2. Determine Post-retirement Spending Needs
Being realistic about retirement spending habits will help you determine the required size of a retirement portfolio. It is commonly thought that post-retirement annual spending will amount only 70-80% of what have been spent previously. This assumption is unrealistic, particularly if unforeseen medical expenses occur or the mortgage has not been paid off. Retirees also usually spend their first years traveling or other bucket-list goals.
By definition, retirees are no longer at work for eight hours per day so they have more time to travel, go shopping, go sightseeing, and join other expensive activities. Accurate post-retirement spending goals help in better planning process since more spending in the future requires more savings today.
Note: Actuarial life tables can help estimate the longevity rates of individuals and couples (referred to as longevity risk).
Moreover, if you want to purchase a house or fund your children’s education after having retired, you may need more money than you think. Those need to be factored into the whole retirement plan. It is also necessary to update your plan once each year to ensure you are keeping on track with your savings.
3. Calculate After-Tax Real Rate of Investment Returns
Once the expected spending requirements and time horizons are determined, you should calculate the after-tax real rate of investment return to assess the feasibility of the portfolio creating the needed income. A required rate of return in excess of 10% is commonly an unrealistic expectation. As time passes by, this return goes down, as low-risk retirement portfolios are mainly composed of low-yielding fixed-income securities.
Investment returns are typically taxed, depending on the type of retirement account you hold. As a result, the actual rate of investment return must be calculated on an after-tax basis. But determining your tax status as you start to withdraw funds is a component of the retirement-planning process.