The good news is that we are living longer! The bad news is that we are living longer!
The average life expectancy when Social Security was first adopted was dramatically lower than it is today. With healthier lifestyles and medical advancements, we can expect to live into our 90s. In fact, 100 may be the new 80.
Let’s look at what we need to think about when it comes to spending in our retirement years.
There have been various theories as to how much you withdraw and how you prepare for these years.
Before we discuss the strategies, let’s talk about preliminary retirement planning. Aside from working as long as possible and investing the maximum amount during your working years, you need to think about a few key factors when you retire.
First, try to calculate your retirement expenses reasonably. It is suggested that you anticipate spending 70-100% of your current expenditures. There are some expenses that will decrease right away—most notably your retirement savings and your payroll taxes. However, you are going to exchange some of those expenditures for others such as travel and health care.
Second, although assets garner much of the retirement planning attention, your liabilities are just as important. Your retirement expense figure depends on if you will have any debt or are thinking about additional debt, such as a second house.
Third, inflation is always with us. Although inflation has been relatively flat over the past several years, the average inflation rate has been 3.24% since 1913. At that rate, prices double every 22 years.
With the market volatility of the past several years, it is easy to think that you should invest only in fixed income investments. However, that investment strategy will not likely serve you well for your retirement years.
Many advisors recommend “compartmentalizing” your retirement funds into two to four buckets.
- The first bucket is an amount that you would need to fund your retirement living expenses for one to two years and is invested in short-term cash reserves.
- The second bucket holds your income-generating investments.
- The third bucket holds your equities and has the potential for the greatest volatility.
- The final bucket is your “fun bucket” to be used for trips and other luxuries. It is also the bucket you have the greatest flexibility to reduce if the market gets tough.
Now that we have conceptually divided our retirement funds, let’s discuss how much we can take out annually. The rule of thumb is to withdraw 4% or less of the market value. There have been articles which encourage you to take 5 to 6% while you are healthy and active and reduce it later. However, aiming for the 4% figure is probably the more sensible and conservative choice.
In order to use a 4% withdrawal figure, your total investment portfolio will need to contain equities. You need that growth component. In this low interest rate environment, you cannot rely on fixed income to generate enough to cover expenses and inflation.
Having established the percentage, you have to review that figure with actual numbers for annual living expenses. In other words, if you need $60,000 per year for retirement expenses, subtract what you will receive from Social Security (www.ssa.gov). If you are going to receive any pension from your employer (which is fairly unusual these days), you have your net figure or what needs to be funded from your savings and retirement assets. For example, if you will receive $27,000 from Social Security, then you will need $33,000 of annual inflation-adjusted distributions from retirement savings.
At age 66, how much would you need to have in savings to generate $33,000? You will need somewhere between $660,000 and $825,000. A distribution of 5% from $660,000 generates $33,000, while a 4% distribution from $825,000 generates $33,000.
You may think that this amount of savings may be high; however, remember that you will be withdrawing from your retirement account on a total return basis. In other words, the $33,000 will be generated by both income (interest and dividends) and some actual liquidation of principal. That is why you need the growth component.
If you will not have that much saved by age 66, do not panic. Estimate the amount you will have saved and multiply it by 4% to get an idea of your possible distribution amount. This will at least provide you with a ballpark figure for your retirement planning.
It is never too late to review your retirement plan, whether you are approaching retirement or are already in retirement. With a comprehensive analysis, you can reduce your trepidation and look forward to those golden years. What are your plans for retirement? Are you on track to enjoy your golden years on your terms? Share your goals with us in the comments below.
For additional information and tools on retirement planning, please visit our Financial Resource Center at hillsbankwealthmanagement.com.Investment products are not a deposit, not FDIC insured, not insured by any federal government agency, carry no bank guarantee, and may go down in value.