How Much Money Will You Really Need for Retirement
Mark Miller

How much money will you need to live comfortably in retirement?

One way to calculate the answer is the old income-replacement rule of thumb -- to retire comfortably, you must replace 80 percent of your annual pre-retirement income. But at best, this is a rough estimate. For example, it doesn't take into account unforeseen spending needs such as higher health care expenses or a long-term care insurance policy.

At the same time, the rule doesn't recognize that some expenses might fall or disappear entirely, such as commuting or maintaining a business wardrobe.

But most important, the income replacement method is wrong for our current hard times economy, because it puts all the focus on wealth accumulation. It doesn't begin with the correct questions: What is the lifestyle I want? How much will I need to spend on basics? What can I afford to spend?

"The replacement ratio method is a good place to start, but it ignores major changes that can result from reduced expenses for dependent children, paying off a mortgage or downsizing major items like your home or cars," says Steve Vernon, an actuary and president of Rest-of-Life Communications, a retirement-education concern.

"It also assumes you'll want the same material standard of living in retirement that you had before. That ignores the possibility that you might be willing to live on less. Often, as people age, they're less interested in material things and more interested in learning, hobbies, volunteering, and spending time with friends and family."

A better approach in hard times is to start with a clean slate. Take the time to ascertain what foreseeable retirement expenses and balance them against the sources of income that you can count on. Here's a checklist of major issues to consider:

1. What are you spending now?

The first step is getting a precise handle on your current budget. You can do that using any of the major financial-planning software tools or by tracking what you spend on a spreadsheet for a couple of months. Working with a trusted financial planner is another good way to zero in on what you're really going to need.

2. Subtract for retirement lifestyle.

Once you've got a good picture of current spending, subtract any regular expenses that won't continue in retirement--for instance, the cost of commuting, dry-cleaning bills, wardrobe and taxes on income for Medicare and Social Security.

3. Add back in retirement expenses.

Some discretionary expenses could rise in retirement, say, if you plan to travel extensively. And your non-discretionary spending almost certainly will rise, as well. Health care is the expense many of us fail to anticipate; Medicare deducts premium costs from Social Security checks, and you'll probably pay additional premiums for a Medicare supplemental plan and a Medicare D prescription drug plan. Finally, you may want to consider a long-term care insurance policy.

Fidelity Investments has been publishing an annual report on retiree health-care expenses since 2002. In that time, average costs have jumped 50 percent, rising 6.7 percent in 2009 alone. Fidelity reports that a 65-year-old couple retiring in 2009 will need to spend $240,000 out of pocket to cover medical expenses in retirement, assuming that the man lives 17 additional years and the woman 20.

4. Inflation.

While the cost of living has been flat lately, the Consumer Price Index has jumped about 3 percent annually over the past 20 years, and can't be expected to stay quiet forever. Most seniors live on fixed income--with the exception of Social Security, which is indexed for inflation. That means inflation must be factored into your retirement planning as a cost that will erode spending power.

5. Housing and other debt.

It's difficult to overstate the importance of debt reduction as a retirement planning strategy. Avoid carrying a mortgage and other expensive debt--such as credit card balances--into retirement if at all possible. This is one of the best routes available to cutting expenses and boosting monthly retirement cash flow. That means getting on an aggressive debt-slashing path in the years leading up to retirement. And in some cases, it may make sense to sell your home and move to a less expensive part of the country--or even rent.

6. Emergency funds.

Budget for the unexpected -- home repairs, emergency medical needs or even money you may want to set aside to help out children or aging parents.

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