How much do I really need to retire? How much should I plan on spending in retirement? These are the two most frequently asked questions that I get from pre-retirees.
Unfortunately, there are no simple answers to these questions. Retirement experts have put together a few general rules regarding how much you need to save or expect to spend while in retirement. Two of the most common benchmarks that you may have heard of are the multiplier of your income to determine how much you should have saved for retirement and the income replacement amount to determine how much you should look to spend in retirement. For example, Fidelity  says that by age 60 you should have 8 times your salary in retirement savings and at 67, you should have 10 times your salary saved. The other frequently used benchmark comes to determining how much you will be spending in retirement, known as the income replacement rate. One common rule of thumb is the 80% rule--that is, in retirement, you'll need to replace about 80% of your working income. Benchmarks like these can provide a quick check on what your retirement savings number should be or how much you may look to spend in retirement, but not used as an absolute.
As you get closer to your target retirement date, it makes sense to really focus on the details as there is a lot of variability in these common benchmarks. For example, if you have been earning a higher income throughout your career, you may have saved more, which means that the percentage of income that you need to actually replace may be lower. On the other hand, the total amount you should have saved for retirement depends on a number of factors such as your income, your savings rate, market returns, and many more. Some of these factors are within your control while others have nothing to do with your decisions. Things like the timing of investment returns can have such a large impact on your outcome and yet it is not something you can control.
It’s understandable why you may want to know how you stack up to your peers. Nobody likes the feeling that they aren’t doing enough and on top of that, there is the additional confidence that you might feel if you know you are ahead of the game.
However, none of that matters. Let’s say that you are right in line with what Fidelity says, you are 60 years old, and you have your 8 times your salary saved and then you start running the numbers and realize that is not enough for you. As hard as it is, it is important to focus on your individual retirement goals. General Rules of thumbs are just practical guidelines.
When trying to figure out how much you really need to retire, the first thing should do is look at your current spending and your expectations for your retirement spending. if you are close to retirement and you are looking to maintain your current lifestyle, you’ll want to start with your current income as the baseline. To find your specific income replacement ratio. From there, you’ll want to subtract out your current savings rate because if you retire, you won’t be saving into a retirement plan anymore. For example, if you are contributing let’s say 10% to your retirement plan, your income replacement rate now drops to 90%. From there, you will want to subtract out Social Security and Medicare taxes because you are no longer paying those taxes. Those are the easy items to consider, then come the aspects that vary by individual. What kind of lifestyle changes are you planning on making? Some retirees may look to move to a different part of the country while others look to downsize their home. Even if you stay where you are at, there is a high likelihood that your spending will change when you retire. According to research from JP Morgan , almost 80% of people experience substantial changes in spending and not all of those people reduced their spending. In fact, over 35% of people had increased their post retirement spending. It will be important to get a good idea on where you are spending money prior to retirement and then planning for things that could change your spending. Things like healthcare costs, travel, and entertainment that may increase. Whereas things like commuting, clothes, and food that may decrease. Analyzing your spending and what you plan on doing when retired will give you a better idea of what your specific income replacement rate will be and what income you should be looking to generate in retirement.
Once you have determined your income need, then you can start looking at how that income will be funded and from what sources. The goal here is to figure out how much you will eventually need to rely on your portfolio for income. So, once you have figured out how much you would like to spend in retirement, the next thing you will want to do is determine how much of your income needs will be supplied by guaranteed income streams such as social security or pensions. Adding up your guaranteed income streams will tell you exactly the amount you will need to draw from your portfolio to fund your retirement lifestyle.
Once you have figured out how much you will need to draw from your portfolio each year, the next step is to determine if that amount you plan to withdraw from your portfolio is sustainable for a long period of time.
In 1994 Bill Bengen  published a research piece with the purpose of determining a safe withdrawal rate over a 30-year period of retirement to avoid running out of money. Out of this research came the commonly used 4% rule.
From his research, Bill found that an absolutely safe withdrawal rate based on historical market returns came out to 3%. 4% was considered safe because it never resulted in a portfolio being exhausted in less than 33 years. Bill also found that having too much stock exposure during retirement is just as risky has having too little in stocks, saying that an allocation in the 50-75% range was ideal. In a recent interview , Bill now recommends a higher withdrawal rate in the 5-5.5% range due to the change in the inflationary environment and low bond yields. With a range of 3-5.5% as a general consensus of a sustainable withdrawal rate, the next step in determining how much you need in savings to retire is to take that portfolio withdrawal amount, which is your desired retirement income minus your guaranteed income streams and divide it by your total retirement savings. If the amount you need to withdrawal turns out to be over that 3-5.5% range, you’ll likely want to reassess your retirement picture. Think of this as your car’s gaslight coming on and telling you that you have less than 20 miles until empty. So, you can either get off at the next exit, or try and push it until the next major town 35 miles away. At least with your car it is not a permanent problem. Unlike your retirement where once you run out, there’s no repairing that.
Let’s say that you do all of this work, you figure out your retirement income needs, and determine that it is sustainable based on how much you have saved. Ok, what now. The next thing you will want to consider is how you want to go about portfolio withdrawals. There are two popular withdrawal strategies that you may want to consider. Those being systematic withdrawals and the bucket approach.
Systematic withdrawals pull income from the total sum of your retirement account. In this strategy, your entire portfolio is treated the same and you will withdrawal a proportional amount from all of the investments in your portfolio to meet your income needs and to keep your asset allocation balanced as you sell off investments.
The other strategy is the bucket approach, where you divide your retirement assets into categories based on when you will draw down on them. The first bucket is designed to meet your near-term living expenses for one or more years. Bucket 1 should be highly liquid and is by no means the high risk, high return category of your portfolio. The next bucket is for the portion of your portfolio that you expect to use in the medium term or 2 to 10 years. with a goal of income production and stability. This bucket is typically dominated by high-quality fixed-income exposure, and it might also include a small share of high-quality dividend-paying equities and other yield-rich securities. The third buckets is the longest-term portion of the portfolio. This is money that you don't expect to use for at least 10 years and can be invested in higher risk investments like stocks that will provide you with higher long-term rates of return. With the bucket strategy, even if there's a market crash during your retirement, the stocks you hold will be in a long-term bucket and will give you the time needed to hold onto those stocks for quite some time, which should give your portfolio time to recover. The key to the bucket strategy is in the ongoing maintenance. As you spend down bucket 1, you will need to add assets to that bucket which can be done through income distributions from buckets 2 and 3 as well as rebalancing will help refill the assets needed in bucket 1. One of the biggest advantages with the bucket strategy is that it can help you control your emotions when the market drops so that you can maintain a long-term investment discipline. Staying disciplined pays off over the long run. According to data from JP Morgan , missing just the best 10 days in the market over a long period of time can dramatically impact your long-term investment success.
The closer you get to retirement, the more granular you want to be on every aspect of your retirement plan. If this feels complicated and you find yourself needing help, our firm would be happy to help with an assessment of your retirement to determine if you have enough for retirement and are on track to your retirement goals. Use the link above to schedule your assessment today.
1. Fidelity – Fidelity viewpoints – How Much Do I Need To Retire – 7/21/2020
2. JPM Asset Management – Three Retirement Spending Surprises Jan 2019
3. William Bengen – Determining Withdrawal Rates Using Historical Data, 1994
4. Michael Kitces – Financial Advisor Success Podcast Episode 198 – Oct 13, 2020
5. JPM Asset Management – Guide to Retirement 2021 Edition
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