A retirement game plan

Most of your retirement planning should take place well in advance of when you actually quit your job or sell your business. You really need to start formulating a game plan at least five to seven years prior to your actual retirement date. The first question you need to answer is: Can you really afford to retire?

To get started, it’s helpful to know a few rules of thumb. As a general rule, most people need retirement income that is at least 70 percent of their current salary. For example: if you make $100,000 a year now, it would be a good idea to target at least $70,000 of retirement income annually. 

It is also important to set a realistic withdrawal rate from your investment portfolio each year. Many investors use a 4 percent withdrawal rate adjusted for inflation every year as a guideline. For example, if you have a million dollars in assets, you would distribute $40,000 the first year. Studies show that if you only take out 4 percent adjusted for inflation each year, your money is likely to last 30 years (although there are no guarantees). While you might be able to live on a higher distribution rate, such as 5 percent or 6 percent, that will require meaningfully higher investment returns, which are less likely to occur.  So to be cautious, it’s prudent to start with a 4 percent guideline.

That means if you want $70,000 of distributions in retirement and are using a 4 percent withdrawal, you can estimate how much retirement savings you’ll need by dividing $70,000 by 4 percent ($70,000/.04), which gives you a target of about $1,750,000 of savings.

Once you know how much you need, then you have to decide on how to invest the money.  And investing to live off your money is different than the investment strategies you used to accumulate assets for retirement. The difference all comes down to the need for consistent distributions, and the fact that you simply can’t wait 20 years for an investment to produce positive returns.

A good approach to consider for retirement is to own a diversified portfolio of high quality dividend paying stocks. The dividend income production from the stocks can help you meet your distribution needs each year without having to rely so much on the volatile nature of capital gains. And if you focus on owning companies that have a history of increasing dividends, you have the opportunity to see your cash flow grow, which helps you keep pace with the effects of inflation. 

Another way to conserve cash for retirement is to aim for becoming debt-free. Try to make sure your mortgage has been paid off. Avoid incurring auto loans or expensive credit card debt, because unlike a mortgage, these extra interest payments aren’t deductible and deprive you of money that can be better spent on living or medical expenses.

When it comes to living expenses, shelter will make up the bulk of your budget. So, consider your current housing situation.  It may not make any sense to stay in your current home if your children are gone, you live in an area with high property taxes, or your home is expensive to maintain. If you downsize, you can use any extra funds from a sale to pay off your mortgage and add to your investment account to produce more income to live off of. However, if you have no mortgage and your property taxes are low, then maybe it makes sense to stay put, especially if it would be more expensive to move elsewhere.

Insurance is another expense to consider. You may need supplemental health insurance to buttress Medicare. Explore these costs before you retire, so you know what to expect. For example, you can buy additional coverage called Plan F for several hundred dollars a month. You might also want to investigate long-term medical insurance to cover chronic conditions for you or your spouse.

Regardless of when you decide to retire, you need to plan and prepare financially for that day well in advance, so there aren’t any unpleasant surprises along the way or 20 years down the road.