Do You Know What You Need for Income in Retirement?
The average business owner has a lot of financial planning going on all the time. From business expenses, income, and cash flow to retirement savings plans for owners and employees, there is a lot to think about and plan. With all those financial plans and decisions, it is a lot to ask to add one if not already in place. While you may be carefully planning for a substantial retirement income, are you missing the boat on the spending side?
Depending on your intended lifestyle in retirement, your spending needs can vary quite a biti:
- The Simple Lifestyle – If your intention is to pay off your home, vehicle(s), and other debts before retirement, it is a great start. If you also have a mostly stay-at-home lifestyle planned, with conservative pastimes, maybe fishing and camping, then your level of spending should be accommodated with social security and a retirement account or two.
- Get More Lavish – If you are in the debt-free position, but you also plan on a lot of travel, especially out of the country, then your spending projections should be ratcheted upward. If you enjoy going out for fine dining, it is another upward adjustment for spending.
- Working in Retirement – Some people just cannot relax or just enjoy doing fun things. They have worked a lifetime and they know no other lifestyle. Also, many just love to work, and they find it fun. There are two spending fronts in this case; you plan for your business spending and your personal spending. Then you factor in your work income to offset expenses.
- The Passive Income Infusion – For those who invest in income-producing assets such as rental properties, they can build a portfolio with significant monthly cash flow to fund their retirement. However, there are maintenance, management, property tax increases, and other expenses to factor into the analysis.
Basing your retirement needs on your current income is a common practice, but it may not be the best way if you are young or in career flux. It becomes difficult to project retirement needs using current spending and income, so a better way is to base your analysis on your projected spending in retirementii.
You cannot predict inflation with certainty, but current estimates are in the area of 4% per year for inflation. Even if you come up with a reasonable estimate of future retirement expenses based on current projections, inflation must be addressed. So, if you come up with an estimate of retirement expenses for one of the four situations above or similar, you must not only use the current costs of that lifestyle, but the inflation rate as well. It makes a big difference.
A Rule-of-Thumb Multiplier
There is a commonly used multiplier to get an idea of the size of a retirement portfolio necessary to fund a projected lifestyle’s expenses. It considers inflation and spending. The multiplier is 25, meaning that you would multiply your current/projected annual spending by 25 to come up with portfolio size necessary to fund a 4% per year withdrawal for spending.
Using that multiplier, and adjusting for Social Security projected income, the size of your retirement portfolio necessary to fund spending $45,000/year would be $1,125,000. Depending on your age when you start saving for retirement and your available savings cash, this is not out of reach for many.
The takeaway here is not necessarily any particular multiplier or dollar amount, but most importantly that you must consider your spending in retirement as your guide for savings.
i Plan for retirement based on lifestyle, not current income, TheBalance.com
ii Focus on spending, not income; TheBalance.com