To estimate your expenses during retirement, think about what kind of lifestyle you want to live. Omyen recommends starting with what you spend currently. Some of the expenses related to your work e.g. commuting to work, work clothing, eating out etc. will be eliminated. But you may have new expenses in the form of additional travel, recreational activities, and healthcare expenses. While planning for your expenses, it is important to categorize these expenses as required (non discretionary) and nice to have (discretionary).
Whereas saving for retirement is fairly straightforward, deciding on a good withdrawal strategy is very challenging. There is no simple answer to the question of withdrawal rate as it depends on a number of factors. Some of these factors include:
Predicting your lifespan involves a lot of considerations e.g. your health and family health history, and lifestyle. Consider using an online life expectancy calculator to estimate your life expectancy.
An important factor affecting retirement financing is the expected return from your retirement portfolio. Unfortunately investment returns are never predictable. Financial markets could remain flat or enjoy several years of a bull run. However, historically over a long period of time (15-20 years), financial markets provide a much higher return than you would receive in more predictable CDs or Treasuries. Many advisors are currently expecting a long term average return of around 7% for a diversified portfolio invested in stocks (60%) and bonds (40%). Timing of retirement is also very crucial. If you retire when the market is at historically low levels, you are more likely to run out of money sooner.
In retirement, you usually pay less in taxes year over year than you did when you were working, because your annual income is typically less. You can expect to pay taxes on the withdrawals you take from your 401(k), 403(b), and IRA accounts. You will not have to pay tax on withdrawals from your Roth IRA accounts as they are tax free. Withdrawals from retirement accounts are taxed at ordinary income levels, similar to how you paid tax during your working years. You don't pay capital gains taxes, taxes on interest, or taxes on dividends in your retirement accounts.
For individuals who are managing their own retirement portfolios, here are some commonly practiced techniques by several financial advisors.
Once you have organized your portfolio according to this plan then each year you need to reallocate so that you are continuously pulling out one year's worth of expenses from #2. and move it to #1. and from #3 to #2.
You can adjust the movement of money to your cash account from the bond account or diversified portfolio based on market performance. You can raise cash by culling the underperforming bonds or stocks, or you can trim any overexposure to a specific asset class when your portfolio gets unbalanced.
If you have your retirement savings invested in different types of accounts then it is a bit tricky to determine how much to withdraw from which account. Typically you withdraw from non-qualified (non retirement) accounts first, then from taxable retirement accounts, and finally from Roth accounts. Reason being, you incur annual taxes from your non qualified accounts, so you want to exhaust these accounts first so that your recurring tax burden is eventually eliminated. You then tap into the taxable retirement accounts, because you would rather pay ordinary income tax on a smaller amount today, as opposed to a larger amount at some point in the future. You also want to eliminate your tax liability early on as opposed to later, because money might get tight towards the end of your lifespan. Finally, you tap into your Roth accounts to let them grow as much as possible tax-free.
