We would probably all agree that “net income” is not a particularly difficult concept to understand: Deduct costs and expenses from gross income and net income is what is left. But, like many things that are easy to understand but difficult to practice—regular exercise, for example—too often investors overlook expenses that must be deducted from their gross income to accurately calculate their retirement net income.
Figuring out what you will really have to spend in retirement is a process, one that should begin a good two-to-five years before “R-day”—the day you actually do retire. One place to start is to look at your personal finances the same way you do a business. In both a business and your personal finances, you have revenue/income and expenses.
In both cases, you deduct one from another to calculate your profit/net income. To get the precise profit/net income amount, you cannot overlook a single expense, whether it is an upgrade of your company’s entire computer system or the amount you spend on paperclips. The same is true of your personal finances.
So, let’s start with what you spend to maintain your lifestyle and two very important questions:
First, do you plan to downgrade your lifestyle after you retire? Many people will answer “no” to this question. That brings us to important question number two:
What do you spend every year and every month of every year? Once again, you cannot leave anything out. And just as you do with a business, you have to include major expenses, from large investments, like renovating your rental properties, to what you spend on the flower arrangements that grace your primary residence. Even for those who diligently note down everything they spend, expenses are sometimes overlooked because, well, they may not seem like an “expense.”
Think about investment fees and taxes, for instance. Both are an “expense” because they are “deducted” from your gross income. And, generally, neither one will go away after you retire. For example, if you have a $5 million IRA, after taxes you might net $3 million. Some would argue, “But I will be in a lower tax bracket after retirement.” But will you? Remember, maintaining the same lifestyle will require the same income. And, yes, maybe more.
Figuring out what you will really have to spend in retirement is a process, one that should begin a good two-to-five years before ‘R-day.’
Whether you love world travel or art collecting, after retirement you will have a lot more time to do that and more. But will you have the same amount of money? This is why, during that multi-year ramp-up to retirement, keeping tabs on non-essential expenses is important, too.
And when it comes to income, don’t forget that after you retire, income is not a resource that gets renewed regularly like the salary you get from working. Also, living off capital is not an option since it automatically diminishes the engine (business) that drives your retirement income. There are still other important income issues to consider.
For example, will one spouse’s pension disappear or shrink after his or her death? And, since you can spend only the net income from investments such as rental properties, can you count on them if unforeseen expenses (there they are again) should occur?
Also, are you prepared to weather the next (inevitable) market downturn without changing your lifestyle? (In our view, that means having the equivalent of 12–to–18 months of income in cash available at all times.)
In short, to calculate your net retirement income, we believe you must accurately and honestly estimate your gross income, and be sure to include every single expense in your calculations. Yep, even the paper clips.
This information is being provided only as a general source of information and is not intended to be used as a primary basis for investment decisions, nor should it be construed as advice designed to meet the particular needs of an individual investor.
Katie Coleman is licensed and registered to do business with U.S. residents only in the state of NY, MD, OH, PA, DC, IN, FL, NV, DE, HI, ME, NJ, SC, NM, NC, CA, VA, CT, MA, GA, MO, IL.
Joseph S. De Sena is licensed and registered to do business with U.S. residents only in the states of NY, NM, VA, NJ, DC, GA, CO, CA, NC, CT, DE, TX, IL, PA, AZ, NH, NV, MD, OH, MA, HI, MO, ME, IN, SC, FL.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM and CFP (with flame design) in the U.S. Ameriprise Financial Services, Inc., Member FINRA and SIPC.
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This article was originally published in the October/November 2016 issue of Worth.