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calculated retirement

Have you ever thought you had a goal nailed down? Exactly what you need to do, how long it’ll take, and when you’ll get there. Then as you work towards that goal, life happens, your desires adjust a bit, and now the plan is a little bit farther or closer than initially thought. That’s commonly the way I think about the question, “how much do I need to retire”? Experts for years have disagreed on the right way to help someone figure out this number, but it seems to be, in my 15 years of helping people with retirement planning, that the successful ones are not fixated on the actual number they need because from now until retirement things are going to change and adjust. Instead, they are fixated on their Baby Step 4, saving 15% of their income, which will create the outcome they’re looking for. However, throughout this article, I’ll try and give you some guidance around how we would help a client try and determine if they’re on the right path to retirement and help them answer the question, “How much do I need to retire?”

First Things First: Baby Step 4, Save 15% of Your Income Towards Retirement.

Let’s all agree on one thing right off the bat…. You can’t get to any level of security without saving for retirement. That’s why we recommend that clients first pay off all their debt, excluding their primary residence, because we know that your greatest wealth-building tool is your income, and the more of it that is paid to the bank, the greater the propensity not to be able to be consistent enough with your retirement saving. Additionally, retirement is a basic equation: income must equal expenses. Your income is now becoming Social Security and/or pensions plus investment income; therefore, the more you don’t have “payments” to the bank, the less you need in income, meaning the fewer total assets you need, getting you to retirement quicker. Don’t ever let a Financial Planner tell you that debt is a good thing or something you should take into retirement. It’s a curse, the Bible calls us a fool for having it, and it only increases the wealth of the banks, which have been known to screw up our economy a time or two in the past.

Once your debt is paid off, you can begin saving for retirement using the Baby Step 4 method. This method is simple: You need to save 15% of your income towards retirement. We, along with Ramsey Solutions, would argue that this needs to be 15% of YOUR income (excluding your match). Still, even if you achieve 15% of your income by including your employer match, there is a high propensity that you will be doing well, especially if you started at a reasonable age. I recently did a video walking you through how we would recommend you execute Baby Step 4. This can be seen here by clicking here.

Guaranteed Income: Social Security, Pension, Etc.

Most individuals in America will have some level of guaranteed income in retirement. If you’ve worked in the private sector, you’ll have Social Security and possibly, if blessed to work for a company providing one, a pension. If you worked for any level of the Government, you’d have a pension through either the Federal System (FERS) or a state or local-based pension system. How much of these benefits are replacing your income? If you’re on Social Security, you can estimate that about 40% of your income will be replaced by Social Security, according to this article by AARP. If you’re in a pension, typically, if you max your benefit, you’ll receive about 70% of your income. Both are excellent benefits, and they give us a great start; however, nothing that will allow you to have that retirement you’ve been dreaming of. Therefore, we need to take that next step: Investments!

The 4% Rule, Perhaps 5% Rule

Bill Bengen was an engineer turned financial advisor in Southern California. As many engineers tend to do (shout out to our excellent engineer clientele), he needed to take apart the question, “how much of my client’s portfolio should they withdrawal each year” and understand it backward and forwards. Knowing that clients, when they are close to or at retirement, should have allocated a portion of their portfolio towards safer, slower-growing investments, especially if they’re using their portfolio for income replacement, he assumed that he shouldn’t be recommending a 10% type withdrawal rate, but having some stocks in the portfolio also meant he didn’t need to recommend a 2% withdrawal rate. He back-tested every percent, and the number that never created a situation where a client exhausted their money, was 4%. Even in the worst case, Great Depression type of scenario, a client would still have something left over their retirement lifetime, which he defined as 33 years. The years he calculated were 1926 through 1976. If you’d like to read the Journal of Financial Planning article, click here!

However, Bengen was recently interviewed in 2020, saying the 4% rule was a starting point, not an end-all-be-all. He articulated that while the 4% rule has its critics and contenders, he only meant that number as a worst-case scenario. Instead, he says, when testing the data, there were times that a retiree could have taken out 7%, and there were other times it reached as high as 13%. Today, he is retired and living his best life in Arizona (yes, we Financial Planners even plan our retirement), and he is currently taking out 4.5% of his portfolio. He would advocate that perhaps a 5% rule is more realistic in today’s world. You can read that article here.

With that backdrop, let’s assume the 4% rule is the number you’d like to use to turn your investment balance into an income stream. An article I recently wrote about the happiest retirees discussed how the happiest retirees had around $500,000 in investable retirement assets. Therefore, if we had saved $500,000 and used the 4% rule to help us calculate the income we could safely take from that portfolio, it would tell us to take $20,000 / year or $1,666 / month. Want to use the more aggressive but high probability number of 5%, then you’re looking at $25,000 / year or $2,083 / month. Of course, you can take higher amounts than discussed here; you just run a higher risk of running out of funds later in life.

Expenses In Retirement

When retired, do you need to replace 100% of your income? Typically, the answer to that is no. Retirement is so dynamic, and everyone’s situation is unique. Research has shown that the average retiree will need about 80% of their income in retirement, but we’ve seen clients that have dropped to around 50% of their pre-retirement income. One choice that significantly reduces what percent of your income you need in retirement without changing your lifestyle is how successful you were in saving in Roth IRAs. The average person pays the IRS 10% - 25% of their income. If you can reduce that number to zero because of substantial Roth IRA and Roth 401(k) contributions throughout your life, then you’ve lowered the amount of income you’d need to replace without cutting something out of your life you’d like to do, because you’ve eliminated or significantly reduced taxes in retirement.

We have a particular way our Financial Planners and Advisors help our clients figure out their expenses in retirement. We start with their current income and adjust it for inflation in the future. We subtract out their income: taxes (today and future expected income taxes) along with Social Security and Medicare taxes that you typically don’t pay in retirement. We then remove any liability payments you have today because we strongly recommend that you not enter retirement until you’re debt free. We back off your savings rate, meaning if you have been saving 15% of your income towards retirement that doesn’t need to be replaced in retirement, and then we add things like Medicare Premiums, travel expenses and home maintenance expenses, and any other individualized expenses, you’d like to see in your plan.

This helps us to answer what your specific replacement needs may look like in retirement and therefore show someone when they’d have saved enough to live off 4-5% of their portfolio and eventual pensions and/or Social Security to guide them around if they’ve saved enough for retirement and/or how much do you need to save to hit generate enough income to equal your total retirement expenses.

How Much Do I Need? Create a Plan!

To Recap, you’ve taken steps to begin saving 15% of your income for retirement. You’ll probably replace about 40% of your income through Social Security (perhaps more with a pension). Then your investment savings will create an income by using the 4-5% withdrawal rate discussed above. Finally, you’ll need to determine your expected living, travel, and home maintenance expenses, along with taxes (income and property) and health insurance premiums in retirement. So how much you need is a moving target, which is why so many people, even the devout do-it-yourselfers, eventually seek the input and advice of a Financial Planner.

The key to having confidence is to have a plan, look at the projections of that plan, and then begin to execute that plan to success! A recent research piece by the Employee Benefit Research Institute (EBRI) found that only about 42% of people even tried to calculate how much retirement assets they’ll need to have a secure and comfortable retirement. That number is dangerously low, and you shouldn’t have to live with that uncertainty. Talk to one of our Financial Advisors today, and they’ll begin to dialogue with you about the steps you need to take to start creating a successful plan.


August 28, 2022

John-Mark Young

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