Everybody who is saving for their retirement will at some point begin to ask if they now have put away enough. They want to know if they have reached their goal of being able to live off what they have saved.
Many people think that making this decision starts with adding up all their assets and working out their total wealth position. However, where this process should really begin is not by analysing how much you have, but how much you are going to need.
“Every retirement planning discussion should start with the same question: how much do you spend today,” explains Mark Lapedus, divisional director for product development at Liberty. “You need to know what your budget is so that you then have a number in mind as a target. If you don’t have a target you will never know if you’re ready.”
Knowing what you need to cover your expenses is the basis for every decision you will make. This is why it is so important for anybody to keep track of their cash flow, ideally through a budget. If you don’t know where and how you are spending your money you can’t begin to calculate what your retirement plan should look like.
“It’s only once you know how much you will need that you can look at what provisions you have, how much you are putting aside, and do some projections around that,” says Lapedus. “You can calculate that, given your current rate of savings, if you receive a certain level of growth you will have accumulated a certain amount by a certain date, and then determine whether that will be enough to generate your required income or if it will fall short.”
Keeping a budget will also help you determine how your spending might change after you retire, as a number of your expenses may fall away. For a start you will no longer be paying a portion of your income into a retirement fund, which is why you are unlikely to need to replace your full final salary.
Your travel expenses may also reduce, since you won’t need to get to and from work every day. And if you have an income protection policy covering you in the case of disability, you will no longer need to pay those premiums.
“You have to know what your expenses are before retirement and how they might change after retirement,” says Lapedus. “You also need to look at what is going to happen to those expenses on a yearly basis. What are you going to need next year and the year after.”
This also means considering inflation. Not just in the sense of the country’s official inflation rate, but in particular reference to your own expenses.
“Some of your expenses might escalate quicker than others,” Lapedus explains. “So what you need to make sure is not just that you have enough money for next year and the year after, but for the foreseeable future.”
It’s also vital not just to consider these calculations in an ideal world. You need to be aware of what might go wrong.
“For instance, the markets could fall and the investments you have are suddenly worth less than they were before,” says Lapedus. “Or you could fall ill and your expenses could go up. You need to have considered all those different scenarios.
“You are not just deciding whether you’re ready to retire if everything goes according to plan and you only live for 15 years after you stop working,” he adds. “You need to ask whether you’re ready to retire if you live another 30 years and face a number of curve-balls along the way.”
An important part of this is being able to put some capital aside that is separate from the money from which you are drawing a regular income.
“If your provisions can only meet your needs in a perfect world that assumes nothing goes wrong, then you’re at risk,” says Lapedus. “We know that life happens. You need to have some form of buffer so that in the event of things going wrong you have more income to draw on or additional capital put away. If the only asset you have is being used to generate an income that meets your exact expenses, you are not actually financially ready to retire.”
Brought to you by Liberty.