It is the most critical question on most people’s minds; yet, because there are so many
variables, it is one of the most difficult to answer with any degree of certainty. Considering that
saving for retirement is still a relatively new concept, even financial planners are still trying to
figure things out. For much of the last century, most people worked until they died. We have
also seen the demise of guaranteed pension plans, which has shifted the burden of providing
for a secure retirement squarely on the shoulders of individuals. With many variables at play,
it’s essential to ask yourself this question and answer it as accurately as possible to establish a
clear target.
It Starts with Knowing Your Spending Needs
Several formulas can be used to determine how much you will need to live comfortably in
retirement, but they are all premised on one key factor – your retirement expenses. Knowing
how much money you will need to save for retirement is more straightforward when you know
how much you will be spending in retirement. If your time horizon is still a ways off, estimating
your expenses might be more difficult, but if you are within ten years, it can be a more realistic
exercise. In either case, having a clear vision of what you want your retirement to look like will
make it easier to estimate what it will cost.
The exercise involves creating a monthly budget around your expected retirement lifestyle. Of
course, it needs to account for any changes you expect to make in your finances and lifestyle
between now and then. For example, will you downsize your home or move to a less expensive
area? Will you be carrying any debt into retirement? Will you have any dependents relying on
your financial support? How will your spending change between now and retirement? The idea
is to create your retirement budget now based on your vision for retirement and adjust it as
your circumstances or goals change.
Many financial planners suggest using the 70 percent rule to form a baseline for your budget.
The rule says that, on average, retirees can expect to replace 70 to 80 percent of their income
in retirement. It assumes that some expenses will decrease, such as work-related costs
(commuting, professional fees, dining out for lunch, clothing, etc.) and housing costs. But don’t
assume you will spend less money across the board.
Other expenses may increase, such as travel and leisure. To plan more conservatively, you can
start with a higher baseline of 80 to 90 percent. Your budget number, the amount you expect to
spend each month, becomes your target because you will need to accumulate enough capital
to hit it every month for the next 25 or 30 years or more.
Next, you can subtract the income you expect from Social Security and other income sources,
such as a pension. You can use the retirement estimator at SSA.gov for a current projection of
your Social Security benefit. If you are to receive a pension benefit, your pension administrator
can provide you with an estimate of your income at retirement.
Don’t Forget Your Medical Expenses
You also have to plan for medical costs and other unexpected expenses. According to Fidelity
Benefits Consulting, a 65-year-old couple will spend $315,000 on medical expenses throughout
their retirement, which doesn’t include long-term care costs. In addition, you will need a
spending cushion or cash reserve to cover unexpected expenses. The recommended amount to
set aside in cash reserves is 12 months’ living expenses. These additional requirements should
be funded separately and added to the capital needed for your retirement income.
Work Backwards to Find Your Number
One of the more commonly used rules to calculate how big of a nest egg you need to build is
the 4 percent rule. This is the rate at which you can draw down your assets each year without
the risk of outliving your assets. The 4 percent drawdown, which should be adjusted annually
for inflation, is based on a portfolio with an asset allocation of 50 percent stocks and 50 percent
bonds.
For example, if you and your spouse receive $4,000 per month ($48,000 a year) in Social
Security benefits and need $80,000 to cover your living expenses, you must generate $32,000
from your savings. Using the 4 percent rule, you must accumulate $800,000 of capital
($32,000/.04 = $800,000).
It’s a Continuous Planning Process
The key to making the 4 percent rule work is to make minor, incremental adjustments to the
drawdown rate as circumstances dictate. You can do this by recalculating your drawdown rate
based on your portfolio value. For example, if, as a result of your withdrawals and poor
investment performance, your savings balance has declined, you could adjust by forgoing an
inflation increase or scaling back your drawdown for a year or two. Conversely, you could
increase your spending or cushion during years of robust returns. You could also plan
conservatively using a lower drawdown rate, such as 3.5 percent. It would require more capital
at retirement but also account for greater uncertainty.
Establishing Your Unique Retirement Strategy
While general rules and guidelines can provide a solid foundation, achieving a retirement that
fully aligns with your goals and circumstances requires a personalized approach. Every retiree’s
situation is unique, and understanding your individual needs, risk tolerance, and lifestyle
aspirations is crucial to creating a strategy that works for you.
If you’re ready to take the next step in planning a retirement you can feel confident about,
we’re here to help. Schedule your PersonalPath Intro Call today, and let’s explore how we can
create a tailored retirement roadmap that suits your future.
