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With These Five Steps You Can Assess Your Retirement Financial Readiness

“Do I have enough money to retire?” As the wave of boomers approaches retirement, this is the question on the minds of many. But, how do you find an answer to this most important, but complex of questions?

Follow these steps and you should have a sense of whether you have the financial resources to retire:

1. Determine your retirement income

Social Security: The Social Security Administration can provide an estimate of your retirement benefits. Get an estimate of your benefits at the ssa.gov.

Pension Benefits: Pensions are becoming less frequent these days. If your current employer offers a pension plan, contact your Human Resources Department for an estimate of benefits at your proposed retirement date.

Retirement Savings: If you have retirement savings in a 401K, IRA or the like you will need to estimate the balance at your proposed retirement date. Savings forecasting tools are available online.

Post-Retirement Income: If you are anticipating working in retirement or plan to start a home-based business, you should estimate the annual income you may derive from this.

2. Estimate your expenses in retirement

Expenses: People normally believe that expenses will decrease in retirement, although this is dependent on individual spending patterns. Start with your anticipated income just before you plan to retire. Estimate your current expenses. If you use personal finance software such as Quicken, this should be easy. Make an estimate that what will be your major spending in retirement(such as food, housing, taxes, etc.).

Some categories of spending may go up, such as entertainment and health care. However, some will go down. For example, you will not be contributing to a 401K or IRA when you retire. You will not have Social Security or Medicare taxes coming out of your check if you don’t work. Your state and federal taxes should decrease. If you downsize your residence, your housing expenses such as utilities and property taxes should decline.

Relocation: If you are planning to relocate to a different city when you retire, the cost-of-living in the new location may increase or decrease compared to your current residence. To get a handle on the cost-of-living in your new location compared to your current residence, go to one of the many online cost-of-living calculators.

3. Estimate the unknowns

Inflation: Inflation affects your cost-of-living. We don’t know with any certainty what it will be in the future. However, one good bet is to use the long-term average between 3.2%-4.0%.

Investment Returns: Unless you plan to draw out your savings in retirement and stuff it in a mattress, you should earn a return on the balance. It is difficult to provide a specific percentage because it will vary with your mix of investments. However, you can research the internet for guidelines on the historic returns for each investment class you own and do an estimate of the returns you can expect.

Lifespan: How long will you live in retirement? In other words, how long must your savings last?

4. Bring all of the information you have gathered together to get an estimate of how well you are financially positioned for retirement

Normally, you might search out for an online retirement financial calculator. Retirement financial calculators are very useful for assessing your financial readiness. However, the more accurate your assessment of your retirement income, expenses, and the unknowns, the more reliable the results. Don’t be overly optimistic. In this case, hedging your bets (being a little pessimistic) will probably work better for you. Also remember, as the assumptions change such as when you would like to retire, your savings balance, your social security benefits, etc. you should reassess.

5. Consider the uncertainties

Most online retirement financial calculators have simple outputs.You just put in numbers and they come back with a specific number of years your savings will last. However, the reality is that given the uncertainties a specific number is likely to be inaccurate.

The sophisticated financial calculator uses the statistical procedure known as “Monte Carlo” to estimate retirement financial readiness. Monte Carlo changes the question from “how long will my retirement savings last” to “what is the probability that it will last for various time periods.  There are no certainties in the world. This is a far more realistic way of assessing your financial health.

Retirement financial planning can be complex and a little daunting. However, if you follow the five steps, you should be on better footing to answer the question of your retirement financial readiness.

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