Retirement Income Planning: How to Know if You’re On Track

Am I on track for retirement? That’s a tough question to answer because there’s no way to know for certain how long you’ll live, how the markets will perform, or what expenses you’ll actually incur. Your decisions could either take you off track or put you on the right track. So even with the uncertainty, it’s worth coming up with a basic retirement income planning framework so you can get a general sense of whether you’re on track to have savings that lasts throughout your retirement years. Let’s take a look at what you can control as you plan for your retirement.

Identify Retirement Expenses

There are a couple ways to estimate how much you might spend each year in retirement. You can use an income-planning worksheet to help identify your large expenses and project future spending. Or you can use a general guideline such as 85% to 90% of your ending salary. Of course, the actual amount needed will vary depending on your lifestyle, financial situation, and other factors. 

Regardless of which approach you use, it’s a good idea to ask your spouse or any other family members who might depend on you in retirement for their input. It’s important to make sure everyone’s on the same page about the future and that you’re capturing the right expenses so you can plan properly. Often one spouse or partner sees retirement differently than the other, which is why it’s helpful to discuss potential expenditures earlier rather than getting surprised later on.  

You may also want to separate your costs into three buckets: needs, wants, and wishes. Needs are your essential expenses, which include your living expenses and “must haves.” Wants and wishes are discretionary items that could be cut from your budget in the event of a market downturn or unexpected costs. It may be helpful to factor in items like a new car and home improvement or repairs. Retirement could be a long phase of your life, and during this time period you’ll likely face these types of expenses.

Assess Retirement Income Sources

To know if you’re on track for retirement, you’ll want to identify any income you’re likely to receive besides your savings and investments. Most likely, you’ll have Social Security and possibly a pension or an annuity. All three offer the potential for lifetime income, so you may want to earmark them for your essential expenses. Other possible sources of income include alimony and rental income. Of course, those aren’t guaranteed to last a lifetime.

Match Lifetime Income Sources to Essential Expenses

Once you know your income and expenses, you can match your lifetime sources to your essential expenses. This will help determine if you have a solid foundation to maintain the retirement lifestyle you envision. If you have enough lifetime income sources to cover your essentials, then all your remaining assets are available to cover your wants and wishes (your discretionary expenses). You can reduce, postpone, or eliminate these expenses if needed in retirement. But what if your lifetime income sources are not enough to cover your essential expenses?

Determine the Gap

If you do have too little lifetime income to cover your annual essential expenses, then you’ll have to figure out how much lifetime income you’ll need each year and look to fill that gap. Insurance products designed to provide lifetime income, like annuities, longevity insurance, QLACs, and long-term care insurance, can help cover your essential expenses while allowing your remaining assets to be available to help cover your discretionary expenses.

As you explore these alternatives, remember that each comes with its own unique risks. For example, lifetime income guarantees on various annuity and insurance products are subject to the financial strength and claims-paying ability of the individual issuing insurance companies. Also, income protection benefits may only be available through optional riders for which you’ll incur an additional cost.   

Your expenses are likely to change and shift over time. Many retirees tend to spend more during the go-go early years of retirement and then again in the late or no-go years due to increased medical expenses and long-term care. Plus, there may be other unexpected costs, like storm damage to your home or a loved one moving in.

Your projected retirement income stream could also fluctuate depending on when you decide to start receiving Social Security or your pension and upon the death of your spouse. Plus, some sources, like rental income, aren’t guaranteed to last. Planning early for these possible fluctuations, some of which could be significant, may help keep you on track for retirement later in life. Consider a couple of different scenarios or plans based on different levels of expenses and solutions for filling your gap. It may be difficult to envision what you and your partner/spouse/family will need in the future, so plan on making changes and refinements along the way.

Estimate Assets at Retirement

Now that you’ve addressed your essential needs, it’s time to look at how you can cover your discretionary expenses. That’s where your savings and investments come in. To estimate how much you may have in assets at retirement: 

1. List the current balances for your bank, brokerage, and retirement accounts.
2. Add any additional money you expect to save or invest over time.
3. Subtract any anticipated withdrawals.
4. Add any expected interest, dividends, or capital gains (potential growth of investments over time).

Be sure to also include your emergency savings fund in the estimate. Although not earmarked specifically for retirement, it’s another way to help manage any shortfall. You might also use a retirement calculator to project the potential growth of your portfolio assuming different rates of return and time frames. Some calculators help you figure out how much your savings will generate in terms of annual income. You can match this number up with your annual discretionary expenses to see if there’s a shortfall.

Another alternative: Once you have your estimate, consider bucketing your assets by time horizon to help you pursue your goal of having enough money to cover discretionary expenses throughout retirement. (Remember, as noted above, lifetime income sources are typically used for essential expenses.) For example, you might break your retirement into three time segments: one to five years, six to 10 years, and 11+ years, with your more conservative investments earmarked for the early years and more aggressive ones for later on to help maximize the potential for growth. 

Many investors who bucket their assets might choose to create a bond ladder for the first five years of discretionary expenses. A bond ladder can help mitigate the risk in a portfolio and potentially reduce the sequence of return risk. Be sure to do your research about bond ladders prior to investing to determine if this is appropriate for your financial situation.

How to Calculate Retirement Income

Once you have the estimate, you’ll need to figure out how long this money might last in retirement. The answer depends on several things, including the size of your income gap, how you filled it, and your drawdown strategy. For example, if you had $500,000 in assets and a $25,000 gap, your nest egg might last 20 years assuming no growth or inflation ($500,000/$25,000 = 20). Keep in mind, you may need to increase the amount you withdraw over time because of inflation and higher expenses. How do you make up for the impact of these events? You could consider putting a portion of your savings in growth-oriented investments like stocks. Of course, that will depend on your personal level of risk tolerance.   

It’s important to focus not on how long you think you’ll live but rather on how long you think you could possibly live. If you’re in good health, your retirement could last 30 years or more. So you may want to test different withdrawal rates to see how much the change may help extend the longevity of your assets; a 1% difference could have a seven- to eight-year impact on your savings. And remember to include your spouse’s needs and any other household members who depend upon you. However, pulling out too little each year might keep you from doing the things you want to do. Consider the potential trade-offs for each withdrawal rate to help you find the level that makes the most sense.

Another potential factor is market performance. Extended downturns could shorten the longevity of your assets because you have less time to bounce back. To help manage this risk, many people tend to take a more conservative investment approach as they get older. Obviously, this concept conflicts with the idea of having more aggressive investments for further out in time, an alternative mentioned above. 

Adjust Your Retirement Plan as Needed

It’s generally a good idea to periodically review your retirement income-planning strategy to make sure you’re not underestimating your expenses and overestimating your assets. Market fluctuations, legislative developments, and job changes can all impact your potential income over time while unexpected events, such as medical expenses, could drive up costs. Based on your review, you might decide to make changes to your asset allocation or your withdrawal amounts to better address any shortfall and to help improve the sustainability of your income. You might consider researching additional types of insurance products such as longevity, long-term care, Medicare supplement, or disability to potentially help hedge your risks.

Estimating your income needs is an essential part of retirement income planning. It can help you set your savings goal and develop an effective withdrawal strategy when the time comes.

TD Ameritrade does not provide tax or legal advice. Please consult an attorney or qualified tax advisor. Please consult an attorney or qualified tax advisor with regard to your personal circumstances.