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How to
Plan Ahead for your Retirement
By Amy S. Born, American Medical News
April 13, 2004
Question: I am fast approaching retirement and have amassed some wealth in my company retirement plan, personal savings and have some value in my medical practice. But how do I know if I have accumulated enough wealth to sustain my standard of living during my retirement years?
Answer: Planning for retirement can be a daunting task. Often people fall into traps that prevent them from achieving their retirement objectives. Those traps include procrastination and simply failing to plan. Retirement is a big responsibility; however, it also can be a great opportunity -- an opportunity because the process can provide many options as to how you want to structure your life today and in the future.
Retirement planning can be viewed as a four-step process: Establish your retirement goals; determine where you stand today; calculate your retirement needs and re-evaluate your retirement goals, if necessary; and revisit the entire process periodically.
The first step is establishing your retirement objectives. That is, when do you want to retire and with what lifestyle would you like to retire? The earlier you want to retire, the longer your assets have to last to fund your retirement. For example, a 55-year-old retiring today should expect to live another 25 to 30 years.
Another question to ask yourself is how much of your annual preretirement income should you expect to use during retirement. A rule of thumb would be to expect to need 60% to 90% of your preretirement income. But your individual circumstances might be significantly different from the norm. For example, if you expect to travel a lot during retirement, you may, in fact, spend 100% of your preretirement income.
Next, determine where you stand today. This entails preparing a net worth statement and estimating your current spending. Create a listing of all of your assets and liabilities and determine your current net worth. Then highlight those assets earmarked for your retirement (company retirement plan, IRAs, brokerage accounts, etc.) and add those. Then estimate your current spending. If you do not keep track of your expenses through the use of a software program, you can roughly estimate your spending by taking your earnings net of taxes and other deductions (401(k), health care, etc.) and reduce it by any amount you systematically save outside of your retirement plans.
Once you have determined retirement assets and current spending, you will need to decide on certain assumptions that will factor into your retirement projection. These include rate of return on investments, inflation rate, tax rates and additional savings. This will help you in your third step, calculating your retirement needs.
The rate-of-return assumption could have a major impact on your retirement projection. Be sure that the return assumption is consistent with your investments. For example, don't assume an 8% return if you are invested in CDs and other fixed-income instruments. A reasonable return assumption on a portfolio of stocks and bonds, and/or stock and bond mutual funds, would be between 6% to 8%. Further, you may want to assume a postretirement rate of return that is lower by 2% to 3% because you might be investing less aggressively during your retirement years.
Although current inflation is running at about 2%, the average rate since 1953 has run between 3% and 4%. Therefore, a reasonable inflation rate assumption could be between 3% and 4%.
Your effective tax rate might or might not be lower upon retirement. For example, if you anticipate that you will receive a substantial pension or plan on taking withdrawals from your retirement plans, your effective tax bracket may be similar to what it is today. To be conservative, it may be reasonable to assume the same tax bracket. The top tax bracket for federal purposes is currently 35%, but don't forget about state taxes.
You should include current systematic savings into your company retirement plan as well as any personal savings when calculating any additional savings.
Once you have determined your current spending, you will need to apply a replacement ratio to arrive at your retirement income needs. Again, generally this figure will be between 60% to 90% of your current income.
Once you have determined your assumptions, run the numbers. There are many software tools that are available to use to calculate retirement projections. If the calculator is estimating that your goal cannot be attained, you should re-evaluate your plan and determine what changes could be incorporated such as working longer, saving more, and/or spending less during retirement. After you determine what changes need to be made, create a plan of action and stick to it.
Retirement planning is an iterative process. It is important to revisit your plan and re-run the numbers periodically (every two to three years) to ensure that you are on-track to meet your objectives. Take charge of your financial future, as your ability to achieve your retirement objectives is directly related to your involvement in the process.
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