By: Jerry Love, CPA/PFS, ABV, CVA, CFP
This is a question I am frequently asked by the Baby Boomer generation. After all, most of us have accepted there are stages in life and the logical progression is after we have been in the workforce for 40 something years, we should be able to retire. Well, the answer is the infamous “it depends.”
In the prior column, we explored the concept of when should you begin to draw your Social Security. So this article seems to be the logical extension of that one.
This question is really not very difficult to answer if you can tell me a few things: 1) how much will you be spending each year, 2) at what age will you retire, 3) how much do you have in savings, 4) what is your rate of return on your investments, and 5) how long will you live? OK, I would also need to know a few more things including how much you will be getting from Social Security and any pension or annuity type payments etc. Of course, we also need Big Brother to tell us exactly how much inflation will be by year, how much your investments will earn each year and whether there are any other variables such as family members coming to live with you or huge medical bills that are not covered by Medicare or your long term care policy.
These are all very important questions because according to Bank of America, http://learn.bankofamerica.com/articles/money-management/how-much-do-you-need-for-retirement.html, “many Americans have a retirement savings shortfall”. According to the Employee Benefit Research Institute (EBRI), about 64% of all workers have less than $50,000 saved for retirement.”
Further EBRI says, “almost 50% of workers ages 45 and older do not know how much they will need in retirement.” (http://www.deseretnews.com/article/865577034/How-much-money-you-need-to-retire-comfortably.html?pg=all)
So let’s begin to work through this maze.
Any planning for your retirement has to begin with our determining how much you are expecting to spend. Yes, this is basically me asking do you have a budget? The most frequent reply is “no”. So what I will generally do is encourage the client to do one of two things: either take the most current year or at least the prior three months and summarize by category what you have spent. From this historical summary, we can then identify what you would be expecting to spend in the first year of retirement.
Yes, we will make some modifications to this to adjust for items that may not be necessary during retirement which may include items you have been spending related to your work. There have been many articles written about how a person only needs 70% - 85% of their pre-retirement income. However, I have found it is better to assume that your spending will not be reduced during retirement and may in fact increase because you want to do some traveling or other items on your bucket list.
So first contrast that there is a difference in how much you are making prior to retirement and how much you are spending. If you are taking the rule of thumb literally, your current spending is probably in the range of 70% - 85% of your current income, if you consider that in most cases, 7.65% is going to pay your Social Security and you may be deferring 15% to your 401k or similar plan. If you throw in a few items such as commuting costs and anything else directly related to your employment, you might be on target to these rules of thumb. I choose instead to help clients think in terms of what they are spending. Some surveys indicate that as many as 15% to 20% of retirees see their spending go up during the early stages of retirement.
It is also important to understand that there are some increases to your budget during retirement, not the least of which may be medical expenses. From: http://business.time.com/2013/02/11/sizing-up-the-big-question-how-much-money-do-you-need-to-retire/#ixzz2WPgTrJyW, “EBRI estimates that a 65-year-old couple in 2019 that does not have any employer-provided health benefits will need $450,000 to have a 50% chance of funding healthcare expenses not covered by Medicare. Even with employer benefits, there is a 50% chance that out-of-pocket expenses will reach $268,000.”
In addition to the unknown of how much may be needed for medical expenses, it is also important to discuss if there are other major expenditures the client may have in mind during retirement.
Another important factor for us to anticipate is how long you will live. From http://business.time.com/2013/02/11/sizing-up-the-big-question-how-much-money-do-you-need-to-retire/#ixzz2WPg1OTqv, “The Society of Actuaries estimates that for a married 65-year-old couple, there is a 45% chance of one person reaching 90 and a 20% chance one will reach 95.”
Of course no one knows exactly how long we will live and for most clients, we are attempting to determine the life expectancy of two people not just one.
The actuarial tables are a good starting place. I generally ask the client to compare those life expectancies with their family history. There certainly seems to be support for the premise that the current population is living longer than prior generations due to improvements in our medical profession and that we are more educated about ways we can improve our health. Taking all of this into consideration, I find that it is generally a good idea to begin with a longer life expectancy than the tables. Most people would prefer to leave some assets as an inheritance to someone versus running out of money many years before their passing.
Of course, we also have to consider inflation during retirement. If a person retires at age 66, and lives another 20 to 25 years, they should be expecting that each year many things they consume will be increasing in price. Many financial planners will use a 3% assumption for inflation. Assuming you are 66 now and you believe your life expectancy will be only 15 years. If inflation is 3% per year, that means that the next year your expenses would be $51,500 which is $50,000 + ($50,000 x 3%) and the second year your expenses would be $53,045 which is $51,500 + ($51,500 x 3%) and so on up until your retirement 15 years from now when you will require $77,898 to buy the same things that you can buy today for $50,000.
