Figure out what expenses are disappearing
The first thing to do when determining how much income to replace is to consider the expenses that may disappear once you become a retiree. For example:
- You no longer have to save for retirement. If you were investing 10% or 15% of your income, this expense goes away.
- As many as 40% to 50% of retirees have paid off their mortgage. While you still have property taxes and insurance, your housing costs drop if you're one of them.
- You no longer have transportation costs to and from work. The average annual cost of commuting is nearly $5,750 or around 10% of median national income.
Eliminating these expenses alone can save you a fortune. If you were devoting, say, 15% of your income to a mortgage payment, 15% to retirement savings and 10% to commuting, you've already eliminated 40% of your preretirement spending.
You can run through these numbers yourself, considering how your lifestyle will change to understand what your new budget may look like.
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Discover the secretDon't forget to account for added expenses
While you'll potentially be cutting a lot of expenses, you may also be taking on some additional spending — and you need to account for this when you're figuring out your income replacement rate.
Retirees may add some optional expenses, like travel. But you should also plan for an increase in essential expenses, like health care costs.
The U.S. Bureau of Labor Statistics reports average health care spending of $7,492 a year for those aged 65 to 74, and $8,145 a year for those over 75. Compare what your future care costs may be relative to what you were spending now to ensure you're ready to pay for potential medical bills.
You should also think about how else your life will change in ways that may cost you more. Will you spend more on hobbies? Or, do you want to spoil your grandkids? All this should be taken into account as it could change your budget.
Ultimately, it's best to err on the side of saving more than you think you'll need. Still, don't take 80% as the default rule. Do the math — or work with a financial professional — to get an estimate of your spending needs — and make the best, most informed decision about when you have enough money to retire.
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