You have heard it time and time again. We are living longer thanks to medical advancement and seniors’ healthier and more active lifestyles. We are living so long, in fact, that our health care system desperately cries out for an updated work-out regiment.
How can you ensure that you won’t outlive your assets? Gone are the days of companies paternalistically protecting us with pension plans in retirement that complement social security benefits. Speaking of which…what about social security? Will that particular “ponzi scheme” hold up for most of us? And now that employer 401k plans, which became “201k” plans earlier in the year, have morphed only back into “301k” plans over the last few months, retirement funds may not be on track to get us to our golden years.
How much is enough for our retirement? I like to think of planning for retirement in three basic steps. These steps are for those who are still earning money and not yet financially retired. (I will address retirement for seniors who no longer work in another column.) I call these steps the big E’s: Enlighten, Evaluate, and Energize.
You should enlighten yourself about your current (and future) income and expenses. It may sound simple to some and boring to others, but you should know your individual or family cash-flow statement intimately. Only when you do, can you estimate how it may change in retirement. It’s a dynamic exercise, the numbers can change as often as necessary. But without a beginning there’s no way you can plan for change in the future. Once you know how much your life costs you each month and year then can you begin to have real control over your future.
Let’s pretend that currently you spend $75,000 a year and you are not planning on retiring for another ten years. In ten years you will be 65 years old and assume you will live for another 35 years. In 10 years, at a 3 percent average annual inflation rate, that $75,000 needs to be $101,000. But don’t fret, because by enlightening yourself you may have determined that though you spend $75,000 a year today, in retirement you will only need $50,000. Perhaps your home mortgage will be paid off, or you will no longer have to support your children, or maybe your Aunt Tilly named you a beneficiary of her sizable IRA. With inflation, that $50,000 needs to be $67,000 when you retire in ten years in this example. But before you move on to the second step, to evaluate, remember that the $67,000 may be subsidized by social security, a company pension plan, or an annuity. Just subtract the expected annual receipts from social security, pension, or annuity from the total amount you expect to need from your investments (your investments include both your retirement and non-retirement accounts). For example, if you expect to receive $2,000 each month, or $24,000 per year, from social security when you retire, then you should plan to withdraw $43,000 a year from your investments ($67,000 less $24,000). Next, it’s time to evaluate how much you will need in the pot to generate $43,000 of cash flow from your investments each year throughout your retirement.
The evaluate step may be especially difficult for many people. A knowledgeable friend or a trusted investment advisor or financial planner can help you calculate this. The evaluation involves determining how much money you will need in your retirement pot on day number one of retirement to ensure that you won’t outlive your annual need for, in our example, $43,000 each year throughout your retirement years. Assumptions must be made with regards to the investment returns you will earn through the years, how long you will live, and how much money you want to leave to your heirs, if any. In our example, assuming a 7 percent average annual return on your investments, your need for $43,000 for the 35 years in retirement puts your magic retirement number at $867,000.The final step is learning how to energize, or add to, your current asset base to get to that necessary lump sum for retirement.
Now that you have an idea as to how much you will need in the retirement pot on day one of retirement, you then need to make it happen! For many, this is the truly hard part. It’s a reality check. It may be impossible to get to the magic number given your current lifestyle. This is vital information indeed. It can encourage you to make dramatic lifestyle changes now for the benefit of your future. To reiterate, our example says that in ten years you will be 65 years old and will live for another 35 years. Assuming a 7 percent average annual return on your investments, your need for $43,000 for those 35 years puts your magic retirement number at $867,000. That means if you don’t already have that much money in your investment accounts, you need a plan to work towards getting it over the next ten years. How much you need to invest each year to get there depends on how much your asset base is now and how many years of earning power you have to contribute to your investments. For example, if you already have assets worth $200,000 you will need to invest much less each year than if you have $300,000 already built up. Similarly, if you have fifteen years of earning power ahead of you instead of ten, you will need to put away less money.
You are in charge
If all of this sounds complex and scary then you probably should talk to someone you trust, a friend, family member, or investment professional, who is comfortable with numbers and spreadsheet calculations. Every individual will have their own unique situation with a multitude of details to consider. Also, different assumptions about investment return percentages, number of years until retirement, and number of years in retirement may be used for different people. For each and every one of you, a little enlightenment that is evaluated and then energized can go a long way towards making you feel in control of you money and your life.