You’ve read for years how financial experts preach to put a little money aside on a consistent basis during your working years in preparation for retirement.
You’ve also read how social security, the government’s so-called “safety net,” is doing so poorly that the Social Security Administration may have to cut benefits by 21%+ by the year 2035 if Washington does nothing to shore it up.
Let’s say you heeded the experts’ warnings and scrimped and saved as much as you could during your working years. You went about life thinking everything’s fine as you watched your nest egg grow. You’re now beginning retirement and think the many years’ of sacrifice will pay off with a comfortable financial cushion for the next 20+ years, right?
Not so fast. Even the best-laid retirement plans sometimes forget to plan for two potential land mines—overspending and unexpected income reductions. Either could wreck an otherwise comfortable retirement.
That’s why even if you have a sound financial plan, you can never over plan for contingencies.
First things first
Whether you’re still working or retired, you don’t need a business degree to understand basic financial principles. If your income exceeds your expenses, you earn a profit. Sustained profits mean you won’t deplete your assets.
Conversely, if your expenses exceed your income, you incur a loss. Losses mean you either borrow or liquidate some of your assets to cover the shortfall. And the greater the loss, the quicker you run out of money.
To determine whether you’re generating a profit or loss, you must first know your income and expenses as accurately as possible. Only then can you plan for contingencies.
Calculate your income and expenses
Tallying up your income is straightforward. Assuming you’re already retired, add up your interest, dividends, pensions, annuities, and social security. You can use the 1099s you receive at the beginning of the year to calculate these figures.
Alternatively, if you’ve tucked your documents away in the attic, just review your last few months of online banking and brokerage statements.
Calculating your expenses is a tougher task and one that most people shun. However, with all the free tools, forms, tutorials, and guides available on the internet, it’s easier than you might think.
Use forms with built-in expense captions to jog your memory as to where your money goes, then examine the past few months of your checkbook (or your online bank statements) to get the exact amounts. You want to be as accurate as possible when estimating expenses. Since some expenses occur periodically, review several months’ worth to ensure you’re not overlooking infrequent categories.
If you find your income exceeds your expenses, be grateful and continue monitoring your inflows and outflows. If your expenses outweigh your income, examine your spending for potential leaks. The sooner you know your situation, the quicker you can improve it.
The danger of overspending
Now that you know the extent of your annual profits or losses, you’re better equipped to prepare for unforeseen events. Chronic overspending is a common pitfall. We’ve all done it at one time or another, but you can’t make it a recurring theme.
While you may think it’s okay to overspend a little each month, it’s important to keep time frames in mind. Overspending by just $100 a week can cost you more than $140,000 over 20 years (assumes 2% inflation and 5% annual returns not earned on the amount overspent).
Overspending takes several forms. It can come from underestimating expenses, like forgetting to include infrequent expenses. It can stem from not having a budget or not keeping track of your spending. And sometimes we overspend because of unforeseen expenses like major vehicle repairs.
Safeguard your retirement from loss of income
Another surprise that can devastate your retirement isn’t an expense at all. Rather, it’s the loss of crucial income. For example, this can happen when one spouse passes away. If you’re not prepared, this could cause a particularly dire financial situation.
Namely, because when a spouse dies, their social security income ends. If the surviving spouse had the lower social security of the two, he or she typically gets an increase equal to the difference.
Still, losing a spouse during your retirement can result in a drastic reduction in total social security income. Add to that the total loss, or at least a reduction, of pension income - depending on the type of pension payout.
Losing either of these income sources could be difficult, but to lose both could represent a catastrophic blow to the surviving spouse’s finances.
Clarity makes planning easier
The key to safeguarding your retirement from the unexpected is to prepare for loss of income and unplanned expenses.
Sure, this level of preparation may seem time-consuming, especially in the beginning. However, getting a handle on your income and expenses - now - will help you sleep better knowing you can persevere through short-term setbacks.
And come on, who couldn’t use a good night’s sleep in this day and age?