“Can I afford to retire?” is probably the most popular question I get from clients day in and day out. Most people assume the answer depends on hitting some magic number. But I think a lot of the American public has this question backwards. The more useful starting point is your spending.
Start with your spending, not a magic number
It really comes down to how much you’re going to be spending year in and year out in retirement. I’ve seen people retire with less than half a million dollars who have Social Security and a pension coming in, and they end up building wealth in retirement because they live a simple, inexpensive lifestyle. And I’ve seen people retire with $10 million who spend 20% of their retirement funds in the first few years building or buying an extravagant home in Florida.
Getting a good sense of what your budget will be year in and year out in retirement, and looking at what your expenses are four to five years before retirement, can tell you a lot about whether you can actually afford to retire.
Factor in inflation
Two other important variables are inflation and taxes. Nobody knows what inflation is going to do year in and year out, but zooming out and looking at historical averages can give you a reasonable sense of how much things will cost in 10 years.
Factor in taxes
On the tax side, someone who has 100% of their money in 401(k)s or IRAs is going to pay a lot more in taxes than someone with 100% of their money sitting in a savings account. Getting a good sense of how much money you’ll keep in retirement, and how much you’ll give to the government, tells you a lot about whether you can afford to retire.
Identify your dependable income sources
One final consideration, and it’s an important one: figure out which of your income sources are dependable and which ones are less dependable. That means looking at the income you’ll have coming in from something like Social Security, a pension, or an annuity that promises a certain dollar amount for the rest of your life (or even your spouse’s life). Those give you a good sense of income you can count on.
Then, for outside investments where there’s no guarantee the values will go up or down year to year, you can size up how much risk you need to take on in retirement and whether you need to keep building funds before you retire.
I always suggest talking to your accountant, your attorney, and your financial advisor to have a thorough discussion about whether you can retire.
