Perhaps one of the most terrifying concepts about retirement is living on your investments rather than your job income. It takes a bit of adjusting to the concept and there is the obvious fear of did I get this wrong. Did I get the taxes right? Or did I forget the car insurance? Did I leave enough for food?
So to help get over this fear I’m going to suggest the year before you retire you do a little two fold experiment. First track every penny you spend for the year before you retire. I know it’s a pain in the ass, but it will be highly useful to prove to yourself you have saved enough.
Then second track all of your investment income for the year. Every dime of it. Then when you file your taxes do a test run for that year. This is ideal if you use tax software. Do your regular return and then do a test run with your job income at zero.
Now adjust your spending for the year to match your projected retirement lifestyle. Strip out parking and any job related expenses and add in an real cost estimate of any trips you would have taken if you were retired or hobbies. Then compare your income test run to your modified spending. Is the income higher? If so, great you are ready to go. If not, you likely forgot something or you need to look at your numbers again to satisfied yourself you know what happened and you are not worried about it. Remember this is all about putting your mind at ease so be honest with yourself.
The other great concept about the test year if you can also build up a nice cash reserve to help cover any unexpected expenses or be your first years income when you pull the plug. The cash reserve gives you the option of delaying taking money out of your investments if you hit a down market.
So what do you think? Would the test year be useful for you or not? Or do you have a better idea? If so, please share with a comment.