Building Financial Security for Retirement? Focus on Spending First 

Experts have different opinions on exactly how much you'll need for a comfortable retirement. How do you figure out the amount of savings that's right for you? Learn why it makes sense to focus on spending first.

The question of how much money is needed to enjoy a comfortable retirement is often debated. For years, experts have suggested that you need 70 to 80 percent of your final pay annually in retirement to meet the goal of living comfortably. Like any rule of thumb, this guideline makes it easier for many people to plan. But is it an accurate measure of how much money you’ll actually need?

Not necessarily.

Rules of thumb, online calculators and other tools are a good starting point for estimating retirement savings needs. However, these tools can only take you so far. In reality, there’s no such thing as a “magic number”—at least not when it comes to something as crucial as ensuring your financial security.

To understand why, meet Joe and Lisa Harris and Joe’s twin brother and his wife, Tom and Mary Harris, four hypothetical 50-year-olds.

Identical but Not the Same

Joe and Tom are identical in several significant ways: With his wife, each has a combined yearly income of $325,000; each has consistently deferred the maximum amount allowed each year to a workplace 401(k) plan; each has managed to sock away an additional $35,000 a year in various accounts for retirement; and each has a total of $895,000 saved in his qualified and non-qualified accounts.

Using the 70 to 80 percent rule of thumb, both Joe and Lisa and Tom and Mary will need between $227,500 and $260,000 each year after they stop working to fund the retirement they want.

As with most twins, however, Joe and Tom’s lives are not exactly the same.

Joe and Lisa have been married for more than 20 years. They own their home outright, and they have no children. In contrast, Tom and Mary’s marriage is the second one for both. Their blended family consists of two children each from prior marriages and two kids together, ranging in age from 8 to 22. In addition to child support and college expenses on the horizon, they have 15 years remaining on their mortgage.

So which couple is better prepared financially for retirement?

You might think that Joe and Lisa have an advantage. Without a mortgage or children to support, they have fewer fixed costs in their budget and, therefore, more money to eventually fund their retirement.

But those savings are only part of the equation.

A successful retirement doesn’t rest solely on the amount you save; it’s also dependent on the percentage of that amount you spend annually after you retire. Your lifestyle needs and wants, and the amount of money you’ll need to fund them, profoundly impact how long your money is likely to last. Let’s dig deeper into Joe and Tom’s respective lives to see how.

Accounting for Lifestyle

Joe and Lisa have a wonderful life. They dine out three to four times a week, mostly at higher-end restaurants. They travel extensively, often for weeks at a time to different countries. They indulge in their love of theater with trips to New York to catch the latest Broadway shows, and they follow professional sports with season tickets to baseball, football and hockey. Their goal is to continue enjoying these outings for as long as they can in retirement. After all, once they stop working, they’ll have access to their 401(k) accounts and other retirement savings—money that can help fund their discretionary spending.

But remember, it’s not enough to look just at savings when creating a sustainable financial plan for retirement; it’s crucial to look at spending, too.

So what will Joe and Lisa’s retirement cost them?

To maintain their current lifestyle after they stop working, Joe and Lisa will need to budget approximately $255,000 a year. Assuming Joe stops working at normal retirement age and receives the maximum Social Security benefit possible ($30,396 for 2013), that leaves them with roughly $225,000 of expenses (including taxes) that will need to be paid from their personal retirement savings. That equals 5.6 percent of the $4 million they estimate their savings will be worth at retirement. That’s a lot of spending if their portfolio needs to last 30 or more years.

Current studies show that future safe retirement spending rates, based on current stock and bond market forecasts, will range anywhere from 2.5 percent to 4.5 percent. To help ensure their money goes the distance, Joe and Lisa will want to focus not just on how much money they have, but also on how far that money can take them. This may mean creating a budget to determine which of their retirement needs and wants are important and which ones aren’t.

What About Tom and Mary?

Tom and Mary also have a wonderful life, but it looks very different from Joe and Lisa’s.

Tom and Mary eat out two to three times a month, typically at casual dining restaurants. They take advantage of every chance they have to travel, but they prefer to pitch a tent with their kids at a national park to paying up for a room at a five-star hotel. Like Joe and Lisa, they love cultural and sporting events; however, they’re perfectly happy to catch opening night at their local repertory theater and to cheer on their local little league and high school ball teams. Because of this, their spending on discretionary items like travel and entertainment is significantly lower than Joe and Lisa’s.

What’s more, when Tom and Mary retire 15 years from now, their mortgage will be paid off and their kids will be finished with college, providing them with more financial flexibility in the future than they currently have. If they continue their current spending rate in retirement, they may find they have extra money to help their children or to use for additional travel and entertainment once they stop working.

Enlisting the Help of a Trusted Guide

Bottom line: It’s both your spending and your saving that may be the most important part of achieving financial security in retirement—and that’s why it makes sense to consult with a professional about your retirement and wealth management goals.

A wealth management professional can help you create a sustainable spending plan for retirement by guiding you through the process of identifying the specific needs and wants that matter most in your retirement. This includes quantifying your basic needs—in other words, all of your fixed costs (mortgage, property taxes, utilities, insurance and the like) and funding them with assets that produce guaranteed income streams regardless of market conditions.

Next, it involves identifying and funding your wants, including those assets you’re hoping to leave to your heirs or charity. Discretionary spending is typically approached with a more diverse portfolio that includes the potential for growth to help keep pace with inflation. The result is a saving and spending plan that can help ensure you have the money you need for retirement, for as long as you need it.

Contact a wealth management advisor today to talk about your goals for retirement and how he or she can help you reach them.