Think about your future income needs as the amount of money you will require to meet expenses once you stop working. You will no longer earn income from your current job during your retirement. Here’s one way to do a simple, back-of-the-napkin projection of your post-career income need.
How Much Retirement Income Do You Need?
Add up all your expected income sources in the first year after you leave the workforce. Multiply this yearly estimate by 25 years. The difference is a rough estimate of what you need minimally to maintain your lifestyle during retirement. If you’re over that number, you’re off to a great start. Further analysis can help ensure you have more than enough income. If you’re under, what can you put in place to build a strong income plan for the future?
Start by calculating 75 percent of your current income. For example, if you currently earn $200,000 per year, you would need approximately $150,000 per year if you stopped working today. This 25 percent reduction helps account for excess income you may earn now. This includes funds you’re saving and investing for the future. It also accounts for reduced expenses after your career, such as a mortgage that may be paid off by then.
Next, estimate the inflation on that income number. If you plan to leave the workforce in 10 years and the inflation rate is three percent, your base income need of $150,000 (in today’s dollars) would be $201,587 per year at that time. For the total amount you’d need to cover that phase of life, multiply that number by 25 years. That is $201,587 x 25 years = $5,039,675. That’s the total amount you’d need to fully fund your future lifestyle after retirement.
Now that you know how much income you’ll need, add up all your expected sources. These include pensions, investments, rental income, inheritance, business distributions, Social Security, annuities, and life insurance cash value. Subtract this from your projected income need, and you’ll have a clear idea of how much more you need to save to maintain your current lifestyle when you’re no longer working.
Retirement Do’s And Don’ts
- Don’t use your entire principle to pay down debt, such as a mortgage. A better option is to save that principle to meet your income needs.
- Don’t forget about taxes. Tax obligations continue to apply to your retirement income.
- Don’t make investments with too much risk for your age and income needs. In general, your investment portfolio should become more conservative as you approach your target retirement date.
These mistakes could seriously derail your long-term financial strategy. You might end up spending down your principal too quickly. You could run out of money, forcing you to either return to work or significantly scale back your lifestyle in your later years.
- Do invest in income-generating assets. These assets could include residential rental property, commercial property, annuities, private lending and businesses. You could invest in a variety of income-generating assets under the structure of a business without having to start one yourself.
- Do have a long-term cash flow projection. This projection should account for your life expectancy and include your retirement goals and plans. Identify any gaps in that projection and start working on them now.
- Do account for increased inflation. Your retirement income needs should be based on estimated inflation, not today’s dollars.
Making smart choices about your retirement income increases the likelihood of your financial success and accomplishing your personal life mission.
