“Retirement is not the end of the road. It is the beginning of the open highway.” – Author Unknown
"Do I have enough?"
That is a question that I hear quite frequently. Digging a little deeper with pre-retirees, they quickly realize that when they retire, their financial life comes down to one binary question which is actually a more explicit restatement of the above question - "Will my money outlive me, or will I outlive my money?" I'm sorry, but retirement only has two possible financial outcomes.
To make matters worse, these two outcomes are mutually exclusive. You can't have a little of one and a little of the other. Unfortunately, that is the stark reality.
Retirement Outcome #1
Obviously, the best outcome in retirement is that your money outlives you. I have found that the two most important qualities in the life of a retiree are being able to maintain your independence and your dignity. These two qualities are maintained when your savings continue to grow even though you are withdrawing more money each year in order to keep up with your increasing living costs.
Soon the retiree realizes that they can also have a meaningful impact on the lives of their loved ones. Maybe it means being able to fund the higher education of their grandchildren. Or it could mean leaving a substantial legacy to their heirs. It could also be used to support a worthy institution such as a children's hospital, a school, or a church. Talk about having an impactful life!
Retirement Outcome #2
Outcome #2 or the other outcome is not preferred. A retiree does not want to outlive their money - ever! When they see that they are on a path where their savings are shrinking each year, the retiree soon realizes that their independence and dignity are being diminished as well. This is a hard truth. Outcome #2 is to be avoided
So how do you go about ensuring that Outcome #2 is not what awaits you during retirement? Many people work hard for the majority of their life in order to reach a retirement where they can relax, travel, and find time to do the things that they truly enjoy. Everyone has different goals for retirement, and nobody knows how long they will live, so how much do you need in order to live comfortably during your post-work years?
Every pre-retiree needs to have a formal, date-specific, dollar-specific retirement plan. This is the only way that I know of to achieve Outcome #1.
Just as every retiree is unique, every retirement plan is unique. Every retiree has a different lifestyle and vision for retirement. This means that everyone’s savings goal for retirement will differ. Whether you are already retired or are just starting to think about your retirement, planning ahead is crucial. There are many common obstacles that every retiree will face and therefore need to plan for. The biggest and most insidious of which is inflation.
Inflation - The Enemy of Your Retirement
It’s been a long time since investors have had to worry about inflation. A really long time. I can assure you that inflation never went away. It is always there; slowly eroding the purchasing power of your money. It is why stocks are the bedrock of any successful long-term portfolio. While it may sound like a cause for panic, inflation simply refers to the gradual rise in prices over time, meaning the dollars you have today won’t stretch as far as they will tomorrow. This isn’t necessarily a bad thing. Stable, predictable inflation is actually considered a good sign for a growing economy.
But did you know that if inflation averages 3% during your retirement (since 1960 this has historically been the case), your cost of living will rise about two and a half times over a 30-year retirement? In other words, something that costs $1.00 today will cost $2.40 in thirty years. Therefore, if you do not have a plan to increase your income by at least as much as your retirement living expenses are going up, you are heading toward Outcome #2. You essentially now have a plan for outliving your money.
A 30-Year Retirement?
At least! A non-smoking couple aged 62, has an average, joint life expectancy of 30 years. That means that the second person will pass away at age 92. Beware. This the average. Some people will live longer than 30 years. And since no one knows when they will pass away, this very well could be you.
But here's a little secret - if your savings are growing at a faster rate than your cost of living, you cannot possibly outlive your money. So it doesn't matter if your retirement is 30 years or 40 years, your money will outlive you.
Whatever your goals for retirement may be, there is one guideline that you can follow to better determine how much money it's going to take for you to be able to retire comfortably and to remain comfortably retired. This by no means replaces the individualized guidance that a retirement income planner can offer, but it does give soon-to-be retirees an idea of where to start.
The 4% Rule is Now the 4.5% Rule
You may have heard about the 4% Rule. But what exactly is it? The 4% Rule was first proposed by William Bengen in an article that he wrote in 1994. When utilizing the four percent withdrawal rule, the idea is to build up a retirement portfolio that can provide income annually at a four percent withdrawal rate. Bengen has since updated his rule to the 4.5% Rule - meaning that 4.5% of a portfolio could be withdrawn safely from the retirement portfolio in the first year of retirement. After the first year, you “throw away” the 4.5% rule and just increase the dollar amount of your withdrawals each year by the prior year’s inflation rate.
For example, say you’ve determined you’ll need around $72,000 per year in retirement. Following the 4.5% Rule, you’d want to do some quick math:
$72,000/4.5% = $1,600,000
In order to follow the 4.5% Rule, you would need around $1,600,000 in savings before you retire.
The idea behind the 4.5% Rule is that your annual withdrawal plus inflation are accounted for in your portfolio’s market returns. This assumption is based on historical market performance, meaning there is never a guarantee of future performance.
Not a Substitute for Retirement Income Planning
The 4.5% Rule is not a substitute for a comprehensive, date-specific, dollar-specific retirement plan. Our lives are not linear. There will be some years in retirement where spending is greater than other years. The only way to plan for your retirement income needs in light of these irregular portfolio withdrawals is with a comprehensive retirement income plan. The 4.5% Rule is a rule of thumb to see if a pre-retiree is in the ballpark of having enough to retire. It also provides the pre-retiree accumulator a target to shoot for. "If I want to retire in five years and be able to withdraw $72,000 each year adjusted for inflation, I need to grow my portfolio from its current value of $1.2 million to $1.6 million through contributions and growth by then." That is a concrete goal - something that you can work towards with confidence.
When it comes to your retirement, it’s crucial that you are diligent in your planning so that you can live out your final chapter the way that you deserve. If you are used to living a particular lifestyle and want to continue doing it once you are no longer working, planning ahead and working with a knowledgeable advisor is imperative. Retirement income planning is a very important and necessary function in developing a comprehensive retirement plan. The adverse impact of not performing this detailed planning is Outcome #2. You’ve worked hard and saved diligently for your retirement. Let's make sure that you have the retirement that you've always dreamed of.
As a retirement income planning specialist, I create reliable income strategies so that my clients can enjoy their retirement without having to worry about what the market or the economy does. Do you know exactly how much money it's going to take for you to be able to retire comfortably, and to remain comfortably retired? Would you like me to sit with you, and help you figure it out?
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This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.