Why Retirement Planning is important
We all (well most of us!) dream of that day when we no longer have a set routine of getting up and going to work. However, while not having to go in to work ever again has its benefits, the downside is that, for most people, the income they use to meet life’s expenses comes from working. Therefore, not having access to a steady source of income may mean being unable to maintain living standards. Having a clearly outlined path to navigate reduced income will help to ease anxiety. This article will focus on some of the factors which can be used to determine how much money you need to set aside for retirement.
While the size of retirement savings will vary dependent on current age, current income, debt and individual health, the steps identified below aim to provide general points of focus to help anyone planning for retirement. In identifying the integral factors, we will explain the role each element plays in helping to define the level of income required. Defining your requirements for retirement is crucial to identifying any shortfalls in your existing plan and should be the first step when setting up your plan. It is recommended that a recap of retirement plans be carried out regularly to incorporate any situational changes which may impact previous assessments.
Firstly, the aim is determining the level of income needed for the remainder of life. This will never be accurate based on the increasing cost of living and the upward trajectory of human life expectancy. However, identifying the factors particular to your situation will help you to create a worst-case scenario for planning. After this, we can focus on potential revenue streams for coverage. This will help to identify any shortfalls, which allows for revising of the formulated plan.
It is imperative that one considers trends in inflation. Observing the general increase in prices over time will help you to ensure that your savings target moves in line with the prices of goods and services.
Identifying Major Expenses
There’s a misconception that, at retirement, expenses will decrease. This is untrue. If anything, expenses may increase. With age, medical expenses increase significantly. Besides living expenses and medical expenses, other expenses to factor in are based on lifestyle and family size. We will explore each of these and provide methods to reduce the overall cost. Preparation is intrinsic for retirement. Once the major costs can be identified, putting away money early can prevent heavy cashflow burdens in one’s latter years.
Health & Medical Expenses
The largest and most important element is medical expenses. Quantifying medical expenses is key to determining the right amount needed to retire worry free. This item will progressively take a sizeable chunk out of your savings the longer you live. Factoring this in with limited health insurance options means that you potentially will have to foot those bills out of pocket. The first step to estimating medical expenses is identifying what health issues pose potential risks to you. This will help you to identify the cost of treatment and determine whether any major surgery could be required in the future. Once this information is known, find an insurance option which will help to defray these hospitalization costs and put aside a portion of monthly income in advance to build a cushion, specifically for medical emergencies. One way to beat the expense of doctor visits and medication is to find a contributory medical plan which will partially offset these costs even in retirement. While this may add to your monthly expenditure bill, it will provide substantial cost saving in the long run, as the total cost of healthcare will be partially offset.
Another significant expenditure item is educational expenses for children. Tuition costs have increased over time, as demand for higher education increases and avenues for state and school sponsorship become more and more competitive. This means that as a retiree, one may have to shell out more than previously expected to assist dependents with school fees and / or lodging costs. These expenses can place significant strain on limited resources. It is recommended, once realistic targets are set, that periodic payments toward the expected cost be set aside well in advance by using products such as annuities. In this manner, a significant buffer can be accumulated.
Daily Living Expenses
A third large expenditure item is the cost of everyday living. As a retiree you still have basic needs, for example, housing, transportation, food and insurance. The cost of living expenses is expected to remain relatively stable in comparison to the previous items. It should be noted however, that new diet requirements which can help reduce risk to lifestyle diseases may cause potential increases in the cost of food. Also, as identified previously, inflation can cause the cost of living to increase over time. Avenues for reducing the overall cost of everyday living expenses lie in the various discounts for the elderly provided by many public services, for example transportation and medical care. Also negotiated discounts from retiree associations can assist with the cost of foodstuff, leisure and exercise.
Identifying Potential Sources of Revenue
After identifying expected expenses, we can now turn our focus on revenue streams which will cover our costs. Most countries offer state benefits and grants (pensions) for the elderly. Filing for these benefits should be done as soon as possible to ensure that regular payments are received. Aside from a pension, one option which provides a steady stream of income once set up properly, is having a part-time job. Other options relate to setting up private revenue streams from annuities and insurance plans, investing in financial instruments and leveraging owned assets to generate cash.
While it may seem that the point of retirement is not to work, a part-time job can help meet day to day expenses. Many people choose the option of semi-retirement because they have skills and knowledge attained during their working life which they can use without a fixed schedule. Examples of this are consultancy, online investing or sales. While the financial costs to set up these types of businesses can be low, time, or any other entrepreneurial skill developed through experience, networking and education, will have to be allocated in the early stages to ensure success.
Annuities & Retirement Products
More traditional retirement income streams come from setting up personal annuities and retirement fund accounts. These instruments take advantage of the concept of the time value of money. In simple terms, the longer in advance money is set aside, the greater the time for it to accumulate and earn interest. Therefore, annuities and retirement savings must be set up long in anticipation in order to derive maximum benefit.
Rental & Home Equity
Another means of generating income is a by leveraging existing assets. Homeowners can build additional space onto their homes for rental purposes. Another recently popular trend is the use of reverse mortgages to provide cash to retirees. A reverse mortgage pays a portion of the assessed value of a house in cash to a retiree. In return, the retiree agrees to the sale of the home upon their death to repay the loan.
Investing personal wealth into the financial markets is a fourth avenue for maintenance of one’s standard of living in retirement. Retirees have more time to monitor markets for opportunities for profit. Investments can be in the form of fixed income instruments which pay a predetermined rate of interest over a specific time-frame, or equity instruments which experience ebbs and flows in value. However, this comes with a caveat: take time to understand the ramifications of your trades. Knowledge and understanding are vital to success in financial markets.
Retirement is a time to relax. Planning for one’s retirement is essential to ensure a smooth transition from a fixed schedule to constant flexibility. Setting aside income in advance, finding additional revenue streams and mapping out possible expenses are the best way to ensure you can cover life’s expenses after letting go of your major income source. The earlier one acts, the better prepared one will be. Also reviewing the identified points on a periodic basis will help you to keep your plan updated for new situations.
Author: Dike Caesar, Investment Analyst.
Mr. Caesar is an Investment Analyst with the Trinidad & Tobago Unit Trust Corporation. He is a graduate of the University of the West Indies, holding a Bachelor of Science degree in Banking and Finance.