How Much Do I Need to Retire?
Posted: April, 2008
While sitting in your boat, fishing, and contemplating retirement, you may find the concepts of formulas, life expectancy, rapidly rising medical costs and asset investment to be very overwhelming and stressful. Suzy Orman keeps telling you to diversify, but that is only the tip of the iceberg. With a limited amount of time left to prepare, what are you to do? Relax and keep fishing; it is not quite so daunting.
The first step is probably the most difficult, though straightforward. That is, where is your life going? Do you see yourself active with a part time job, or living in Florida in a condo? To some extent, this question gnaws at the very essence of who you are. The only restrictions are that you will have to live within your means, which gets to the next part of the question. How much income do you need per year? This means you need to estimate all costs in your retired life. Will you still have a mortgage? You must budget for health insurance, heating, the car, gas, clothes, gear, food, vacation and anything else that you would spend money on. Try to come up with a yearly amount in current dollars. Ignore inflation for now; we will deal with that later.
Once you have some idea as to your needs (a range is fine) in your ideal retirement, try to estimate your retirement income. The government sends out a statement on your Social Security, so begin there. Do you have a fixed payment on a pension from work? Add up these retirement sources. Now you can compare what your needs are with what you anticipate in sources of income. Is there a shortfall? Let’s look at that.
Do you have your own IRA? You can take out of that IRA a fixed amount per year starting at age 59 ½ without penalty with a required minimum amount once you are 71. Do you own any securities in a taxable account? Add these up and take four percent of the total. Now where do you stand? If you are still short, multiple the shortfall by twenty five. That is how much you need in additional savings.
Example: Yearly Basis
Income or Sources
Pension Payment: $ 12,000
Social Security 14,000
Social Security (Spouse) 8,000
IRA (4% withdrawal rate) 8,000
Securities (4% withdrawal rate) 8,000
Total $ 61,000
Rent or Mortgage $ 21,000
Heat, Transportation (Gas) 6,000
Car and Home Maintenance 5,000
Medical (including insurance) 10,000
Vacation, Entertainment, etc. 7,000
Total $ 66,000
Shortfall $ 5,000
X25 = $ 125,000
The $5,000 shortfall requires that this person saves another $125,000. Four percent of that amount equals the needed $5,000. Now what is so magical about the four percent? Studies have shown that it is an amount you can withdraw per year with a strong probability of having your money grow at the inflation rate and perhaps more. This means that over time you should be able to increase your distributions by at least the inflation rate. This necessitates owning stocks to some extent. A balanced account of sixty percent stocks and forty percent bonds works well. The key is to generate the four percent in current income so that during market declines you are not forced to sell securities to make the distribution. Assuming bonds don’t default and dividends aren’t cut, you should be fine.
This plan also has appeal in that you are not forced to pick your “death date” because you have run out of money. It is important to understand that a large percentage of our population will live much longer than they anticipate. Thirty years from now it will be common to see people reach 110. You’ll run marathons at 70 and play tennis until 90. Picking the death date is never wise. Living off of four percent can go on forever.
The obvious question is how to generate four percent income yield safely. This calls for proper and creative portfolio management which is a subject for another day.