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When Your 401(k) Becomes Income
PHOTO: Individuals tend to focus on saving money for retirement but fail to set a retirement budget.

Considering the emphasis that many people put on planning for retirement financially, it's ironic that many of these same individuals pay so little attention to what their retirement is going to cost.

Too often, even those who focus intently on accumulating money for retirement fail to ever set a retirement budget. When you think about it, this is an astonishing lapse. It's like driving to a destination without first knowing how much gas you're going to need.

The key is to set a retirement budget and then work back from it to see how much money you should be contributing to your 401(k) account every month out of your paycheck. The funding for this budget will be income that will be replacing the paycheck you now receive. In many cases, this would include money from selling assets in your 401(k) plan and from other sources, including Social Security (do you know how much this will be?), inheritance and any part-time or contract work you may end up doing during retirement.

Expenditures in this budget will include some items on which you'll probably spend more during retirement than you do now, including:

1. Health care

Your health care costs will probably increase during your retirement years, when you'll likely lose all or most of the health care benefits that came with your job. You'll have Medicare, but Medicare isn't a complete solution because there may be gaps in coverage that you'll need to cover with a supplemental plan. Also, Medicare doesn't cover vision, hearing and dental, nor does it cover long-term care, for which you should have insurance because the costs can be devastating.

2. Travel (if you can afford it)

This is an expense that many don't budget for adequately because they merely project their current travel costs forward. But you have a lot more time to travel during retirement.

3. Hobbies and recreation

Again, these costs may increase because you've got more time to play golf, go skiing or get the membership value out of a country club. On a more modest level, you'll have more time to make pottery or take a cooking course. Of course, if your idea of recreation is taking a walk near your home or entertaining a friend, your costs on these pastimes are low now and will be low during retirement.

For many, these expenses are offset by savings on items that you spend on during your working years but likely won't during retirement. These may include:

4. A second car

You and your spouse may be able to get by just fine with one car if neither of you is working, and you won't need as much gas or car insurance, especially if you currently have a long commute.

5. Other work-related costs

These include dress clothes or trade-related clothing, tools or uniforms, and lunch if you typically go out for this.

6. Payments on debts

By the time you retire, you should have paid off all of your debts, especially your mortgage. You don't want to retire with a 30-year, $300,000 mortgage because this can be a real albatross on your monthly retirement budget.

Thus, the basic formula for constructing your retirement budget is your living expenses (adjusted for your anticipated retirement lifestyle) minus current work-related expenses and debt payments.

Once you finish your budget, take a hard look at it to determine what you've left out. People commonly underestimate how much they are spending or will spend. If they spent as little as they think, they'd have a lot more of their earnings left over than they typically do.

Then, take a hard look at how much you're contributing to your 401(k) plan every month, and how your investments are doing. Also, evaluate how inflation will reduce your resources before and during your retirement, which could last 25 years.

If you do this objectively, you'll probably conclude that you're contributing too little to your plan within the allowable limits.

The remedy for this, of course, is to spend less now, which means budgeting for today as well as tomorrow.

People with low incomes typically get depressed over retirement planning, which is understandable if they're already having trouble paying for an extremely modest lifestyle. Yet, depending on their incomes, the number of children they have and other factors, they may still be able to make a significant difference in their retirement resources if they can find ways to spend less now.

One reason many people don't budget for retirement is that they don't tend to plan what they will be doing then. Instead, they focus on what they won't be doing: working. They grind away at their jobs, looking forward to the eventual absence of this pain, without developing a real-life idea of what their retirement lives will be like. Even only five or 10 years out, many people spend more time planning their next vacation than they do thinking about their retirement activities, lifestyles or locations. Often, couples don't discuss this in detail, only to find out late in the game that their spouse has a different vision.

Instead, the key is to have a realistic plan and make sure it's consistent with that of your partner. By working back from your ultimate vision, you can make course corrections that will help you realize it.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Anthony Kippins is president of Retirement Plan Advisors, Ltd. a Registered Investment Advisory firm that addresses the needs of retirement plans and the employees who invest in them. An Accredited Investment Fiduciary Analyst (AIFA®) with more than 30 years of experience domestically and abroad, Kippins specializes in providing fiduciary advice to retirement plans on governance, investments and educational services. He also advises individual clients on retirement planning and investment management after retirement. Kippins serves as managing director of Institutional Fiduciary Assurance LLC, an organization that provides fiduciary advice to trustees of endowments, foundations, non-profit organizations and charitable trusts. He can be reached at rpa@retirementplanadvisorsltd.com.

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