Your ability to retire well depends not on how much you save but on how much you spend, says financial planner Kevin McKinley.
As you’re celebrating our nation’s independence this weekend, you might want to spend some time—between your first and second hot dogs, maybe?—contemplating how well you’re doing in achieving your own financial independence.
Your ability to reach a comfortable retirement has less correlation than you might expect with how much money you earn, how much money you already have, or how you invest that money.
Instead, it depends upon how much you spend—and how much you plan to spend in the future. The more money you spend now and going forward, the more you will need to accumulate to support your lifestyle.
A simple formula can tell you not only how much you will need, but also how close you are now to getting where you want to be.
What’s your destination?
Start by looking back on the last month to see how much you’ve spent. You can do this by reviewing your checking and credit card account statements, or you could use an expense-tracking program like You Need a Budget or Mint going forward a month.
Once you have a handle on a typical month’s spending, subtract any Social Security payments you and your spouse or partner expect to receive in retirement (find estimated amounts at the Social Security website). You can also subtract any pension payments you know will be coming your way.
Then multiply the remaining amount by 200. The result is what you will need to have in savings, investments, and retirement accounts before you can retire comfortably.
Or, in a formula:
(Monthly Spending – Expected Monthly S.S./Pension) x 200 = Target Retirement
So, if you’re spending $4,000 per month and can expect $1,500 per month in Social Security retirement benefits, your net required liquid assets are $2,500 x 200, or $500,000.
Are you on track?
You can use a similar variation of this formula to see how you’re doing toward your goal. Again, start with your typical monthly expense amount. Here’s where you should be…
In your 20s: Current Monthly Spending x 10
In your 30s: Current Monthly Spending x 25
In your 40s: Current Monthly Spending x 50
In your 50s: Current Monthly Spending x 100
(By the way, in case you plan on winning the lottery well before retirement age and want to be financially free forever, you’d better hope you hit the Mega Millions, since you’ll need about 300 times your monthly expenses.)
If your net worth isn’t where it should be, don’t panic. Instead, go back to your list of expenses to see what is less important to you than your long-term financial security, and try to reduce or eliminate it. A quick way to increase your net worth and reduce your spending is to bump up your deferral in to a pre-tax retirement plan, like an IRA, 401k, or 403b. The money is still yours, but since you’re taking home less, you’ll be forced to live on a little less (and you can always change it back).
Bonus: Saving more for retirement this way also means you’ll pay less in taxes each year.
Will your kids be on track?
Best of all, this process can help you provide a priceless lesson to your children.
Many of us want our children to have high-paying jobs in adulthood so that they can cover their own living expenses with as little parental assistance as possible.
But simply by learning that it’s easier to spend less money than it is to make more, our children will be free to pick an occupation based on what they find most fulfilling, rather than the one that just fills up their bank accounts fastest. Minimizing their expenditures also gives them more flexibility to change careers, move to a more desirable location, go back to school, or stay home to care for a child (our grandchildren!).
Most importantly, spending less money allows them to save more of what they earn—so that they’ll be able to reach their own financial independence much more quickly.
Kevin McKinley is a financial planner and owner of McKinley Money LLC, a registered investment advisor in Eau Claire, Wisconsin. He’s also the author of Make Your Kid a Millionaire. His column appears weekly.
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