To quote http://www.newretirement.com/Planning101/Inflation.aspx, “when living on a fixed income, inflation has a profound impact on your quality of life. Basically, inflation makes goods and services more expensive and decreases the value of your money. When you are working – your wages generally rise as the costs of goods and services increase. Your earnings ‘keep pace with inflation’, so normal inflation is not generally a big concern. However, when you are living off of savings – inflation literally robs you of income.”
Keep in mind that history shows that inflation runs about 3% a year, meaning the cost of living doubles roughly every 24 years. Some articles say that you should conservatively assume inflation will be 4% annually.
The next element in our calculation is how much will our investments earn during our retirement. This is especially important considering that many people have a perception that as they approach their retirement age, they should move closer to having 100% of their retirement assets in CDs, savings accounts or bonds. However, you should note that many of the retirement calculators assume an annual return of 8%, a lofty goal in today's investing environment.
Here is some data for comparison. According to an article written by Chris Taylor, March 28, 2012, http://www.reuters.com/article/2012/03/28/us-column-yourmoney-retirement-returns-idUSBRE82R0XH20120328, “a couple of basic building blocks: According to Irvine, California-based Index Fund Advisors, 86 years of data reveals the long-term return of the Standard & Poor's 500 index to be 9.78% annually, while long-term government bonds average 5.73%. That's a good place to start, and then you can start refining from there, depending on your particular asset allocation.”
He continues in his article to observe: “Even among financial professionals, there's a wide range of expected rates of return. For its sample pre-retirement balanced portfolios, Baltimore fund shop T. Rowe Price plugs in 7% annual returns, pre-retirement. Vanguard uses 6% for a long-term, balanced portfolio. In a recent research paper titled ‘How Much to Save for a Secure Retirement,’ Boston College's Center for Retirement Research analysts used a slim 4 percent. That might be overdoing it on the cautious side - but if being ultra-conservative prompts you to save even more, then that's not a bad outcome. Better to end up with too much than too little.”
Another critical element for us to understand is how much we are taking out of the retirement savings each year. This is called the “spend rate”. According to Vanguard, “basically, retirees who have a diversified portfolio of stocks and bonds can generally withdraw roughly 4% of their assets during the first year in retirement. In subsequent years, they should then adjust the dollar amount of withdrawals based on inflation. As an example, let's consider a $1 million retirement portfolio with an initial 4% withdrawal of $40,000. Assuming an inflation rate of 3%, during the second year the dollar amount of the annual withdrawal would increase by 3%, to $41,200.” (https://retirementplans.vanguard.com/VGApp/pe/pubnews/4PercentRule.jsf)
According to http://www.retirementwatch.com/CashSample4.cfm, “most studies conclude that the maximum safe rate is just over 4% of the portfolio's value.”
However it is important to note that one size does not fit all. According to http://www.advisorone.com/2012/03/26/milevsky-what-is-a-proper-spending-rate-in-retirement, “the greatest economic scholar of the first-half of the 20th century, Professor Irving Fisher, was born in 1867 and served as a professor of economics at Yale University during the years 1900 to 1935. Fisher’s Optimal Retirement Plan - If you haven’t heard of the infamous 4% rule of retirement income planning, it’s probably for the better. Most economists do not take kindly to this rule and the source of their discomfort can be traced directly to Irving Fisher’s ideas about lifecycle consumption smoothing. Fisher’s philosophy was that there was no universal spending or consumption rate and that everyone should pick a number that would best smooth their consumption. It does not have to be fixed or flat over time, and really depends on your personal preferences and especially your attitude towards risk.”
So about now, I imagine some are saying “my head is spinning, can you just tell me how much I need to have in my retirement account?”
From https://www.fidelity.com/viewpoints/personal-finance/8X-retirement-savings, “to simplify matters, we’ve created a rule of thumb: Save at least 8 times (X) your ending salary to help increase the odds that you won’t outlive your savings during 25 years in retirement. Fidelity suggests that you should have saved 1X your current salary by 35, then 3X by 45, and 5X by 55.”
From: http://business.time.com/2013/02/11/sizing-up-the-big-question-how-much-money-do-you-need-to-retire/#ixzz2WPfLeA2e, “the fund company T. Rowe Price advises a multiple of 12 times final pay. And another approach from Dallas Salisbury, president of the Employee Benefit Research Institute offers: You need 33 times what you expect to spend in your first year of retirement—after subtracting Social Security benefits.”
In conclusion, what I hope you will be able to take away from this article is that the answer to the initial question of “do we have enough money to retire?” is a complex matter that requires a skilled financial planner who will help you work through several inter-related assumptions as you make this evaluation.
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at
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