Any retirement plan is a function of good data. I've always said the output is as only as good as the input. Garbage in means garbage out. Although detailed retirement planning can require detailed work, part of the input requires some though around some key assumptions. If you think about it, assumptions is a fancy word for guesses. I want to share with you five key assumptions that goes into a retirement plan.
When do you want to retire?
Pick an age, any age. As I've said before, retirement is personal and when you want to retire is up to you. Although most people say they want to retire earlier, you still have to do something with your time. Statistics today suggest that the earlier you retire, the more likely you are to go back to work. Be realistic about this assumption because early retirement is not always better.
Related article: When is the Best time to retire?
How much do you plan to spend in retirement?
Most people have the greatest amount of difficulty answering this question. Probably the best way to figure this out is to have a good idea of how much you are spending today. If you do not know how much you are spending, then you might want to try the 70% rule of thumb which suggests that you will need 70% of your pre-retirement income in retirement. It's not perfect but it is a good starting point.
Related article: How much will you spend in retirement?
How long do you plan to live?
I've always joked in my profession that if you can give me your date of death, I can create the perfect retirement plan. It's important to know your date of death so you can figure out how long you need your money to last. Most people use life expectancies but it's rare we die on time. What if you live longer? What if you don't? This can be a tricky assumption because if you assume you will live longer, naturally, you will need to save more money.
Related article: How much will $100,000 pay me in retirement?
What rate of return do you expect to return on your investments?
If I said that your portfolio is going to make 6%, chances are some of you will think that is a low return and the others will think that assumption is too high. There's also a difference of what rate of return you will have before retirement and after retirement. It is often very natural to be more conservative when you are retired and not working. Preservation of capital tends to become a higher priority. In retirement planning, you have to come up with a figure so really think about what kind of investor you are and what return is realistic. My suggestion is to test different returns to see how much of an impact different returns will make on the bottom line.
Related article: What rate of return should you use for your retirement plan?
How much have you saved?
How much have you saved towards retirement and how much can you save in the future. Very few people can retire decently without any personal savings. We all know we have to put away something for the future because government benefits alone will put you under the poverty line. Most people use retirement planning to help determine how much they need to save. When I think of saving, remember 2 rules: now is better than later and anything is better than nothing.
Related article: How to save for retirement
When I think of retirement planning, the scope of planning depends on your age. Generally speaking, the younger you are, the less detail you need because there is so much unknown in the future. Retirement planning at this stage is really about getting some direction and developing some good positive financial habits like regular savings, paying down debt and managing cashflow.
The older you are and the closer you get to retirement, the more detailed planning needs to be and the more inputs and assumptions you will need to explore. No matter how old you are, its time to devote more of our time to retirement planning so get started now.
Jim Yih is the author of 10 Things I Wish Someone Told Me about Retirement and has also recorded a AUDIO CD called Retire Happy, Making Retirement the Best Years of You Life. For more information check out the Retire Happy Store.