STEP TWO: WHERE DO YOU WANT TO BE IN THE FUTURE?
(Creating an Income & Expense Statement for Your Retirement Lifestyle)

Imagine yourself going to an international airport and taking off on an airplane that has no specific destination and no plan for getting there. It sounds unsettling and almost absurd, doesn’t it? However, it’s an appropriate analogy for what could happen when you’re investing your hard earned money without having any clear objectives. How then can we get this financial airliner on a vector toward a suitable destination for you?

Most financial planning scenarios we run tend to have retirement planning as a primary objective, so we’ll focus on retirement planning in this planning exercise. As our society has transitioned away from pension plans and into 401(k) plans, we are not only required to fund our own retirements, but to also manage those funds. Therefore, as retirement grows nearer and nearer, there is indeed an enormous amount at stake for each of us.

Determining where you want to be in the future all starts with the Income & Expense Statement from our last exercise. The Income & Expense Statement is particularly useful for quantifying your “current lifestyle,” since it provides a fairly clear picture of what it feels like to live your life right now in dollar terms. We begin this retirement exercise by modifying the Income & Expense Statement of your current lifestyle in such a way as to reflect your anticipated income sources and your anticipated expenses during retirement in a manner that you would consider viable.

Let’s first begin by modifying the left column (Income) of the Income & Expense Statement to reflect the sources and the amounts of income you expect to receive in retirement. You should first list any fixed sources of income to include sources such as social security, pensions, rents, royalties, and part-time employment, etc. You should especially note the sum of these fixed sources of income, because these are the sources that will undergird your retirement.

Secondly, reference and modify the expenses in the right column to reflect the expenses you would expect to incur in order to support your lifestyle in retirement. The tally of your annual expenses in retirement is known as your “retirement lifestyle,” and this is the primary objective of the financial planning exercise when it comes to retirement planning.

Lastly, compare your income sources to your expenses. If you have a negative cash flow in retirement as a result of expenses being greater than your fixed income sources, then you will need to supplement your retirement income with distributions from your retirement savings.

How much will you then need to have saved in retirement savings in order to supplement your retirement income? How should your savings be invested? Those are two very important questions you should be asking yourself once you’ve arrived at this point. The answers are complex and dependent upon many, many variables; however, we’ll provide some guidelines for consideration in the next segment on how you are going to get there. In many cases, the initial retirement goals are not viable, but this exercise will give you an idea of where and how to begin making adjustments to your goals.

Hopefully, the fog is starting lift and you’re now starting to grasp why we started this process by gaining an understanding of where you are financially right now so that you can then envision retirement for yourself in today’s dollars. As your life marches forward and unfolds, your retirement goals may change on your own volition or they may be forced to change due to circumstances beyond your control. Nevertheless, you can begin to develop a picture of your retirement and your other financial goals if you follow this process of creating and updating your Net Worth statement and your Income & Expense statements on a regular basis.

There’s one last point I want to stress about retirement planning at this point. You may have options on when and how to begin receiving your social security and pension benefits. It is absolutely critical to analyze these choices ahead of time, since these decisions are generally irreversible once the benefits commence. Moreover, there could be a significant enough loss of income to the surviving spouse if the pensioner happens to die an untimely death. A properly developed retirement plan should evaluate these options.

These are some of the issues we guide clients through as part of our financial planning services. For more information, please contact Leo Cunningham CFP