Retirement is expensive, and many Americans worry about running out of savings. You can minimize this risk with careful planning, but it's impossible to know precisely how much money you will need. If you find this daunting, I have good news.
You may not need quite as much money as you think. Here are three factors you may not have considered that could reduce your expenses in retirement.
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1. Your living expenses may be lower
Some expenses like groceries, utility bills, and taxes will follow you around forever. But other costs may disappear in retirement, which reduces your annual living expenses. Your children will likely be grown by this point, so you won't need to provide financially for them anymore. And if your home is paid off, you will no longer have a mortgage payment.
You also won't have to save money for retirement once you reach retirement. If your income right now is $50,000 per year and you're contributing 10%, or $5,000, of that to your retirement savings, then you're really only living off of $45,000. If you estimated your living expenses as $50,000 per year, adjusted for inflation, in your retirement plan, you'd be figuring higher than necessary.
Think about which expenses you will still have in retirement and which ones will disappear. Then, calculate your expected annual living expenses. Keep in mind that inflation will keep driving up the cost of living over time. You can use 3% per year as a rough estimate for inflation. So if your living expenses were $45,000 this year, figure $46,350 ($45,000 x 1.03) for next year, and so on.
2. Social Security will supplement your personal savings
While it's true that the Social Security trust funds will be depleted by 2034 and that the program may no longer be able to provide full benefits to everyone after this point, it is still going to be around for decades to come. These benefits can ease the burden on your personal retirement savings, especially if you delay your benefits until your full retirement age (FRA) or beyond.
You become eligible for Social Security at age 62, but if you start claiming your benefits this early, you'll only receive 70% or 75% of your scheduled benefit, depending on your FRA, which is either 66 or 67 for today's workers depending on their birth year. For every month you delay benefits past your 62nd birthday, your checks increase until they reach 100% of your scheduled benefit when you reach your FRA. You can continue delaying your benefits past your FRA to grow your future checks by 2/3 of 1%, until age 70 when you qualify for your maximum benefit, which is 124% or 132% of the amount you would have received if you'd started claiming at your FRA.
The amount of your Social Security benefits is based on your average indexed monthly earnings (AIME) during the 35 highest-earning years of your life. Anything you do to boost your income today, like pursuing a promotion or working overtime, will boost your Social Security checks in the future. By boosting your current earnings as well as by thinking strategically about when to take Social Security, you can reduce the burden on your personal retirement savings and help stretch your nest egg so it doesn't run out. It makes sense to start Social Security early if you don't anticipate living long, but you're better off delaying benefits until your FRA or age 70 if you expect to live a long life and if you don't need the money to cover living expenses right away.
3. You may be in a lower tax bracket
Because your living expenses will probably be lower in retirement, it's quite possible you could move to a lower tax bracket than you're currently in, especially if you have substantial Roth retirement savings. You paid taxes in the year you made your Roth account contributions, so you don't owe taxes on the distributions, as long as you're 59 1/2 or older and the money has been in your account for at least five years. These withdrawals don't count toward your taxable income, so in the government's eyes, you're earning a lot less and therefore, you'll pay a smaller percentage in income tax.
But your tax bracket isn't guaranteed to change. You can't know for sure how much lower your income will be in retirement or how the tax brackets will change. It's best to plan as if you're going to be in the same tax bracket that you're in now. That way, if you are, you'll be prepared and if not, it'll be a pleasant surprise.
If the thought of retirement expenses overwhelms you, the best thing to do is figure out how much you need by totaling up your living expenses and multiplying by the number of years of your planned retirement, adding 3% annually for inflation. Then, subtract what you expect to get from Social Security and any employer-matched retirement contributions and make a plan for how you'll save up the rest on your own. Don't forget about the three factors listed above. You may find you don't have to save as much as you thought you did.
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