Whether you are a do-it-yourselfer or you plan to work with a financial planner, it might help to do a little retirement readiness assessment on your own. This basic review of your own situation will help you focus on the most important issues.

There are three basic questions that retirement planning is designed to answer:

  1. What will my expenses be during retirement?
  2. What annual income can I expect to receive when I stop working?
  3. Do I have enough savings to make up the difference?

How much do I need?

The first, and often the most difficult step, is to determine how much you will need each year once you retire. A concept you might find useful is to differentiate between essential and discretionary expenses. For the most basic categories (food, housing, transportation, healthcare, insurance and personal care) identify the minimum annual amounts to maintain your required level of financial security as essential-level expenses.

For example, this would include a primary residence, but not the beach house. The beach house would be a discretionary-level expense. For food, your regular grocery bills with an occasional, modest night out would be your essential-level. Lavish or frequent dining out or expensive wines would be discretionary-level. Travel to visit the grandchildren once or twice a year would be an essential-level expense, while taking the whole brood on a cruise to Alaska would be a discretionary-level expense.

What makes this a workable concept is that you are identifying different levels of a required expense, such as food and clothing, rather than trying to identify entire categories, such as a vacation, as wholly discretionary.

Don’t overstate or understate the amount you think you will need to spend. This can cause you to retire too soon or rely on unrealistic investment performance or non-sustainable withdrawal rates. On the other hand, being too conservative can lead you to work longer, or live more frugally than is really necessary.

What income can I count on?

Take an inventory of what income you can expect to receive and when after you retire. Get an estimate of your social security benefits. If you are one of the lucky few who have a pension, get an estimate of what that payment will be. If you have an annuity, estimate what the monthly payment would be in retirement. You’ll want to look at these income items at various ages such as 62, 65, 67 and 70.

Do I have enough?

Ideally, you would hope to cover your essential-level expenses with guaranteed income sources such as Social Security, pensions or annuities. Discretionary-level expenses will be funded with excess annual income (in a perfect world) or with portfolio withdrawals, asset sales, or part-time income during retirement. Since most of your lifestyle in retirement will fall into this category, it is very important to be realistic about your long-term ability to fund these expenses.

Designing a sustainable withdrawal strategy from investment portfolios and retirement plans is one of the most critical elements in successful retirement planning. Remember that you may be retired for decades. If you are too aggressive in withdrawing money, you run the risk of having to drop your standard of living in later years. If you are too aggressive in seeking investment returns, you run the risk of losing your money outright. Most planners would agree that a withdrawal rate of four percent to five percent per year is probably the upper limit of their comfort zone. That means taking $5,000 or less from a $100,000 account per year.

Now what?

If your savings won’t support the withdrawals you’ll need for your essentials and your lifestyle, you need to begin the frank, and often uncomfortable, discussion of whether your retirement goals should be modified. Working another few years, downsizing to a less expensive home, moving to a less expensive area or adding some part-time income are all examples of the tradeoffs that you might consider.

Of these, working longer is usually the most effective choice. But, beware of assuming that you’ll just die at your desk. A large number of current retirees did not choose to retire. Sometimes retirement chooses us as when health issues or a job loss forces the decision.

Knowing how much you will have coming in and what you can realistically expect to draw down from your savings will enable you to determine your retirement readiness. If you are doing your own planning or working with a financial planner, this assessment is the first step to a secure retirement.

FPA member Helen Modly, CFP®, ChFC, is a principal with Focus Wealth Management, a woman-owned registered investment advisor in Middleburg, Va.

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