Do you hope to retire at some point? Is it in the next 5 years? 10 years? 20 years? longer? Now is a good time to assess if you’re going to be ready. Do you know how much money you’ll need to retire? Read on.
What retirement do you envision?
When I envision my retirement, it is definitely not sitting on a front porch working on Sudoku puzzles with a cup of coffee. I mean, I do like my Sudoku, and I do like a good cup of coffee, don’t get me wrong. However, I imagine a much more active retirement, especially since I’ll be early to mid-50s when I do so. I plan for a retirement filled with travel across the country, travel to other parts of the world, a little bit of “gig” work here and there to keep my mind sharp (done wherever I choose to be located at the moment) and loads of time spent with my family. I have always been passionate about music, singing my way through high school and college, and I jokingly tell people that I “sold my soul to get into business.” I plan to pursue my passion for music in some capacity as well.
The point is, it is important to have your vision for your retirement. Otherwise, you don’t have that clear future for which to strive. I hear people say quite often…”I’ll never be able to retire” or on the other end, I hear some say, “I never want to retire.” With both statements, I think it is more of an issue that there is not a clear picture in that person’s mind of what their retirement looks like. If you’re currently doing your passion work, I think that is great, and I applaud that you’ve found something you never want to stop doing. But, for most of us, we enjoy what we do perhaps, but there are additional chapters to be written in our lives beyond “the work” of our day jobs.
How do you know if you’re financially retirement ready? Understanding how much money you’ll need to retire.
There is this little thing called the 4% rule. It is a frequently used rule of thumb developed through the Trinity Study conducted by Trinity University in 1998.
Simply put, you add up all of your savings and investments, then multiply that by 4% (0.04). This is the amount that you can safely withdraw from those investments in your retirement every year, and the study shows that it will last 30 years. Add this 4% amount to any other income you expect in retirement, including social security, part-time work perhaps, along with any pensions you are entitled to.
Let’s break it down for someone who wants to retire at 65 with $800,000 in investments, $15k/year in part-time work and $24k/year in social security:
From investments: $800,000 X .04 = $32,000/year
From part-time work = $15,000/year
From social security = $24,000/year
TOTAL annual income = $71,000
Now, for those of us who want to retire further ahead of 65…let’s say at 55, that social security isn’t coming for a while! And some feel, it may NEVER be there. Let’s do a little reverse on the above. Let’s imagine you’ve paid off your home, you carry no debt. Your expenses are normal things like property taxes, car insurance, groceries, travel, etc. Let’s take this from the expense side and build from there.
$10,000 Housing expenses, including utilities
$8,000 Food/groceries
$6,000 Health care (Note: you need to figure a way to cover health insurance before 65! Hint, if you make less than $69k as a family of 2 in retirement, you qualify for subsidies under the Affordable Care Act)
$3,000 car/gas/transportation
$6,000 vacation
$3,000 dining out/entertainment
$6,000 miscellaneous spending
TOTAL Planned Expenses: $42,000
Now, we’re going to apply the same 4% rule, but backward, by multiplying annual expenses by 25 instead.
$42,000 X 25 = $1,050,000
How much money will you need to retire? This is basically saying, you need to have just over $1M in investments to sustain this particular lifestyle each year. THIS IS YOUR RETIREMENT NUMBER. Also, when 65 hits, many of those health care costs go away with the introduction to Medicare and additionally, social security begins to kick in as well (depending on when you choose to take it).
As you can see by this example, when one keeps their debts to $0 by age 55, their cost of living drastically reduces, and they can still enjoy vacations, dining out and so forth in an early retirement. No need to live on beans and rice and spend retirement clipping coupons. Although, I do love my coupons :). This is why I encourage people to pay down their debts sooner vs. later. It opens up all-new possibilities and helps you realize you don’t require a significant retirement income to live a very comfortable life in your non-working years.
But, how can you be sure the 4% rule will actually work?
I actually plan more conservatively using a 3% rule. This is all a matter of personal projection, but I live a vegetarian lifestyle. I am in good health overall. Who knows what the future will bring, but by planning more conservatively, I’m saying that I plan to outlive the normal life span of an average male. This helps to ensure my chances of my savings outliving me are greater. I plan to leave money to my heirs. Much of which is due to the story of my upbringing.
Additionally, through the Trinity study referenced above, the study showed in numerous scenarios that the 4% rule has a VERY high likelihood of providing at least 30 years of income. The study does base its research on a portfolio of 50% stocks and 50% bonds. This would NOT work if all of your investments were in cash, for example.
But, what about inflation in retirement?
Inflation is a real concern, especially to retirees. The 4% rule takes inflation into account. By following this rule of thumb, you withdraw 4% in the first year of retirement, then you adjust for inflation/cost-of-living each year thereafter. So, if your first year’s withdrawal is $42k, and inflation the following year is 2%, you withdraw $42k + 2% = $42,840.
Now, you shouldn’t just go into this blindly and set 4% withdrawals on autopilot year after year. You need to keep an eye on things and ensure that you adjust accordingly to the market over the years. Hence, why I choose to plan for a 3% withdrawal every year in my retirement to build a bit of a buffer in there.
What if the market tanks right after I retire?
Again, this is why I plan at more of a 3% withdrawal rate vs. a 4 or 5% one. I expect that I will have to adjust down further in certain years where the market is brutal. In my opinion, however, this fear should not hamper your retirement plans. The market goes down and it comes back. It has done this for decades, which is why I recommend that people never try to time the market. Money in the market over the course of time, regardless of when, brings you returns over time. The crash of 2008 is the moment that brought me my greatest wealth-building opportunity. I didn’t realize it at the time. I just ended up having extra money to invest due to low living expenses. One big key to early retirement is, you need to have more than one income stream. If your 4% withdrawal is your only source when you retire at 55, that probably isn’t the best plan. If, however, you have a part-time gig earning you a little bit of cash on the side, this reduces your need to withdraw a full 4% from your investments annually.
Wrapping things up
Figure out YOUR NUMBER and make a plan to achieve it in the timeframe you wish to do so. I read lots of articles, and I believe the financial services industry largely keeps people in fear of retirement. Headlines like “Will inflation be the death of your retirement?” are regular occurrences. I’ll cover why I don’t use a financial advisor in another post. I happen to believe that an early retirement is achievable even though you think it might not be. I challenge each and every one of you to determine what you really need in retirement, add a little to it as a buffer, and make a plan to get to your “number” so that you can live your best life.
Until next time,
Jason