Last Updated May 23, 2011 10:54 AM EDT
So an essential part of your retirement planning is to prepare a budget of what you think your living expenses will be in retirement. Welcome to Week Eight of my series, 12 Weeks to Plan Your Retirement. Here we'll look at the second part of the magic formula for retirement security:
I > E, or
Income > Expenses
Conventional wisdom from financial planners says you need a retirement income that's equal to anywhere from 70 to 100 percent of your pay just before retirement. The thinking behind this advice is to provide you with the same amount of spendable income in retirement that you had before retirement (after you take into account reductions during retirement for income taxes, savings, and certain work-related expenses).
But this advice ignores the reality that your expenses can be substantially lower in retirement. And the higher your discretionary income, the more likely that you'll have a larger disparity between your pre-retirement and post-retirement living expenses.
Another problem with the conventional wisdom is that when you do the math, you find that you need a gazillion dollars to retire. So it's a good idea to take a long, hard look at your living expenses, and determine how much money you really need to cover your basic living expenses and afford only what truly makes you happy. It might take some time for you to finish this week's exercise, since I'll cover important parts of your retirement living expenses -- housing, insurance, medical bills and long-term care expenses -- in future posts of this 12-week series.
My previous post, How Much Retirement Income Do You Need?, discussed how your needs might change during retirement, and it offered suggestions for planning tools to help you prepare a retirement budget. You might want to review that post as part of this week's homework.
Developing your retirement budget will also help you think about the tradeoffs you might be willing to make to be able to retire. It might also inspire you to get creative to see how you can reduce your retirement living expenses. What is "just enough" to meet your needs and make you happy? Would you be willing to move out of the suburbs? Share housing to drastically cut your living costs? Become a dropout retiree?
How much is your retirement freedom really worth to you? The answer is different for everybody, but it's well worth your time to find the answer that works best for you.
Image from iStockphoto contributor STEEX
More on MoneyWatch:
- 12 Steps to Get Your Retirement Plan in Order
- The Magic Formula for Retirement Security
- How Much Retirement Income Do You Need?
- How Much is Just Enough? A Smart Spending Strategy
- Retiring Baby Boomers: Dropping Out to Make Every Dollar Count
- Retirement Planning Outside the Box: Move Out of the Suburbs
- How to Retire When You Have No Retirement Savings