How much retirement can you afford? As retirement approaches, financial planning shifts from resource accumulation to resource u

With the leading edge of the 77 million strong baby boomer generation within three years of Social Security and six years of Medicare eligibility, the press has been paying noticeably more attention to retirement issues. Numerous newspaper reports have been published recently on the viability of traditional pensions and of Social Security. With the resulting awareness of retirement matters, people are beginning to take their pre-retirement planning more seriously.

Pre-retirement planning takes place during the working years, when the most important retirement planning questions concern how to accumulate sufficient resources to live for many years without a paycheck. As retirement looms closer, perhaps within the last five working years, the next planning step transitions from resource accumulation to resource use--what happens during the retirement years. By then retirement benefits and savings are pretty well determined. Making the most of savings and benefits moves to center stage.

Critical to that consideration is planning for retirement spending. It is the last piece of the retirement planning puzzle that can be controlled during retirement. It deserves significant attention in any serious retirement plan. This article offers advice on how to estimate retirement spending so that you can set appropriate savings targets. The advice is relevant to government finance officers at any stage of their career.

PREDICTING RETIREMENT SPENDING

Of course, it is hard to make predictions of spending needs for an untried retirement way of life. It is tempting to take the planning shortcut offered by simplistic retirement planning books and online planning systems--the spending replacement ratio. The appeal of the replacement ratio method is its simplicity. Just plan to spend 75 percent (or perhaps 80 or 85 percent) of your pre-retirement income and you will somehow maintain your preretirement lifestyle.

True, some expenses will be missing from your retirement budget: Social Security and Medicare taxes, commuting costs, work wardrobe purchases, perhaps the mortgage payment. On the other hand, new costs may take their place: a work wardrobe is replaced by new leisure clothes, commuting probably costs less than retirement travel, and health care could cost as much as your old mortgage. A replacement ratio ignores individual differences. Some people retire with a significant mortgage payment. A lucky few can expect generous employer-paid health benefits. Some plan extensive international travel, while others look forward to a sedentary life.

Serious retirement planners reject the simplistic replacement ratio approach, seeking instead a thoughtful retirement budget. Even though future retirement spending needs cannot be exactly predicted, the deliberation that goes into planning an informed retirement budget provides the best foundation for your plan.

A good retirement planning budget is a prediction of actual future spending, not a document meant to control current costs. Those who do budgets often assume that budgeting necessarily means producing a tight and disciplined spending plan. It seems that budget and cut are words that always go together. It is prudent to make conservative estimates in planning, of course, but a conservative estimate for retirement spending should be realistic within means and not overly frugal.

FINDING THE BALANCE

Doing a useful retirement planning budget calls for another important planning step. Distinguishing between needs and wants reveals spending flexibility. It shows which expenses can be reduced if times get rough. Money budgeted for travel, for example, can be shifted to health care if needed. This planning step will also show the value of pre-retirement debt reduction to increase retirement spending flexibility by reducing or eliminating debt payments.

The ideal retirement plan ensures that enough income to cover the needs budget--for basic living expenses--is available from secure lifetime sources such as defined benefit pension payments, Social Security, withdrawals from conservatively invested retirement accounts, and maybe an annuity. The more controllable wants budget covers extras such as eating out, optional or luxury purchases, travel, gifts, and entertainment. These optional and irregular expenses are best covered, as needed, from variable withdrawals from invested retirement accounts. Some genuinely compulsory but unpredictable spending needs are variable, too. Extraordinary out-of-pocket medical costs are best met from reserves and need not be included in the monthly budget.

PLANNING FOR HEALTH CARE COSTS

Retiree health care costs may be the most difficult single retirement budget item to predict, and are commonly underestimated in individual retirement plans. Health care costs were not an issue for us during our working years if we were accustomed to generous employer-provided health, vision, and dental benefits. Being fully responsible for health care costs in retirement, perhaps for the first time, may cause "sticker shock." The cost will be especially startling for those who retire before they are eligible for Medicare at age 65 and who have no employer-provided retiree health care support.

Current health care costs are challenging enough, but expected cost increases may be even more of a problem. During the debate about Social Security's future, too little attention has been given to the even more severe financial plight of Medicare. Today's level of Medicare benefits is in jeopardy, and retirees, inevitably it seems, will be picking up a greater share of their own health care costs.

Uncertain Medicare benefits, rising health care costs, and increased individual health care utilization as we age means we must expect escalating out-of-pocket health care costs. One estimate of the savings needed at retirement, for a person retiring in 2017 at age 62, is that savings of more than $600,000 will be needed just to pay out of pocket health care costs to age 90--assuming the rate of health care cost increases moderates to just 6 percent annually!

Medicare's Web site (www.medicare.gov) provides a helpful starting point for estimating health care costs after age 65. Select "Compare Health Plan Options in Your Area," and see available Medigap policies and Medicare Advantage Plans in your area, including predicted out-of-pocket costs and coverage. That's the starting point for a retirement health care budget. Then, expect costs to increase at a rate perhaps twice that of general inflation.

PLANNING TO GET OLDER

We all look forward to a long active life, but few of us seem ready to confront the foreseeable financial consequences of aging. It is hard for us to imagine ourselves old. Studies show that people tend to underestimate their own life expectancy. A person in reasonably good health ought to plan for independence well beyond the actuarial average lifespan, probably into their mid 90s.

Anticipating our own aging helps prepare us for the inevitable financial consequences of getting older. Retirement planners observe three typical stages of retirement spending as we age. The early years of retirement are the most active, with spending for travel and other leisure activities. It is tempting to spend too much during these on-the-go years. Excessive early spending may threaten financial independence later on.

In the middle years of retirement, retirees may be content staying closer to home and may spend less than they did during their more active first retirement years. In the last years of retirement, spending may increase again, even dramatically, as health-related costs become a central issue and long-term care needs may arise. Good planning encourages us to keep adequate financial reserves for our late years to maintain our financial independence for a long life.

SURVIVOR PLANNING

There are few life events more traumatic than the loss of a spouse. Realistic financial planning for widowhood is emotionally difficult but is essential to anticipate changes in both income and spending needs. Decisions made by a couple as they transition into retirement have consequences for the eventual survivor. The most rapidly growing poverty segment of our population is that of widows over age 85. Sound retirement planning can help prevent a survivor from falling into financial dependence.

A surviving widow or widower might spend more or less than a couple. How will expenses change? Will paid help be needed to maintain the house and yard, or will lower maintenance housing be required? Will more frequent trips to visit children be affordable, or will widowhood be the time for a move to live closer to adult children who can offer emotional support, and to the enjoyment of grandchildren? Income issues need to be considered, too. How will income from Social Security and pensions change? Will the survivor be equipped to manage investments and financial matters generally?

Seriously considering such issues before the time of retirement, and certainly before bereavement, will help guide the selection of joint and survivor pension option, and the irrevocable decision of which payment option to take at the time of retirement from a defined benefit pension. Anticipating financial consequences of widowhood early can lead to decisions that will reduce money worries at what will inevitably be a very stressful time.

Securing the best retirement you can takes some imagination. Even though the best plan cannot be exact, the effort now means a better chance of having the retirement you want.

GORDON TIFFANY, CFP, CFS, is director of financial and retirement education for ICMA Retirement Corporation.

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