Yahoo Finance Retired Investors Face a Spending Test
The majority of time spent planning for retirement is focused on creating a saving and investing strategy with a goal of accumulating funds. You're likely also thinking through how you will want to spend your time in retirement and the fun things you'll do in lieu of going to your 9-to-5 job.
But a big part of retirement planning, one that does not receive as much attention -- yet is equally important -- is decumulation.
Decumulation focuses on how you will spend your retirement savings and how you will the make money last. It is about how you will actually supply a steady retirement income stream from your hard-earned savings to pay for all those fun things, not to mention day-to-day living expenses.
[See: How Investing Can Boost Your Emergency Savings.]
While the premise of decumulation seems simple enough, there are several factors to take into consideration with retirement income planning. First and foremost, be aware that there are several unknowns that can impact your cash flow situation.
Longevity and the fact that people are generally living longer and thus spending more time in retirement than ever before -- think 25 to 30 years more!
Inflation will change the cost of your groceries, rent and other monthly costs, which can affect purchasing power over a long retirement. Health care costs are only going to rise in the years ahead as well.
Market volatility, and unpredictable swings that can have a big impact on how long retirement savings can last.
To build out a retirement income strategy that accounts for these challenges, and help your money last throughout retirement:
-- Estimate your expenses.
-- Examine types of income.
-- Do the math.
Estimate Your Expenses
As you start to think through what you'll need to pay for in retirement, it can be helpful to bucket things into three categories: essential expenses (like a mortgage or rent payment, groceries, ongoing health care, medications, taxes, etc.), discretionary expenses (like trips, hobbies, entertainment, etc.), and unexpected (like surprise major health care expenses, long-term care, or other emergency situations).
Start with your essential household expenses first, and jot down what you typically spend in a month. As you move to the nonessential and unexpected expenses, you'll want to be realistic. You will have unlimited free time in retirement and may look to fill that time with activities or things that cost money.
[See: 5 Reasons a Market Crash Is the Perfect Time to Buy.]
On the flip side, some people can be overly conservative, which really is no fun when you're ready to kick back and truly enjoy retirement.
Examine Types of Income
Once you've got a handle on what expenses are deemed necessary on a regular basis and have bucketed all of the other potential expenses, you can start to think through how to pay for each category.
Typically, guaranteed income sources such as a pension, Social Security, or an annuity can help cover essential expenses because they are predictable on a monthly or annual basis. Investable assets on the other hand, can be used to cover other expenses that pop up like a big trip or an unexpected medical bill.
Do the Math
Now that you have a basic understanding of how much you plan to spend in retirement, calculate the difference between your planned expenses and your income sources. This may seem like basic budgeting, but it really is the first step to figuring out your retirement income.
If your essential expenses add up to be more than what you expect in guaranteed income, you have an income gap. Sure, investments and other personal assets can be used to help fill in that gap, but it's important to do so in strategic way that helps make sure those other funds don't run out and can be there if you need to use them in the future.
Work with a financial professional to address any gaps in your retirement income, and discuss how you might bridge the gap. This could include various strategies like delaying taking Social Security, or continuing to work for a year or two so you can focus on saving additional money. Or it could mean exploring various financial products that can provide a guaranteed source of income in retirement, such as an annuity.
As with any major life change or decision, having a plan in place can make all the difference. Retirement is a huge milestone, and should be full of relaxation, enjoyment and fun. One of the most important things you can do to help make sure you have a blissful retirement is to plan ahead on how to pay for it so you don't have to spend your time worrying about money.
A trusted financial professional should be an important part of the retirement income planning process, and can help your create a strategy and make sure you have an income strategy to truly enjoy those golden years.
[See: 7 of the Most Common Investing Mistakes.]
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