How to Estimate Your Income in Retirement

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by Advice Chaser
by Advice Chaser

Your retirement may still be years away. And yet it would be handy to know what your income will be. How much will you need? How much will you have if you stay on your present course? What will your tax bracket be?

While it’s impossible to answer these questions with certainty, you can make a good estimate of your income in retirement, even years in advance. Knowing this number can help you strategize better about your retirement planning.

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Estimating Your Income Needs

The first number you can estimate is the income you will need in retirement. Knowing this number is pivotal to your whole retirement plan. Unless you know how much you’ll need, you can’t know how much to save.

You’ll start with the amount you live on today. Not counting retirement savings, how much does each month or year cost you? It would be overly optimistic to think you’ll live on very much less in retirement. You might save some money by downsizing, of course, but you also might choose to use your freedom traveling or spending more on your hobbies. Many experts suggest planning to live on at least 80% of what you spend now—possibly more, if you don’t want to downsize.

You will receive some Social Security income. If your current monthly spending is low, Social Security might cover a good amount of that on its own. But for most, Social Security only covers a fraction of their monthly needs. You can calculate what you will receive ahead of time. To calculate what you will need to withdraw in retirement, subtract that Social Security income from your expected budget.

Remember that healthcare will also be a significant expense during retirement, especially during the later years. Long-term care insurance might be a good way to cover some of that, given you can’t predict what your health will be like in the future.

Estimating Your Actual Income

Further along in your retirement savings, you can start to estimate what your future income will actually look like. Given how much you’ve saved and the length of time you’ll be withdrawing, how much can you expect to take out each month? Is that a number you can live on?

Here, you can start with Social Security income. Add on any pensions you will receive. After that, your income will come from distributions from your retirement accounts. That puts it mostly under your own control—you can take out more or less depending on your needs. However, starting at age 72, you will have to take required minimum distributions (RMDs) from your tax-advantaged accounts. The actual amount you need to take out comes from a formula based on your age and the amount still in your account.

That’s where it gets tricky. The amount in your account will affect how much you must take out as well as how much you can afford to take out. Take out too little, and you pay a tax penalty for failing to use your RMDs. Take out too much, and you have less in the account to keep investing for later.

Even when you’re not yet finished saving for retirement, you can estimate how much you will have if you keep saving at the same rate. The actual number will depend on how the market performs between then and now, you should be able to get in the right ballpark. Then assume that you’ll take out about 4% of your savings per year. Add that to your Social Security and pension numbers, and you have a rough estimate of your retirement income.

Why You Need to Know

So now you have a rough estimate of the amount you’ll need in retirement as well as the amount you’ll have in retirement. The most obvious reason why you need to know these two numbers is to compare them to each other. Will you have enough? If there is a huge shortfall, you’ll need to start saving more or invest what you have more aggressively.

The second important reason to estimate your retirement income is to help you decide whether to invest in a traditional or Roth retirement account. Traditional 401(k)s and IRAs are tax-free when you save the money, but taxed when you withdraw it. Roth accounts are funded with post-tax money, but you can take your withdrawals tax free, including any gains the investments have made.

Because of the added bonus of tax-free growth, the Roth account seems like a better deal. But it really depends on your tax bracket. If you are in a high tax bracket now and hope to be in a lower tax bracket later, you might pay less in taxes by saving in a traditional account. Sure, those withdrawals will cost you in income tax—but, since you’ll be in a lower bracket, you’ll pay less than you would have to now. If you’re younger or have a lot of dependents, however, you’ll likely have more taxable income in retirement than you have now. That would make the Roth account a better deal.

Talk to an Expert

Trying to estimate your income needs and retirement savings in the future is tricky. While many calculators can give you a rough idea, a lot depends on market performance, your own income in the intervening years, and your needs during retirement. An expert can sit down with you and help you run more specific numbers. They can also help you invest more effectively so that the money you save goes further. To meet the right financial advisor for your retirement planning, contact us today.

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