Retirement Income: How to Know if You're On Track

Are you on track to have income that lasts throughout your retirement? Learn six steps to help answer this question and create a retirement income plan.

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Key Takeaways

  • Compare your anticipated expenses and income sources to see if there’s a gap
  • Use a retirement calculator to help project the potential growth of savings and investments
  • Adjust your draw-down strategy to help extend the longevity of your retirement income

How much income will you need in retirement? It’s a common question that’s tough to answer because no one knows for certain how long they’ll live, how the markets will perform, or what expenses they’ll actually incur. But with this basic framework, you can get a general sense of whether you‘re on track to have savings that lasts all your retirement years.

Identify Retirement Expenses

The first step is to estimate how much you might spend each year in retirement, which you can do a couple of ways. 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%-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, ask your spouse for input as well as other family members who might depend on you in retirement. According to Matt Sadowsky, Director of Retirement and Annuities, TD Ameritrade, “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.”  

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.

Assess Retirement Income Sources

Next, you’ll want to identify any income you’ll have, besides your savings and investments, to help maintain your lifestyle in retirement. Most likely, you’ll have Social Security and possibly a pension or an annuity. All three offer lifetime income so you may want to earmark them for your essential expenses. Other possible sources include alimony and rental income.

Determine the Gap

From there, you can determine if you have a retirement gap, which is the difference between your estimated expenses and income. Seems simple enough, but Sadowsky offers an important reminder: this figure isn’t static. 

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. Additionally, you may incur unexpected costs, like storm damage to your home or a loved one moving in.

Your 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 now for these possible fluctuations, some of which could be significant, may help keep you on track later in life.

On track with retirement planning? Identify if you have a gap.

Estimate Assets at Retirement

If you have a gap—and most people do, you’ll want to look for ways to close it. 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 capitals gains (potential growth of investments over time)

Be sure to also include your emergency savings fund in the estimate. While 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. 

Once you have your estimate, consider bucketing your assets by time horizon to help you pursue your goal that you’ll have enough money to cover discretionary expenses throughout your retirement. (Remember, as noted above, lifetime income sources are typically used for essential expenses.) For example, you might break your retirement into three periods: 0-3 years, 4-10 years, and 10+ 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. Obviously your risk tolerance is a factor here, as more aggressive investments may conflict with your risk tolerance, especially in later years.    

Calculate How Long Your Assets Might Last

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 your investments perform, and your draw-down 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 due to inflation and higher expenses. To help offset the impact of these events, you might put a portion of your savings in growth-oriented investments, like stocks, depending on your 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 7 to 8 year impact on your savings. (See Figure 1). 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 find the level that makes the most sense for you.

FIGURE 1: WITHDRAWAL RATE SIMULATIONS. The lines on this chart were generated from 5,000 portfolio simulations to show what could happen to a hypothetical balanced portfolio (50% stocks/50% bonds) over time based on different initial withdrawal rates. The chart assumes a starting balance of $500,000 at age 65 and inflation-adjusted withdrawals each year based on the initial withdrawal rate noted on the y-axis. For illustrative purposes only. Source: Morningstar Ibbotson Wealth Forecasting Engine.

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 farther out in time, an alternative mentioned above. 

Adjust Your Plan as Needed

It’s generally a good idea to periodically review your plan 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. 

Estimating your income needs is an essential part of retirement planning. It can help you set your savings goal and develop an effective withdrawal strategy when the time comes. And remember, you don’t have to go it alone. TD Ameritrade Financial Consultants can work with you to monitor your progress and offer additional retirement planning tips.

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