How to Build a Retirement Plan (and why You Need one)

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Everyone knows they should have a retirement plan. They also know that the earlier they build a plan and begin saving, the better off they’ll be. So much for good intentions.

In reality, Americans do not plan well for retirement. Further, the gap between retirement hopes and reality is getting wider for younger generations, due to declines in Social Security benefits, the disappearance of traditional pensions, and the sustained weakness in real wage gains except for people near the top of the income ladder.

Beyond the scary headlines of retirement crisis reports commissioned by investment companies, you can get a solid and sobering look at retirement challenges by checking out the 2015 Retirement Confidence Survey from the Employee Benefit Research Institute (EBRI), a non-profit consortium of leading consumer and financial organizations.

Underneath the survey’s picture of our collective retirement challenges, I am particularly struck by the differences in retirement outlooks between people still working and those who have already retired. The reality of retirement – what things cost, how much money is really needed for healthcare, and the amount of post-retirement income that actually comes in the door – is less rosy for retirees than the visions of it expressed by pre-retirees.

Fortunately, there has been an explosion of free online retirement planning tools. Many are quite good, but the assumptions on which these online tools are built are often not visible to users. So, use several tools and see how their results compare. The Center for Retirement Research at Boston College has a good interactive retirement planning tool that includes video explanations as you move through its screens.

After writing about retirement for what seems like eons, I think the following tasks are critical to ensure a happy retirement:

• Create a portrait of your later life. Where do you want to live and what will it cost? What will your health be like? How much debt will you have? What will be the financial dimensions of your family obligations? Ditto for legacy wishes, such as leaving money behind for heirs and good causes.

• Build a three-level spending plan:
  1. “Must-spend” monthly obligations for food, housing and the like
  2. “Should-spend” items for upkeep on your home and car, not to mention yourself
  3. “Wish-you-could-spend” items, such as travel, fancy restaurant meals and regular trips to see the grandkids

• Project your retirement income and break down the sources into pensions, Social Security and other guaranteed income, and income from private investments. The goal is to have guaranteed income that at least matches your fixed monthly expenses and, if you’re fortunate, those should-spend items as well. No matter what happens, you can keep a roof over your head, food on the table and the like. Variable monthly income can be spent on those nice-to-have items. If you can, treat your home equity as a piggy bank for unforeseen financial shocks – a family illness or other emergency.

• Plan for income short-falls. If your income won’t cover those “must-spend” and “should-spend” items, how will you adjust? Save more money now, when you have time to fund the retirement you want? Continue working? Downsize your home to save money? Cut other expenses?

Be honest with yourself, or this will be a waste of your time.