Financial Literacy - Retirement income planning
retirement
Figuring retirement needs in shaky economy

After retirement their situation changes. They don't have to pay Social Security taxes or save for retirement any longer, so they can eliminate those costs, and commuting expenses disappear as well. Palmer adjusts their taxes to reflect their age -- people older than 65 get to claim a higher standard deduction and at least some Social Security isn't taxable -- and concludes that this couple needs $61,600 before taxes or about 77 percent of their preretirement income to continue their current lifestyle in retirement.

About 39 percent, or $31,200 of their preretirement income, will come from Social Security. If the couple determines that the remaining $30,400 not provided by Social Security must come from savings, then to ensure a 95 percent probability of not outliving their money, this couple will need to have saved a nest egg of $715,000. If they are content with a 50 percent probability of not outliving their savings, then they'll need $420,000.

Those savings levels appear daunting, but if this couple is willing and able to cobble together the remaining $30,400 from a combination of savings, pension and part-time employment, "then they should be able to reasonably maintain their same standard of living into their retirement years," Palmer says.

Retirement savings needed for success
Preretirement income$80,000$90,000$150,000$200,000$250,000
Social Security (%)3936231714
Private and employer sources (%)3842616974
Total (%)7778848688
Private and employer sources (annual $)
$30,400
$37,800
$91,000
$138,000
$185,000
Savings needed for 50% probability of not outliving assets (27 years)
$420,000
$525,000
$1,260,500
$1,905,000
$2,555,000
Savings needed for 95% probability of not outliving assets (38 years)
$715,000
$890,000
$2,150,000
$3,250,000
$4,355,000
This assumes one wage earner who retires at age 65 with a nonworking spouse who retires at age 62. Social Security includes payments made to both spouses. It also assumes average annual investment returns of 7.8 percent with a standard deviation of 10.7 percent.
Source: Aon Consulting

Other factors to consider

It pays to control taxes. In 2009, when a married couple 65 or older files jointly, they are entitled to increase their standard deduction by $2,200 for a total of $13,600. In that situation, most people who have less than $100,000 in income will pay less federal income tax if they take the standard deduction than they will if they itemize deductions. Taking the standard deduction eliminates any advantage to carrying a mortgage. It also makes living where state and property taxes are low even more attractive because you can take the standard deduction no matter what.

Get rid of debt. Paying off the house gives a retired homeowner the option of taking out a reverse mortgage. Historically, housing has increased in value faster than inflation has risen. Inflation erodes income in later life, so the possibility of taking a reverse mortgage down the road can provide insurance against coming up short. Yes, you can take a reserve mortgage if you still owe on a mortgage. It's one way to pay it off.

Staying healthy is the wild card. Palmer says calculations assume that you won't have health care costs that are higher than average. Buying long-term care insurance can take a bite out of monthly income, but it could pay off in the end. No one can predict when a debilitating illness will hit.

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Should you delay retirement?

It is a particularly bad idea to retire if you will find it necessary to immediately begin taking money from savings right after you suffer market losses. Moshe A. Milevsky, professor of finance at York University in Ontario, Canada, explains how it works.

If you take 9 percent out of your $100,000 portfolio every year (or $750 a month) beginning at age 65 and your portfolio earns 7 percent per year, your nest egg will be exhausted by the time you are just past your 86th birthday.

If you don't earn a steady 7 percent return on your money, the situation can get worse. If, for instance, you start taking out money in a year when the market loses 13 percent in the first 12 months, then the market gains 7 percent the next year and in the third year jumps up 27 percent, trouble comes quicker. While it may seem like your savings would have fully recovered with such generous returns, the age at which you run out of money drops in this scenario to 81 -- five years sooner than it would have if there had been a steady 7 percent return.

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