Watch Out For These Estimating Mistakes

When deTermInIng hOW much to save by retirement age, several variables must be considered, some requiring estimates that will span decades. Err significantly on those estimates, and you can end up with little or no money left during the later years of your life. Three of the most significant estimating mistakes to watch out for are:

underestimating how much income Youll need in retirement. Various rules of thumb indicate youll need anywhere from 70% to over 100% of your preretirement income (Source: Money, January 2009). At first glance, it seems like youll need less than 100%, because work-related expenses, lunches out, expensive clothes, and commuting costs will be gone. But look carefully at your current expenses and how you plan to spend your retirement years before deciding how much youll need. If you pay off your mortgage, remain in good health, live in a city with a low cost of living, and engage in inexpensive hobbies, you might need less than 100% of your preretirement income. however, if you plan to travel extensively, must pay for health insurance, and carry significant debt, you may find that 100% of your preretirement income is not enough. You need to look closely at your current expenses and planned retirement activities to come up with a reasonable estimate.

underestimating how long Youll live. Today, the average life expectancy is 82 years for a 65-year-old man and 85 years for a 65-year-old woman (Source: Journal of Financial Planning, August 2008). however, average life expectancy means the woman has a 50% chance of dying before age 85 and a 50% chance of living past age 85. Since you cant be sure which will apply to you, you should probably assume youll live at least a few years beyond your life expectancy.

overestimating how much You can withdraw annually from Your retirement savings. With a retirement that could span decades, its important to withdraw a reasonable amount so you dont deplete those savings too soon. A number of factors can make that a difficult number to calculate.

First, as noted above, you cant be sure how long youll be making withdrawals. Second, inflation over such a long period means youll have to withdraw increasing amounts just to maintain the same purchasing power. Third, your rate of return on your investments will significantly affect how much you can withdraw annually. When withdrawals are being made, down markets can have a devastating effect on your savings. especially if a major market downturn occurs early in your retirement, withdrawing an amount that may have been reasonable during an up market may quickly deplete you assets. Thus, its generally prudent to keep your withdrawal percentage as low as possible, perhaps 3% or 4% of your balance.