A 3-Step Process for Creating a Sound Retirement Plan


3-step plan to creating a sound retirement plan

A 3-Step Process for Creating a Sound Retirement Plan

The success of any retirement plan hinges on three important numbers.

This post explores the most important, and most personal, numbers that anybody needs to know to retire.

Your Retirement Budget

Okay, this first one is a little unfair because a budget is more than one number. In fact, it’s a lot of numbers. And many people hate the word budget. But I’ll ask you to stick with me for a few seconds, so I can convince you of the immediate and long-term value of knowing your budget.

Budgets aren’t just a joy for spreadsheet nerds who would rather bask in the glow of a computer screen than do… literally anything interesting. Personal budgets (or budgets shared with your spouse or family) are tools to alleviate stress and show how much room you have for the fun stuff. Budgets are like the guardrails at Niagara Falls. You get to bask in the beauty of the Falls without running headlong into danger.

A budget, simply put, is a proactive spending plan. It allows you to tell your money where to go. During your working years, an important goal is to keep your spending below your income. During retirement, it is okay to outspend your income by a little bit (as you draw from your nest egg), but you won’t want to get too wild too early.

To create a budget, you’ll take a detailed look at your income and your spending habits. You can use this free fillable worksheet to help you get started.

When you see your real budget, you can make decisions about the real world and your real values. Do you value driving nice cars, or would you prefer to put more money towards a nice vacation with your family? Maybe downsizing your house would free up extra room in the budget to join a swim club, a tennis team, or buy annual passes to a ski resort. Maybe you like your house, and prefer to spend your time on less expensive activities such as playing music, hiking, or playing pickup basketball at the local park. Those trade-offs get reflected in your budget.

Seeing your current budget can also help you plan for retirement. Most people want their retirement to look similar to their working years, with a few tweaks. They want more time with the people they love, more time for hobbies, and perhaps the freedom to give to charitable causes. The Retirement Budget Calculator is designed to help people adjust their budgets over time. Looking through the numbers can help you see what you need to cut, so you can live the retirement you want.

Your Net Worth in Retirement

Your net worth is the value of your assets (that is the value of the things you own) less the value of the debts you owe. Assets may include your primary home, rental houses, retirement accounts, bank accounts and more. Debts can include loans you owe to family members, credit cards, car loans, and the mortgage.

Net worth is probably the single most accurate measure of wealth for aspiring retirees. During retirement, most retirees will have some income from Social Security, and perhaps some income from a pension, royalties, or part-time work. But most retirees depend on their nest egg to supplement these income sources.

How long will your net worth last in retirement? The answer depends on several factors, but most importantly the budget that we just discussed. Let’s say that your anticipated retirement budget is $50,000 per year, and you have $36,000 coming in from Social Security, a small pension, and a small side business. That means you need about $14,000 per year at the start of retirement. Of course, the amount you will need will go up due to inflation (a decade from now you’ll need nearly $19,000 per year (assuming a 3% inflation rate) to cover the gap).

One rule of thumb for determining how long your net worth will last is the rule of 25. This rule says that if your net worth is 25 times your annual withdrawal rate, you’re unlikely to run out of money in a 30-year retirement. The great thing about this rule is that it already accounts for inflation. In the example above, the person who needs to withdraw $14,000 per year during retirement needs a net worth of at least $350,000 ($14,000 X 25).

There are, of course, caveats to this rule of thumb. For example, for the rule to work, the assets must be invested in stocks and bonds, so $350,000 of home equity isn’t exactly the same as $350,000 in the market.

The Retirement Budget Calculator is designed so that you can see how your Net Worth may change throughout your retirement based on changes in your income and spending. The “Future View” can help you see whether you have saved enough, whether you have too much of your nest egg in your house, and answer other similar questions.

Your Retirement Life Expectancy

The last number you need to know is your life expectancy. There’s an often-riffed joke that goes, “I have enough money to live comfortably for the rest of my life… assuming I die tomorrow.” While it is a way to look at the end of life with levity, the joke belies a planning problem. A lot of people plan to die too early during retirement.

If you make it full retirement age, there’s a nearly 50% chance that you’ll live two decades or more. A good retirement plan will allow you to have sufficient income until at least your mid-eighties and hopefully even longer.

The Retirement Budget Calculator (linked above) now has a feature that allows users to plug in life expectancy. Using the future view, you can determine whether you’re likely to outlive your savings or whether your savings will outlast you.

Planning for a longer retirement (but not an infinite retirement) will help you maximize the time you have left on Earth. When your financial investments are taken care of, you can turn your attention more fully towards investing in the people and goals that have eternal value instead of just monetary value.

Jason Parker

Jason Parker

Jason Parker, RICP® is the best-selling author of Sound Retirement Planning, and the host of Sound Retirement Radio, a popular podcast that is also broadcast on 820am THE WORD in Seattle.