The big question on most people’s minds when planning for retirement is how much money they will need. Even if the concept appears simple, it isn’t an easy question to answer.
You can never know exactly how much annual income you will need after you retire. To cope with this lack of certainty, some folks have tried to create rules of thumb such as the 80% rule. This rule states that your retirement income should equal about 80% of your pre-retirement income, which may be a lofty goal depending on your situation.
For example, if your annual retirement income from all sources, including Social Security, pensions, 401(k) plans offered by employers, IRAs or other retirement savings, should equal roughly 80% of your gross pre-retirement income and you withdraw no more than 4% of your assets annually, then someone with a $100,000 pre-retirement salary would need about $2 million in retirement savings.
You can’t know exactly how much money you will need when you retire and rules of thumb like this are often overly simplistic. But there are some key considerations that may shed useful light on the subject of retirement planning.
In this article, we discuss three considerations when predicting how much of a nest egg you may need to live comfortably though your retirement years. There is no one-size-fits-all strategy that makes your retirement fund sustainable, but these tips should help you further tailor your projections past an initial online retirement calculator.
While you may not be able to project how much you need to retire with certainty, you can help set yourself up for a higher probability of investing and financial planning success. Realistic retirement planning is all about increasing the likelihood of having enough money to last your retirement.
Investors often neglect to factor in their health and family medical history when planning for retirement. However, these considerations are important for many reasons.
If you are trying to build your retirement savings, then you must have some reasonable basis for determining how long your savings will have to last. We call that your investment time horizon. In most cases, retiree’s investment time horizon is often at least his or her own lifespan. In some cases, an investment time horizon may be longer, based on a younger spouse’s life expectancy or other goals, like leaving a legacy for heirs.
The Centers for Disease Control publishes average life expectancies for Americans. But planning for average life expectancy alone may not be enough. Factoring in your health and family history and that of your spouse or other dependents may give you a better idea of your true investment time horizon.
It’s also helpful to have a rough idea of what your ongoing expenses might amount to in retirement. This can allow you to get an estimate of how much you might need to save to meet those ongoing expenses.
We would suggest an easy first step is to identify your fixed costs (those that don’t change over time, like a fixed-rate mortgage) versus variable costs (those that do change over time). Document your pre-retirement expenses thoroughly and use averages for variable costs to get a clearer picture of what the expense normally looks like. A lot of online banking platforms—including most from the big, tech-savvy banks—allow you to categorize expenses online. This can be a huge time saver.
Once you know your current situation, you should project what might change in retirement. This can be harder for someone of age 30 than for someone who is five years from retirement. Variables shift, but having a guideline to start with is useful. Identify any loans you plan to pay off and services you expect to add, eliminate or keep. Don’t forget to include the discretionary things you enjoy doing such as going on vacations, pursuing hobbies and spoiling grandchildren.
Of course, the next step is to assess your income sources after retirement. Once you reach their definition of retirement age, the Social Security Administration should send you an annual statement defining the benefits you have accrued to date. Be sure to understand your Social Security benefits and map out when it might be best for you to begin receiving those benefits.
Consider also whether you or your spouse plan to work at all in retirement or if you expect to receive any other income after you retire, such as pensions.
Total up these income sources—Social Security, employment income and pensions—and compare it with how much you expect to spend after you retire. If there is a shortfall, you may need to cover it with your retirement investments.
Some people enter retirement without considering whether their withdrawal rate is sustainable in the long run. For example, if you plan to withdraw 10% or more of your portfolio annually, you could risk running out of money in less than 20 years (a common investment time horizon for retirees). And that is true even if you invest the money over that time frame. Conversely, if you withdraw a lower percentage of your portfolio annually, your portfolio may be more likely to survive that timespan.
Lower withdrawal rates may increase the chances of your portfolio lasting your lifetime, but that may require a greater base savings amount. Given ongoing medical advances, those who plan to retire even five or 10 years from now may need their money to last even longer than someone retiring within the next year or so.
Once you estimate your annual expenses and desired annual withdrawal rate, you can get a rough estimate of how much you may need to retire. Just divide the amount by the rate. For example, if you need $60,000 in annual withdrawals, a 3% withdrawal rate would mean you need $2 million. However, this simple calculation won’t take into account your investment strategy or investment time horizon, which could alter your calculations drastically. The additional complexity means you may be better off working with a professional to do this estimation.
Finally, it is imperative to expect the unexpected. Even a well-thought-out retirement plan could face headwinds. Maybe the markets performed poorly and investment returns were lower than expected. You may be faced with unexpected expenses, or perhaps inflation was higher than anticipated. All these factors should be considered.
Make a plan for how you and your spouse will cope if something goes against you financially. What could you spend less on? How can you reduce the strain on your savings?
Running out of money after you retire is no fun. But careful planning can help you avoid getting into such a situation. Planning for retirement requires a holistic approach, and Fisher Investments has developed a solution to help toward your long-term financial goals. Give us a call today or download one of our educational guides to learn more.