There is a lot written these days about retirement. Regardless of how you define it, how do you know you’re ready for retirement? Are there financial formulas that need to be satisfied? Is it age based? Is it a lifestyle question? Do you need to have all of the answers before you retire? I’ll address some of these questions in this post and bring up other things you may not have considered.
Many in the personal finance blogosphere write about early retirement. The FIRE (financial independent / retire early) bloggers have brought the concept of early retirement to the mainstream. These bloggers are primarily Millennials. For them, financial independence means savings 50% to 70% of their income each year. Most try to max out contributions to their company's retirement plan. They are frugal, some to the point of minimalism. Virtually all spend less than they make. Many try to develop “side hustles” to diversify their income with the hope of earning enough to replace their corporate salaries.
The idea is to bring themselves to financial independence to have the freedom to work at whatever they choose to do. The idea is to stop working for money and let your money work for you.
It's hard to argue with any of these ideas. I've written about the FIRE community and their views on retirement. I've also written about my changing perspective toward Millennials. At times, I have a love-hate relationship with them. For the most part, the bloggers I know are a hard-working, well-educated group trying to stay out of debt and achieve financial independence at an earlier age than we Boomers. However, they speak as if they represent the majority of the population. That's just not the case. Most people don't live this way.
No one can define whether you’re ready for retirement except you. You are unique. Everyone's situation is different. Let's start with that.
I'll show you the things I think are essential in determining how to achieve the retirement you want, no matter how you define it or when you start.
The Employee Benefit Research Institute's (EBRI) publishes a Retirement Confidence Survey (RCS) every year. The 2018 confidence survey showed that less than 17% of working Americans reported that they are confident they can live comfortably in retirement. Another 47% said they felt somewhat confident they have saved money for retirement. The survey also said, “Retirees remain more confident than workers, with a third (32%) very confident and another 44% somewhat confident that they will have enough money to live comfortably throughout retirement.”
The survey showed that four out of five workers are interested in having more guaranteed lifetime income options in retirement. Most plan on taking their money out of their company's retirement plans and moving it into investments that offer a guaranteed lifetime income. Just under half of the workers (48%) surveyed expressed interest in the ability to purchase products within their company's plan that offer a guaranteed payout at a certain age.
They're looking for longevity insurance to provide income security if they live longer than expected. Qualified Longevity Annuity Contracts (QLAC) offer employees the ability to have up to 25% of their plan balances or $130,000 in QLACs.
Your retirement goal determines your retirement savings need. In other words, you should begin with the end in mind. At what age do you want to retire. What kind of lifestyle do you want? Where do you want to live? Will you ultimately retire or work part-time to stay active? What type of income would make you feel secure? How long does that income need to last?
Notice that the income need is last on the list. What you value, the things that are most important to you in life, are critical to your having the discipline to stick with a savings plan. If your goal is to accumulate an amount of money, it will be easy to get off track. There will always be other, more critical things on which to spend money. However, if the things you value are foundational to your retirement goal, it will be much easier to stick with your plan.
The most important thing you can do to assure a successful retirement is to save money. Most of us will not have a pension income. Various reports on pensions say that only 14% – 16% of private companies still offer a pension these days. That means our retirement planning, saving, and investing are up to us. Most companies with defined contribution plans (401(k), 403(b)) offer matching contributions to help.
Matching contributions mean the company will contribute a percentage of the amount you put into your plans as a match. A typical matching formula might be 100% of your contribution up to 3% total. Another way to come up with the same number is to match 50% up to 6% of your contribution. That's free money. That's a GUARANTEED RETURN of 100% on your investment up to the matching amount. The matching percentage should be your absolute minimum contribution.
Aggressive retirement savers contribute the maximum amount allowable under the current rules. In 2019, that means contributing $19,000 pre-tax. If you're age 50 or older, you can put in another $6,000 as a catch-up contribution bringing the total to $26,000. Of course, most people aren't in a position to contribute the maximum amount. The point is to maximize your contributions.
I hate this term. Fidelity funds had a series of commercials with a green line following those working toward retirement. The green line was their road to follow until they reached their number. Presumably, that number is the amount needed to provide income for a secure retirement. It's a gross oversimplification. There are numerous factors to consider in determining that number.
For example, what other sources of income (pension income, inheritances, Social Security, work, etc.) are available? What will your monthly expenses be in retirement? Will your mortgage be paid off? Will you engage in geographical arbitrage (don't you love these terms?). That simply means moving from a higher cost of living area to a lower cost of living area. You'll need less money for housing, food, transportation, etc. living in a lower cost of living area.
FIRE bloggers of advocate having 25 times (25X) your monthly expenses in investments (taxable, IRAs, etc.). They use the 4% rule as a proxy. That rule says drawing 4% of your investments each year (inflation adjusted) for thirty years allows you to live comfortably without depleting principal. It's based on the work of William Bengen, who published his original paper in 1994. The Trinity Study updated the work in 1998.
