If you had $500,000, would you feel rich? What about $1 million? $3 million? $10 million? It turns out everyone has a different threshold for feeling wealthy, and wealth is far more complicated than your annual income or your current net worth. It’s less about the balance in your accounts and more about your ability to reach your goals.
If wealth is tied, as much as anything, to income stability and well-planned spending, how does that translate to retirement planning?
We can really redefine the meaning of "rich" within the retirement sphere. Being wealthy in retirement could mean having enough money to feel comfortable and secure while enjoying a retirement lifestyle that allows you to participate in many of the hobbies and activities you enjoy—defining these goals will help you determine your replacement ratio. But the idea of being rich will have a different significance for every individual.
Whether an individual feels wealthy is typically tied to financial stability. Some people in higher tax brackets don’t feel rich, often because they believe they've stretched beyond their means. Plus a high income doesn't mean a high net worth.
An individual’s personal circumstance will lead to their own feelings about wealth. A seemingly large retirement nest egg may give some the impression of wealth, but if the expenses are not in line with the income generated, that large retirement balance may not last through all your retirement years. Even a big dollar amount, like $1 million, doesn't necessarily mean a big yearly income if you’re retired for 30 years.
It all comes down to changing your mindset about wealth, focusing less on the retirement balance number and more on quality of life.
Geography greatly affects wealth, and feelings of wealth, because the cost of living varies tremendously across the United States. A household income of $100,000 could mean a very high standard of living in a medium-sized Midwestern town and a relatively low standard of living in a large coastal city.
Other factors consider:
- Expenses. What basic expenses will you have during retirement? What extra expenses will you have? How much will your monthly expenses decrease (or increase) when you retire?
- Lifestyle. What hobbies do you enjoy? What kind of house and car do you have? What material things do you possess, and what do you want to possess?
- Income. Do you have an income aside from your retirement nest egg? How much money do you net after paying taxes and debts?
- Savings. How much cushion do you have in case the going gets rough? As you work through these questions, you’re getting to the heart of the big question: How much of your current income do you want to replace?
To answer that question, you need to figure out your replacement ratio in order to know how wealth during retirement will look for you.
Let’s look at an example: Stella wants to live a retirement lifestyle similar to her current lifestyle. She anticipates having lower transportation expenses since she won’t commute to work. And she’ll have a paid-off house. But Stella will also have higher utility bills from being home more during the day, and she plans to spend money regularly on her hobbies—photography and gardening. Stella has decided she wants to have the same monthly income during retirement that she has now, so her replacement ratio is 100 percent. (She wants to have an income similar to her current income throughout retirement even though she won’t be working.) Stella's pre-retirement strategy should be based on a goal to replace 100 percent of her current income.
In this example, the balance Stella needs to reach these goals is irrelevant to you and your situation. The amount she needs to provide her post-retirement income may or may not make her look rich in your eyes.
Instead of focusing on your balance, focus on the quality of life you're planning to have in retirement and the goals you've set for yourself. To reach those goals, what kind of income replacement ratio will you need to achieve? When you’re planning for retirement, you need to figure out how much you need to save— and how to grow it with an appropriate investing strategy—in order to have the savings and income that will satisfy your retirement needs.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.