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Can Rules of Thumb Really Help You Decide When to Retire?

By Edited Sep 6, 2015 0 0

When it comes to planning when to retire, the best rule of thumb is don't follow sweeping generalities.

Whether you plan to retire early, or work for as long as you can, make your decision based on your personal financial plan.

When planning when to retire, you may prepare by reading retirement blogs twith titles such as “Financial Review” and “How to Retire Early.” After reading them, you may feel qualified to advise others about early retirement. 

Reading to find out when to retire
However, while reading retirement blogs may be educational, meeting with a CFP and creating a personalized financial plan may be a better course of action to prepare for retirement.

According to traditional models of retirement planning, retirees will need 75% of their current income for their retirement needs. However, those traditional models that often follow rules of thumb may not take into account today’s retirement lifestyle: longer and more active than in the days of yore! When social security was first instituted in America, people were only expected to get payments for a few years, as opposed to today’s retirees who could live for several decades. Moreover, many people choose to retire early these days. Longer retirements translate into more years of current expenses, special expenses, and increased medical expenses.

In order to meet the higher costs of longevity, Dan Ariely, a professor of economics and behavioral finance at Duke University, suggests a retirement ratio of 135% instead of the traditional 75%. (If you have a few minutes, listen the radio interview I did with Dan at the “Radio shows” tab of www.profile-financial.com.)

Ariely bases his figure on the result of his surveying retirees about how they want to spend their retirement. As a behavioral finance expert, he examines lifestyle expectations and emotional needs of retirement, and doesn’t only look at salary figures. He found that most people want to retire to a higher standard of living than they are accustomed to. As any retirement blog will tell you, after putting in many hours in the office, people feel entitled to a life of leisure, even luxury. However, other experts dismiss the 135% ratio as too high. Even if there are increased recreational and medical expenses, other expenses are lowered or eliminated in retirement: there are no pension plan contributions, taxes may be lower, and household expenses for children and commuting pretty much disappear.

However, I wonder whether their dismissal is because they think this budget is objectively too high, or if it is unpopular because it is difficult to attain. While the rule of thumb is nice, its usefulness is meant for generalities, and may or may not relate to your specific individual situation.

Salary replacement ratios may be overly simplistic guidelines because they are based on averages and not individuals. Furthermore, averages ignore one’s individual longevity risk (based on genetic predisposition and lifestyle choices) and the risk of potentially catastrophic health care costs. Therefore, instead of relying on standard rules of thumb when thinking about when to retire, it is wise to meet with a financial advisor, have a “financial review” and create a personalized financial plan.

By discussing your specific retirement goals and income sources, a financial planner can help you determine exactly how much income you might need during retirement and the most appropriate asset allocation that will help you reach your needs.

 

For some additional advice on what you really need, read When Your Retirement Years Should be Your Golden Years.  

 Disclaimer: This article is for educational purposes and is not a substitute for investment advice that takes into account each individual’s special situation and needs. Past performance is no guarantee of future returns.

 

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