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Linnard Financial Management & Planning, Inc.

Fee-Only Financial Planning and Investment Advisor



The Essentials of Financial Planning for Retirement

The primary objective of a good retirement financial plan is to provide you with a financial structure and guidelines that will result in the retirement lifestyle that you desire.  The first thing that you need to do is to define what you would like your retirement life to be like. Where do you want to live? How will you spend your time? Will you be taking many trips? Do you plan to work for part of the time?

The next step is to estimate your retirement budget. Assuming that your lifestyle will not change dramatically from the present, a good place to start is to identify the expenses you have today. Once you have itemized today's expenses, you can ignore expenses that will not continue in retirement, and include estimates of any new expenses that will be incurred. Make sure to include an estimate of taxes that you will pay. For example, one significant pre-retirement cash outflow that will no longer be necessary is setting money aside for retirement savings! On the other hand, your medical expenses are likely to increase. If your residence changes, housing costs and local taxes may change as well.

A primary concern of most people is to make sure that their financial resources will last all of their lives. For this reason, most retirement plans must look well into the future. To figure out how long your plan should last, you can look at census bureau life expectancy tables. You should not use your average life expectancy for your planning. If you do you, you will have a 50-50 chance of outliving your plan. It is safer to work with an estimate that will only be exceeded 10% of the time. The life expectancy table included in this site shows the ages that will be exceeded both 50% and 10% of the time for men, women, and the last living spouse of a couple.

After you have estimated your expected expenses during your planning period, estimate your income from fixed sources like pensions and annuities. Adjust your income and expenses for inflation where appropriate. You may be surprised how large expenses grow and how small fixed pensions and annuities begin to look next to the inflation-adjusted expenses in the later years. You should also find your expected Social Security benefit from the Social Security Administration. Add up all this income and any other from non-investment sources over your retirement years. Subtract the expenses you expect to have. If your income exceeds your planned expenses, you are in good shape. Most people find that their expenses will exceed their income. If that is true in your case, you will need to generate additional income. This is usually provided by investment savings. Use a spreadsheet program to find the "discounted present value" of your savings deficit. This calculation removes the effect of inflation. Then take the present value of the deficit amount and divide it by the number of retirement years you are planning.

Although there is no accurate way to predict the future, William P. Bengen* found historically that if a portfolio was invested at a moderate risk level, and 4% inflation-adjusted withdrawals were taken each year, the portfolio continued to produce income for 30 years or more. If you begin to draw income at age 66 and your planning period is 32 years (a 90% probability that the last spouse of a couple will not live past this time), you can plan on your additional income lasting if you withdraw 4% or less per year. Alternately stated, your initial savings will need to be 25 times the present value of your expected annual income-expense deficit.

These days you might consider being even more conservative in your planning, because investment values are historically high. High valuations create more than the usual risk of a another serious reduction of retirement investment funds. If this is a concern, a 3% withdrawal rate may be appropriate, corresponding to a current portfolio value of about 30 times your required income-expense deficit.

On the other hand, a slightly higher withdrawal rate (5%) can work if your planning time is 20 years or less. Also, a fixed annuity can increase your effective withdrawal rate a bit, because it uses money for current income distributions that you might otherwise leave as a legacy .

Other issues that can be considered are differing tax rates for income and capital gains. A financial planner may also "stress test" your plan against worst-case historical results, or simulate different combinations of investment returns and risk, estimating how much of a safety cushion you will have while you are alive, and what kind of legacy you may be able to leave to heirs or charity.

This approach is included to give you a sense of the retirement planning process. It is not a detailed set of instructions and you should not depend on results that you calculate. At a minimum, you should consult a financial planner and compare notes to identify any differences. The planner's results will probably follow this type of approach with some additional considerations and with complexities like taxes, alternate investment returns and risk appropriately factored in.


*Determining Withdrawal Rates Using Historical Data by William P. Bengen