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Planning for Immediate Retirement

Estimating Expenses

 Alexandra Armstrong CFP, CCPS and Karen Preysnar  CFP Bookmark and Share

As we pointed out in our last article, the problem in calculating what your retirement income will be is compounded by the fact that few retirees will receive a pension providing them with a dependable lifetime income. Even if you’ll receive Social Security income, it’s far from certain whether it will pay you as much in the future as it will now or whether it will be taxed in the same way. Thus, it appears your retirement income will depend in large part on how your investments perform for the next 30 or 40 years, which given the stock markets we experienced in 2008 and early 2009 is pretty scary. No wonder people postpone retirement!

Last month, we assumed you looked at your retirement income and decided you had enough to retire in comfort. But you might be in that group of people being forced to retire earlier than planned and may not have as much income as they’d like to have. Thus, it’s important that you review current expenses and try to estimate how they may change when you retire.
We recommend listing your expenses of the past year and then making two columns beside them: one for what you estimate the first year of expenses will be and then the next year.  The reason we suggest looking at the next two years is that often you have higher expenses the first year you retire.
You might want to take that long trip across the country that you never had time to take before; to redecorate your home, since you’ll be spending more time in it; or to buy a new car, since you’ll be driving it more.
The rule of thumb many financial planners use is that your expenses will be 85 percent of what they were when you were working. This is based on the theory that you won’t need to spend as much on clothes for work, transportation, eating out, etc. On the other hand, expenses you might have been able to charge off to business now have to come out of your pocket.
We think a more realistic estimate, at least for the first year, is to estimate 100 percent of last year’s expenses.  You may spend it on different things, but the bottom line will probably be the same.

Fixed Expenses

On the chart on the attached pdf, we have listed typical fixed expenses. In looking at expenses, the biggest expense usually is your mortgage. A frequently asked question from people preparing for retirement is whether they should pay the mortgage off. The answer is, “It depends.”
As we have said in other columns, this is a financial and emotional decision. From a financial point of view, if you’re paying a relatively low interest rate, this is one of the few tax deductions you have left. Hopefully, the investments you would have to liquidate to pay off the mortgage might earn more than you’re paying in interest.
On the other hand, if you owe a relatively small amount on your mortgage and the interest deductions are small relative to your payment, it might be a good idea to pay your mortgage off in its entirety. There’s no denying it’s a good feeling to be debt-free when you retire.
Another expense might be a home equity loan. This is a second mortgage that may carry a fixed rate of interest, or it may be a line of credit with a variable interest rate.
Home equity lines of credit are generally based on the prime rate and your current interest rate may be low, but your payment will go up when interest rates increase. Although this interest is usually tax-deductible, it might be a good idea to pay off this loan if the interest rate gets too high.
Look at your utility bills and see whether these will be changed in any way. What will you have to pay for health insurance, Medicare, etc.?
As for life insurance, you may have come to a point in your life where you can use the values built up in your policies to reduce the amount you currently pay out-of-pocket. (Consult your life insurance agent to see what you should do in that regard.)
Assuming you’re no longer working when you’re retired, you’ll no longer be eligible for disability insurance. You’ll note that we’ve included long-term care insurance as a budget item. If you haven’t already signed up for this, we strongly recommend you consider this coverage.

Discretionary Expenses

After you consider your fixed predictable expenses, you want to consider your expenses that vary from month to month. These would include groceries, meals eaten out, clothing, dry cleaning, entertainment, travel, personal care (hairdresser, health club and drugstore), dues and subscriptions, cleaning people, medicine, doctor’s visits and gifts.
The one expense we can predict you’ll have that you didn’t budget for will be money needed to help out your children and grandchildren. It might be the down payment on the first home, education for the grandchildren or help after a divorce or job loss. Somehow, sometime they’ll need your assistance. If you’re in a position to help, you may do so, but it can wreak havoc on a carefully constructed budget. But if giving or loaning money is going to cause some hardship, you may have to say no.


We find people are pretty good on figuring out sources of income and expenses but forget to estimate income taxes.
Your tax picture will change when you retire, depending on the sources of your retirement income. For instance, you may have had a relatively high income when working, so you invested in tax-free or low-dividend-paying growth stocks. Now that you no longer have earned income, you need to estimate how your income will be taxed.
Under current law, qualified dividends from investments and long-term capital gains are taxed at a maximum federal rate of 15 percent. But starting in 2011, long-term capital gains are scheduled to be taxed at 20 percent and qualified dividends will be taxed as ordinary income, subject to your regular tax bracket.
A word of warning: This is the current law but Congress can change it at any time, so make sure you stay current with any tax law changes.
In our last column, we discussed the various forms of income you estimate you’ll receive. As part of this exercise, we recommend you talk to your financial adviser about projecting how much you may owe in taxes when retired.
For instance, we suggest that individuals postpone withdrawing from their retirement funds (IRAs, etc.) until they have to — the year after they turn 70 1/2 years old.
But you may find that you’ll have much lower taxable income when you retire than when you worked and might want to take some money from your retirement account before you have to, thus not depleting your personal assets.
For example, say you’re 66 years old and have $500,000 in personal investments and $1 million in retirement accounts. Your personal investments pay you 3 percent, or $15,000 a year, but you need more income than that.
Your calculations might indicate that you need $25,000 in annual income. To make sure you maintain some personal liquidity, you might decide to withdraw the needed $10,000 from your retirement accounts rather than reduce your personal portfolio.
We suggest you consult your financial planner or accountant before making this type of decision.

An Annual Process

We hope that when you look at your total picture, you’re in good shape to retire. If not, now’s the time to make adjustments to sources of income and anticipated expenses.
If you have surplus income, don’t relax too much: Remember that inflation is the “silent embezzler.” Costs of living do go up, so you want to plan so that your income can continue to cover your expenses over the years.
We think you shouldn’t look only at your current financial situation as you get ready to retire. Once you retire, we urge you to promise yourself that you’ll review your income and expenses once a year — for the rest of your life.
We’ll warn you that no matter how carefully you calculate your future expenses and income, it won’t come out the way you expect. Some income won’t be as high as you thought. Some expenses are higher or lower than you anticipate.
But at least if you’ve put together the list of your anticipated income and expenses, you know what your future might look like, which can help you enjoy your retirement. After all, that’s why you worked hard all those years — to retire in comfort!

Alexandra Armstrong is co-author of the fourth edition of On Your Own: A Widow’s Passage to Emotional and Financial Well-Being. She is a Certified Financial Planner practitioner and chairman of Armstrong, Fleming & Moore, Inc., a registered investment advisory firm in Washington, D.C. Securities are offered through Commonwealth Financial Network, member FINRA/SIPC. Investment advisory services are offered through Armstrong, Fleming & Moore, Inc., an SEC-registered investment adviser not affiliated with Commonwealth Financial Network.
Karen Preysnar, Certified Financial Planner practitioner, co-author of this article, is vice president in charge of financial planning at Armstrong, Fleming & Moore, Inc., and a registered representative with Commonwealth Financial Network.
Individuals should contact a financial planner, tax adviser or attorney when considering these issues. Commonwealth Financial Network does not give tax or legal advice. Consult your personal adviser before making any decisions. The authors cannot answer individual inquiries, but they welcome suggestions for article topics.

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