How much money do you need to retire? It's definitely a loaded question. There are so many variables that come into play, it's almost impossible to give a yes or no answer based purely on a dollar figure. In certain circumstances, it's obvious. If you have 5 million dollars saved and only spend $30,000/year, yes you can retire comfortably. On the flip side, if you plan on spending $150,000/year in retirement and have $250,000 saved, retirement it's probably not in your cards yet. But for most people, it isn't quite that easy to determine. Because of that, in this blog we are going to walk through how you can start piecing together your retirement plan to determine if you are ready to pull the retirement trigger or not. And hopefully, answer once and for all, how much money do you need to retire.
Retirement Starts with YOU!
You didn't work your entire life in order to get to retirement and not enjoy it. At the core of retirement, your needs and wishes for yourself should be front and center. Happiness, freedom, and control should be a few of the adjectives that come to mind when thinking about your golden years. So the first thing you are going to want to accomplish is to start creating what your best life in retirement is going to look like. Will you take on new hobbies, travel, or maybe even continue to work in some capacity? It doesn't matter what it is, as long as it's what you want. We will call this your retirement lifestyle. Now comes the tricky part. Trying to quantify what that retirement lifestyle looks like. At the bottom, I would recommend listing all of your basic needs expenses. Food, shelter, water, utilities, etc. What are the expenses that, not matter what, you will continue to need throughout retirement. After that we can move on to the more aspirational spending. Some would call this the "fun" money. Traveling, a second home, or maybe just spoiling grandkids. Once we've identified all the items we'd like to include in each of these two categories of your retirement lifestyle, we can do our best to place a dollar figure on each. I would recommend creating a spending tracker to help monitor real expenses as you approach retirement. This will give you a more realistic picture of what your spending capacity will be in retirement.
"Guaranteed" Income Planning
Now that we have a better understanding of what our retirement might look like from a cost standpoint, we can now do our best to try and figure out how we are going to pay for it. First we need to consider our guaranteed income sources. These are income streams that *should* (never a guarantee) be counted on to be around for the full duration of your retirement. Social Security is generally the most common type of guaranteed income source for people. After that, some pre-retirees are lucky enough to have a pension. A few of you may even have or are considering income annuities as well. Guaranteed income sources are important for a number of different reasons. Probably one of the biggest is it reduces longevity risk. The risk that you live to long and therefore use up all of your other monetary resources before you die. Having a solid guarantee income source of money can allow you to sleep easy at night knowing you will never outlive it. Some will argue that these income streams should cover at least your basic living expenses. Matching the expenses that will always be needed in retirement with income that will always be there in retirement is a good strategy. A lot of that comes down to how risk adverse a retiree is.
The Income Gap
For some, their guaranteed income sources will be enough to cover their basic living expenses and their fun money. But for most, we usually create an income gap for ourselves. The income gap is the difference between what you want to spend in retirement and what your guaranteed income sources cover. The larger the income gap, the more money you are going to need to pull from other resources. Other common resources could be 401(k)s, IRAs, Brokerage Accounts, Checking and Savings Accounts, etc. The bigger the income gap, the more economic risk you will be exposing yourself to. You'll be more reliant on investment performance and other economic events. It also makes the funding strategy of that income gap even more important.
Income Gap Funding Strategies
You have now made it to the point in your retirement planning that has identified your income gap. In order to live your best life in retirement, you need a strategy to fill that gap with the money you've spent your entire life accumulating. We will call these your assets. Like mentioned above, a few common assets people hold in this situation may be retirement accounts, savings accounts, or other investment alternatives. Regardless, the real tricky part is trying to figure out how to turn those assets into money you can actually spend. Some may see this as an easy problem to solve. Just withdraw money from your assets to fill that gap every year. Great, but how long will that last? What if your assets decrease in value due to poor investment performance in any given year? Which assets do you sell first, if you have more than one? How risky should you be with these? What assumptions should I use to project into the future? These are all valid questions that will almost certainly never get completely answered. The best way forward would be to create a funding strategy that takes into account all of these concerns and adjust every year as you go.
The Black Cloud
Most know in retirement there are no shortages of events that can undermine your financial efforts. These could be taxes, inflation, investment performance, economic pressures, interest rates, healthcare costs, regulation changes, etc. This list can become pretty robust depending on what type of retirement lifestyle you have planned for yourself. The worst part is, these events that live in that black cloud will never go away. So you must do your best to manage them as you go. Forgetting about these could mean trouble down the road. Anticipating and planning for these could help reduce their overall impact on your retirement wellbeing. In-fact, the more proactive you can be earlier in retirement with these, the smaller this cloud tends to get as you age. So it's imperative to identify what is waiting for you in your black cloud. And then creating a plan to mitigate these as efficiently as possible.
Ready, Set, Plan!
So at this point you may be a little discouraged. You've worked very hard to put yourself into position to retire and now you have to worry about some black cloud hanging over your head for the rest of your life? That isn't very appealing. However, do no fret! This is where the true power of financial planning can shine! You see, all of these variables are always changing. Some by our own doing and others that are completely out of our control. And that is ok. Life isn't a straight line. It's a winding road that gets messy sometimes. Retirement is no different. The good news is that you can take control. Applying proper financial planning techniques and strategies can allow you to maximize the good while limiting the bad. Whether it's delaying social security, diversifying your tax liability, reallocating your investments, or insuring against other risks, there are no shortages of ways you can tackle any given situation you may find yourself experiencing in retirement.
And the magic number you need to reach in order to retire is.......there is no magic number! There is far to much going on in a retiree's finances to make a retirement decision based solely on how much money you have. Instead of fixating on a dollar figure, you should be concentrating on what lifestyle you want to live. What does your best life look like? Once that is determined, you can start to use proper financial planning to help put all the other pieces together. The one thing better than having a little more money in retirement is having a lot more control. And that is what real financial planning can provide you. Happiness, freedom, and control!'
If retirement planning is a topic you feel you'd like to discuss further, feel free to schedule a complimentary consultation.
- Derek J. Delaney, CFP®, ChFC®, EA, CSLP