Prior to my deployment to Iraq in 2005, we trained for two long months, constantly going over various military maneuvers. Since we were all in the National Guard and had never trained together for more than one weekend per month, the initial battle drills were laughable at best.
We were so inexperienced, there's no doubt that had we been sent directly into combat, the outcome would not have been pretty. But after 2 months of nonstop training, our platoon matured into a well-oiled machine, ready to take on anything.
It was those battle drills. Essentially, dress rehearsals – just with Humvees and big guns instead of costumes and props – that gave us the confidence and experience we needed to succeed when our platoon deployed.
When I talk with clients about planning their desired retirement, I always reference this because retiring successfully demands the same type of rehearsing.
It's fine to crunch numbers as a starting point for deciding how much retirement income you'll need – and therefore the retirement savings you'll need to produce it, but that’s just the first step.
Projecting yourself now into living on that retirement income will tell you about how it will feel to live on it. You can only learn that by doing a retirement dress rehearsal.
A retirement dress rehearsal is important because it will be your first chance to see if you can actually live on your expected retirement income – and give you time to fix it if you can't.
Calculate Your Expected Retirement Income and Your Projected Cost of Living
You'll need to make a list of any and every income source you expect to have in retirement. Look at some of the following categories, and make a reasonable estimate as to how much you think each income source will produce:
- Social Security
- Defined benefit pension(s)
- Estimated income from your projected retirement portfolio (use the "safe withdrawal rate" of 4% per year)
- Estimated income from non-retirement savings (investment accounts, mutual funds, individual stocks, CDs, etc.)
- Income from investment real estate, or investment partnerships
- Any earned income sources you expect to have
Once you've listed and tallied up these income sources, plan to live on them for at least two months, and longer if you can.
Next, make a list of your expected expenses, and what each will cost you on a monthly basis. This list should include:
- Housing, including your mortgage if it won’t be paid off by retirement
- Insurance costs, including Medicare, a solid supplemental health insurance policy, homeowners insurance, car insurance, life insurance, and any other policies you expect to have
- Car expenses, which would mostly be gas, but also a monthly payment if you expect to have an auto loan
- A reasonable estimate for groceries – don't forget nonfood items like cleaning supplies, paper goods and laundry detergent
- Entertainment expenses – you can base this on your current expenses, but you should also include a markup since the free time that retirement will provide you will likely see you spend more in this category
- Travel expenses, broken down on a monthly basis (as if you were saving up money for summer vacation)
- A reasonable estimate for repairs and maintenance to your home and cars; you can do this by making an annual estimate, then dividing it by 12 months
- The cost of maintaining major recreational possessions, such as a vacation home, a recreational vehicle, or a boat
- An estimate for miscellaneous expenses, such as clothing, out-of-pocket medical costs, gifts, and any other expenses that don’t fit into other categories.
Add up these expenses, and make the total your budget for the length of the rehearsal period. And if you find calculating your projected retirement living expenses challenging, it should also give you a better appreciation for why you need to do a retirement dress rehearsal in the first place.
Pretend You Have No Job – How Does it Feel to Live on Retirement Income Alone?
Once you have calculated your expected income and expenses, you need to make the two numbers your budget for the entire duration of the rehearsal. If the retirement expenses exceed your current income, then you should plan to make up the difference out of savings.
The idea is to live entirely on your expected retirement income. That means ignoring the fact that you have employment income, especially if that income is higher than what you expect your retirement income to be.
"The great thing about planning is it allows you to think through how something might feel, long before it is part of your reality. Trying things on for size can be so helpful. Test it. See what it feels like, then, and only then, will you have the information and emotional clarity to make the adjustments that might be needed to your plan", offers Carl Richards, CFP®, founder of BehaviorGap.com and author of the best selling book, The One-Page Financial Plan.
You'll want to gauge not just the financial balance of your retirement budget, but also how it feels. If your retirement income will be significantly lower than your current job income, it may feel a lot like adjusting to being on a diet. You have to make sure that it works for you on an emotional and psychological level. Otherwise you may need to make adjustments in your retirement planning.
How Hard Is It to Live on Retirement Income Only?
If you are finding that it is pretty easy to live on the budget that you have, based on the projected expenses, then that's an indication that your retirement planning is on track. But if you find yourself struggling to stay in budget, or feel an excessive sense of denial, you may need to consider stepping up your retirement savings and income provisions.
How Often Do You Need to Dip Into Savings
One of the best ways to determine the financial balance of your projected retirement income and expenses is how often you need to dip into savings to cover shortfalls. If you find yourself needing savings – other than to cover excess non-retirement expenses from your current life – it's a strong indication that you may arrive at retirement inadequately prepared.
To be sure, you will need to have regular contributions to your savings, even once you retire. Emergency situations happen in retirement, just as they happen during your working years. You'll not only need emergency savings for unexpected expenses, but you may also need a larger amount of savings (as opposed to retirement savings) to weather downturns in the financial markets that may cut deeply into your retirement portfolio.
Make Planning Adjustments Based on the Experience
If during and after the retirement rehearsal, you feel that your projected retirement income will not be sufficient for the kind of retirement that you want and expect, this will be the time to make adjustments.
This is also an excellent reason why you should try doing a retirement reversal, even if you are years away from retirement. Since retirement savings take many years to accumulate, the sooner – and more frequently – that you run a retirement rehearsal, the more opportunity you will have to make adjustments. That will give you plenty of time to make any improvements, if they need to be made.
You may find that you will need to save more for retirement than you are currently saving. You may also find that you'll have to invest your portfolio at least a little bit more aggressively. And if you have any inkling that it won't be sufficient, you may also need to begin procuring other income sources, such as investing in rentals or real estate, or becoming a silent partner in a business.
You should also take a close look at your debt situation. Though I have suggested that you include a mortgage and car payment(s) in your expenses if you expect to have them in retirement, paying them off is one of the best ways to lower your projected living expenses. You may get more bang for your retirement buck by paying off debt, rather than by investing the same amount of money.
You can only find that out by doing a retirement rehearsal. It will give you an opportunity to identify weaknesses in your retirement financial profile well in advance of the real thing.