years of retirement, you probably have a fairly good idea of the lifestyle you desire. You may know you want to work part time, volunteer, and develop some new skills. You might be trying to decide whether you should relocate to a warmer climate, buy a second home, or downsize your housing in order to travel and spend less time on chores. Each of these decisions comes with some type of cost -- financial, emotional, or both.

Many people don't really have a handle on what life is costing them now. We get a paycheck, pay our bills, and if there is anything left over, we spend it or add it to our savings or investments; if we're short, money comes out of savings. Here are some specific things to consider as you think about your financial retirement plan.

Reexamine your 401(k) plan. First and foremost, once you retire, you won't be saving money from your paycheck to your 401(k) plan anymore. So money may start to come out of it rather than go into it every month.

Reslice the pie. Medical care and medications will likely become a much larger part of your overall expenditures, and the cost of leisure travel, which has held fairly steady in recent years, may spiral upward as the 78 million boomers start marching toward postponed vacations. There are many variables to consider -- how long you'll live, the return on your investments, future inflation rates, and unexpected retirement expenses, to mention a few.

Reexamine homeownership. Even if your mortgage will be paid before you retire, you will still have real estate taxes and insurance to pay. If these amounts are currently escrowed and paid for you by the tender, remember to account for them separately when planning for the future. Also, remember that without a mortgage, you will have no mortgage interest tax deduction, so you may see your income tax payments go up. (See the pros and cons of having a mortgage on page 383.)

Separate the necessities from discretionary expenses. Heat, electricity, telephone, health insurance, food, and car expenses are among the things you might have a hard time foregoing. Vacations, club expenses, hobbies, subscriptions, dining out, entertainment, and charitable contributions are discretionary items and may vary quite a bit from year to year. And don't forget the support you may give to your kids, your grandkids, and maybe even an elderly relative.

Don't forget the important capital items. Do you have several cars now that you will continue to have in retirement? How often will you replace those cars, and what will you spend to do so? Will you lease, borrow, or pay cash? Will your home need improvements (a new roof, landscaping, painting, emergency repairs), and what will they cost? Will you be maintaining two homes? If so, what will be the added cost?

Plan for inflation. It can be your biggest enemy (although making bad investments and spending too much on frivolous things can be just as bad). An unfortunate reality is that many people ignore inflation when calculating what they'll need down the road. This is a huge mistake. While working, your raises generally help you keep up with inflation. When you retire, you need to plan for income increases just to pay for price increases. While inflation has been very low in recent years (prices for the goods we buy have increased about 2.5 percent per year for the past decade), this may not always be so. For example, in 1980 the inflation rate was 13.5 percent -- in just that 1 year! And many of the things you will be buying in retirement may increase at much higher rates than the average rate of inflation.

Decide on a reasonable inflation rate for the sake of projection -- say, somewhere between 3 and 4 percent for most of your ordinary expenses, 5 to 7 percent for health care. The chart below, which assumes a 4 percent rate of inflation on purchasing today's equivalent of $25,000 in goods and services, illustrates inflations tremendous impact.

Assuming a 4% inflation rate, 30 years from now it will take more than $80,000 to purchase what $25,000 does today!

Anticipate health insurance costs. They are becoming a huge concern. Currently, Medicare is available at age 65. Whether you retire before or after age 65, you still must anticipate your health insurance costs. Since many businesses subsidize the cost of health insurance, expect that paying the full amount will cost you much more than the amount currently deducted from your paycheck; if you retire prior to age 65, this may amount to an additional $8,000 to $12,000 per year. You may find that your employer provides some coverage upon retirement, but you need to know which family members are covered and how long that coverage lasts. An online study conducted between July and September 2002 by the Kaiser Family Foundation and Hewitt Associates involving 435 companies found that, within several years, more than 20 percent were probably going to discontinue health coverage for future retirees.

If you need health insurance for someone who has a serious health condition, your insurance premiums may be considerably higher. Even when you qualify for Medicare, you may still pay for supplemental coverage and wrestle with the cost of prescriptions. If your health plan now subsidizes your drug costs, that coverage may stop in retirement. In that case, expect your prescriptions to cost up to four times more -- out of your pocket.

Consider long-term care insurance. More than 40 percent of Americans aged 65 or older will enter a nursing home at least once, with an average stay of 3 to 5 years -- and since women live an average of 7 years longer than men, it's more likely they'll end up in a nursing home. A 2003 Metropolitan Life Insurance survey estimated that it costs about $66,000 a year, or about $180 a day, for a private room in a nursing home. Keeping inflation in mind, those numbers will boggle the mind 15 to 30 years from now, when boomers may need long-term care.

Among the largest companies selling long-term care insurance are Transamerica, Occidental, GE Capital, John Hancock, Unum Provident, MetLife, CAN, and Penn Treaty. There are a lot of questions to ask if you're considering this type of insurance: How long has the company been around, and how long has it been selling this type of insurance? How healthy are its finances? (Check www.ambest.com or www.insure.com/ratings/ for financial strength ratings.) What conditions are necessary to qualify for benefits? Is the policy guaranteed to be renewable? Exactly what services are covered (does it cover home care and Alzheimer's, for example)? How long after you need services do the benefits kick in? Is being admitted to a hospital a necessary prerequisite to receiving benefits? What is the benefit period of the policy? Do the benefits keep pace with inflation? Do you need to keep paying the premiums once you start collecting benefits?

Invest less aggressively. Add an element of conservatism to your investment decisions. You will need to make investments, and investments always have risks. The risks could be just temporary declines in the market value of a good company's stock, or they could be more severe -- bonds defaulting, elimination of a dividend you were counting on for your income, or even bankruptcy. If you place too many large bets, you increase the possibility of a failed retirement plan. Because of this, practice diversification, and plan your investment strategy with prudence; don't put all your dollars into one or two companies; place most of your faith in companies that have successfully weathered the past (especially after the three years of investment trauma between 2000 and 2003); and use a mix of investments, such as a combination of bonds, CDs, money market funds, real estate, and stock. Mutual funds are great tools that offer instant diversification within almost all investment asset classes. Don't bet on long shots, or if you must, keep those bets to sizes that you can afford to lose. (For more help with diversification, see pages 389 to 391.)

Reprinted from: The New Retirement: The Ultimate Guide to the Rest of Your Life by Jan Cullinane and Cathy Fitzgerald © 2004 Jan Cullinane and Cathy Fitzgerald. Permission granted by Rodale, Inc., Emmaus, PA 18098. Available wherever books are sold or directly from the publisher by calling (800) 848-4735 or visit their website at www.rodalestore.com

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