The two most significant factors in retirement planning are savings and expenses. The 25X method is a good starting point and will help guide the savings and investing strategies. There are nuances and life circumstances that can change the dynamic pretty quickly. Reducing expenses means you need less money using the 4% formula.
Having multiple sources of income and investments during retirement will go a long way to alleviating the risk of the 4% rule.
Many company retirement plans come with resources to help you with the amount you need to save. If you do not take advantage of those resources, it will be hard to reach your stated retirement goal. Talk with your plan representative to see what options they offer. Retirement calculators range from the very simple to the very complex. These calculators are relatively easy to use and allow you to anticipate better savings, returns, and other variables needed to calculate your retirement needs.
Simple calculators ask you to provide necessary information (including current age, desired retirement age, ongoing total savings, desired income, the rate of return on investments). Then the program calculates an estimate of how much you will accumulate by the desired retirement age. These calculators often assume a fixed rate of return and savings for the duration until retirement. Return estimates that are too high or low produce lump sums at retirement that are unrealistically high or low.
CalcXML calculators offer many calculators. The how much will I need to save for retirement calculator will provide a baseline to get you started. Click on their menu to find other useful calculators to help.
Many advisors recommend calculators that use return assumptions based on market data for the asset classes available in the plan. Rather than come up with a lump sum number, the better calculators express retirement readiness as a probability of success. The calculators run hundreds of sample accumulation scenarios to come up with this measurement.
Most of these tools recommend that to achieve success; the results should range from 75 percent to 90 percent probability of success. Retirement planning is not an exact science. Calculators that present success as a probability provides a much more realistic picture of success.
Once you have determined the amount you need to save, you must decide how to invest the savings. If you use the right retirement planning tool based on the probability of success, you will receive a report with a recommended portfolio allocation. That allocation defines your need to take the risk. That, in turn, must align with your willingness and ability to manage that level of risk. If it does not, your plan will likely fail.
In investing, risk and expected return are related. Money invested in stocks has a higher your expected return than money in bonds or cash. Higher expected returns bring higher expected risk. If you're looking for double-digit gains, expect the same double-digit drops in value when the market goes down.
Let’s assume the plan’s recommended allocation shows you may be subject to a 30 percent drop in portfolio value during the planning period. If seeing this drop causes you to panic and sell your stock funds, you are taking more risk than you should. To be successful, you must be able to stay invested in good and bad markets.
If the thought of a 30 percent portfolio drop causes your stomach to become queasy, you are taking too much risk.
Planning for retirement is about much more than money. People who retire without thinking about how they will spend their time often have trouble. I've had experience with clients and in my family that validates this statement.
My stepfather, Bob, taught pulmonary medicine at Indiana University. He loved what he did and probably would have done it longer than he did. Circumstances (some health issues and my mother's urging him to retire) pushed him into retirement before he was ready. Though my mother had plans of her own for him, he hadn't thought about what he would do with his time. The adjustment of going from a high level, highly engaged professional position to nothing proved too much for Bob. As a result, he became depressed and had a challenging first few years of retirement. His depression and unhappiness put a strain on their marriage.
Fortunately, in time things worked out. He took up painting and found it was something he enjoyed. He became pretty good at it. They began to travel more and spend more time doing the things my mother hoped they would do. After several years, they enjoyed the kind of retirement they had planned. But it could have easily gone the other direction.
Of course, we have to have the money or income to retire at any age. There are a variety of ways to determine what our “number” needs to be. I hope after reading my thoughts you understand there is more to planning retirement than hitting a number. It takes discipline to manage your spending, saving and investing. Automating the process is a great way to stay on track. Discipline matters less when the process is automated.
Lining up your plan with what you value in life is another way to keep you on track. If you're retirement lifestyle lines up with your values, your chances of success are much higher. Chasing an arbitrary number, whether with the 25X method or something else, will lose importance if it isn't matched to those values. Knowing your “why” increases the odds of success.
Be flexible in your planning. Life happens along the journey to retirement that can trip us up. Having a sufficient emergency cash reserve reduces the stress of those unexpected events. If we have to borrow or sell investments to take care of them, it can throw us off track. Be conservative in your return assumptions. Save more than the plan says you need. Spend less than you're currently spending.
The road to financial independence and retirement can be as long or short as you want to make it. The sooner you start, the easier it will be to get there. Ignore the advertisements that try to convince you that you need the newest shiny object. Be frugal, but not cheap. Invest wisely and for the long-term. Get help if you need it.
Most of all, enjoy the journey.
Now it's your turn. Are you on the road to retirement? Are you already retired? What are the keys to your success (or lack thereof)? I'd love to hear from you.
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