Wednesday, November 19, 2014

So You Think You Are Financially Prepared to Retire? Use our Spreadsheet Tools to Test

Generally the focus of this website is to help individuals who are already retired establish an annual spending budget.  From time to time, however, I will venture into the "how much do I need to retire" side of the retirement challenge.   This post is aimed at individuals who are close to retirement but are unsure of whether they have sufficient financial assets to meet their needs throughout retirement.  

This exercise is very similar to what I wrote about in my August 31 post--Managing Your Spending in Retirement--It's Not Rocket Science, except the first step in testing to see whether you are financially prepared to retire is to determine your spending needs in retirement.  Generally this is done by looking at your normal expenses for a year, subtracting expenses that you don't expect to have in retirement (such as Social Security taxes and work-related expenses) and adding expenses you do expect to incur in retirement (such as increased travel and leisure expenses).  Don't forget to factor in taxes that you will need to pay in retirement.

The second step in the process is to determine your total expected income for a year from all sources, such as Social Security, accumulated savings, pensions, annuities, earnings from part-time work and other sources of income.  This is where the spreadsheet tools available on this website come into play.  If you are not going to defer commencement of your Social Security benefit, use the "Excluding Social Security V 2.0" spreadsheet and add in your estimated Social Security benefit (and any other fully inflation indexed annuity benefit and expected earnings from employment) to the total spendable amount.  If you do plan on deferring your Social Security benefit, use the "Social Security Bridge" spreadsheet.  Note that for this step you may wish to exclude some of your accumulated assets, such as home equity or other assets, on the theory that such assets will be available for unexpected (or lumpy) expenses in retirement.  I suggest that you input the assumptions we recommend in addition to your specific data.

The third step in the process is to compare the results of the second step with the first step to see if the two numbers line up.  If the result of the second step is significantly lower than the result of step one, you may not be financially ready to retire.  If you are not as conservative as I am, you can input higher investment return assumptions and/or lower inflation assumptions to see how these changes can affect your expected annual income.  But remember that there are no guarantees when it comes to expected income from accumulated savings and the more liberal (or wishful) you make the assumptions, the more likelihood that future real spending will have to be reduced.

Normally at this point in my posts I provide an example of how this test might work.  I'm not going to do that this time.  Having recently read the quote attributed to Benjamin Franklin, "Tell me and I forget.  Teach me and I remember.  Involve me and I learn", I'm going to encourage you to kick the tires on these spreadsheets.  Take a few minutes to crunch your own numbers.  You'll find it a worthwhile exercise.