There’s a rule of thumb that says you should budget a certain percentage of your income towards retirement. Many experts say you should set aside 10 to 15 percent of your income for your golden years.
But there’s a competing theory that says that you should budget for retirement based on the lifestyle you plan to enjoy, not the income that you currently earn.
To clarify this idea, let’s imagine four hypothetical couples.
Adam and Alison: A Simple Retirement
Adam and Alison are retired. Neither of them generates income. They receive some money from their pensions, their 401(k) withdrawals, and Social Security. Their homes and cars are fully paid off, and they’re debt-free.
They live simply. Most evenings they eat dinner at home, and they enjoy inexpensive activities like gardening, knitting, playing with their grandkids and walking the dog.
Bob and Barb: A Glamorous Retirement
Bob and Barb are also retired. Neither of them produces income, and like Adam and Alison, they receive money from their pensions and 401(k). Their homes and cars are also paid off, and they’re debt-free.
They live large in retirement. They dine at restaurants. They enjoy sailing, golf, and tennis. They own a second home near the beach, and they enjoy traveling overseas.
Carl and Cathy: Working in Retirement for Fun
Carl and Cathy are retired from their primary occupation, but both of them still work. They don’t need the income – they have enough money to live comfortably based on their savings – but they enjoy working.
It gives them satisfaction and purpose, and when they’re not working, they tend to feel bored and depressed. Carl is writing a novel, while Cathy runs an online business. They receive added income from their jobs, which supplements their retirement savings.
However, they’re so busy enjoying their work; they don’t have time to spend it. They’re amassing more savings than they know how to use.
Derek and Debbie: Passive Income in Retirement
Derek and Debbie set up streams of passive income when they were younger. Now their rental houses, royalties, dividend, and interest income provides enough for them to retire comfortably.
Their retirement, however, is tasked with managing these income sources. They often find themselves managing the teams of bookkeepers, property managers and repair hands who keep their investments afloat.
Everyone’s Ideal Lifestyle in Retirement is Different
What’s the point of these four stories? Everyone’s ideal retirement is different.
Some people are satisfied living simple, quiet lives. Some want to enjoy world travel, expensive hobbies, sample fine wines, upgrade their homes and try new activities.
Some people are forced to work because they can’t afford to pay their bills, but others choose to work for pleasure and satisfaction, even though they don’t need the income.
Traditional Retirement Advice is Misleading
Traditional retirement advice prescribes a formula: save 10 percent, or 12 percent, or 15 percent of your current income for retirement.
But that rule-of-thumb advice doesn’t take into account the type of retirement that you hope to have. Adam and Alison are content to live simply. They’re satisfied cooking their meals, cleaning their home, and playing with their grandkids.
If you plan to live like this couple, you don’t necessarily need to budget 15 percent of your after-tax income towards retirement, unless you start saving later in life, you want to leave behind an estate for your children, or you want a solid buffer in case of emergencies.
A couple like Bob and Barb, on the other hand, want the excitement of sailing to Italy, playing golf, taking art lessons and traveling to a beachside villa. If you want to live like this couple, you’ll probably need to budget more than 15 percent towards retirement.
And if you’ve set up passive income streams, like Derek and Debbie, you might not need to max out your 401k contribution each year.
The Rule of 25
So what’s an alternate rule of thumb?
Figure out how much you want to spend, per year, in retirement. Multiply that by 25. That’s how much you should have saved in your retirement account.
In other words, base your retirement account savings goal on your spending, not your income.
Remember: this is just a general rule of thumb. Personal finance is – well – personal. The amount you’ll need for retirement depends on a number of factors including your debt levels, your dependents, your health, your life expectancy, your tax obligations, your insurance needs, and other considerations.
Source: thebalance.com ~ By: Paula Pant ~ Image: C21 Asset Library