Many people wonder “How much is enough when planning their retirement?” This is an important question because it is one of the key factors in making several important decisions in retirement. Decisions such as when do I retire, when should I start drawing Social Security and, what pension option should I take are three permanent decisions that will affect how much you can spend in retirement.
Studies indicate that you should plan on spending 80-85%% of your working income in retirement. One of the fundamental reasons for this is that your taxes in retirement will be much lower. Earned income won’t have deductions for the Social Security tax which is 6.20% and the Medicare tax which is 1.45% of earned income up to $118,500. In Pennsylvania and many PA counties pensions, Social Security and investment income under the PA tax forgiveness threshold are not taxed. This further increases your deductions from income by another 4.07% (3.07% PA income tax plus a 1% county tax). Most likely your federal tax liability will also be lower in retirement.
Retirement saving to 401Ks, ROTH IRAs and other retirement accounts is another expense that goes away in retirement. This could be anywhere from 0 – 20% or more your working income so it is important to take away this expense to determine your actual retirement spending need.
To understand more about expenditures and how they change with age visit the Department of Labor’s paper Consumer Expenditures Vary by Age.
Insurance premiums for Medicare, a supplemental plan, a prescription drug plan and potentially a Long Term Care policy all need to be accounted for in your retirement income need. In addition to premiums you also need to factor in a cost for co-pays, deductibles, dental and vision costs. For many people the difference between medical costs before age 65 and after age 65 is significant and should be factored into your plan.
Travel is another popular expense in retirement. Whether it be the cost to winter in warmer weather or airfare to go see the kids, this expense is a big factor in retirement. Some people say I will only have the travel expenses in the early years of my retirement so my retirement income need will go down in my 80s and 90s. This may be the case but consider if you are not traveling, you may have additional medical costs or conditions that could increase needed services.
Cars and home maintenance should also be considered. Many people view these expenses as extraordinary when in fact they are quite ordinary and should be part of the retirement budget. Homes will always need repairs and renovations, cars will grow old and need to be replaced. We should count on these expenses in a predictable fashion with real assumptions factored into your budget.
As a summary, consider the following calculation for determining your retirement income:
(Non-PA residents will need to adjust line 2 for their states tax rates.)
______________ (Gross Working Income)
-______________(Less 11.72% for Social Security, Medicare, PA and Local income taxes)
-______________(Less Federal Tax Liabilities)
-______________(Less Retirement Savings)
-______________(Less Mortgage if paid off at retirement)
+_____________ (Plus Additional for Medical Costs)
+_____________ (Plus Additional for Travel, Home and Car Expenses)___
=_____________ (Equals After-Tax Retirement Budget)