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Tips for a Worry-Free Retirement4
The thought of retirement can be complex when the economy is in flux.
Most of us have been trained by the traditional financial industry to stay in one lane – to grow a nest egg for retirement primarily by various investments in the stock and bond market. We have been trained to invest in Wall Street. In fact, we have had it drilled into our heads that ‘invest’ means ‘invest in the stock market.’
Another unfortunate confusion that we are conditioned to ignore is to use ‘savings’ and ‘investments’ inter-changeably. For instance, many people who meet for financial guidance point to their retirement account when they are asked to identify their monthly savings. However, savings is different from investing. Money in savings should be in a ‘bucket’ that is safe, accessible, and immune to loss.
Investing, on the other hand, introduces risk. There is virtually no risk when you put money into a savings account. There is substantial risk when you put your money in the stock market. As many Americans learned, unfortunately, within a 2 week period in March of 2020, their stock market investments could lose 30% of their value – just like that.
So what would be wise counsel for what you want your money and wealth to do in retirement? If you read surveys and studies of people who are IN RETIREMENT NO W they would tell you that their greatest fear is not death or disease – their greatest fear is running out of money. When someone in retirement runs out of money they are exposed – vulnerable to poverty. They have to turn to family, even their own children, for help. Many of them become totally dependent on family help and government programs.
No one ever planned for this kind of retirement – but it is because they did not have a good plan that they arrived at that destination. So we should resolve that whatever future retirement looks like for you and your loved ones, the one agreed upon goal is that your money will outlive you; that you will not run out of money while you and your spouse/partner are still alive.
As we approach the four fundamental questions that will help you create a wealthy retirement where your money will not run out, it can be helpful to understand the basics of how to calculate your retirement income. Because your future in retirement will be effected by how you plan today (by the way, most people need to plan on retirement lasting a good 30 years!), guesswork is not appropriate. You would not guess which flight to take on vacation, so why would you guess on what you need to retire on? We need hard and fast numbers.
What needs to be factored into our calculations? Most traditional advisors recommend planning on living on 90% or less than you currently live on. Living on less in retirement is no one’s dream. Living on less in retirement is something people have to do because they did not plan well. People want to travel more, buy nice things and live every weekday like a weekend. You can’t do that on less. So we will not follow this ‘traditional’ approach. We will at least plan on retiring at our current standard of living.
1WHAT RATE OF RETURN DOES YOU WEALTH HAVE TO EARN?
Your money has to grow if you are going to be able to live off of it or it’s interest for the 30 or so years you are in retirement. Most people should aim to have enough money in their ‘retirement bucket’ to live at their current standard of living being CERTAIN their money won’t run out (I think you should aim at retiring wealthy, above your current lifestyle).
So let’s say you are living on $150,000/year right now. if you are saving $20,000/year for the next 20 years and your average interest rate is 5% compounded (assuming you don’t touch it or interrupt the compounding) you will have $744,450. This will not be enough for you to live on for 30 years. If you got 14% you would have $2.3 million. Assuming this money continued to grow at a conservative rate of 3% this would still not be enough to create $150,000/year to live on.
So what rate of return would this person have to have? 16%
Scenario 1
Would it be reasonable to expect a rate of return this high without any losses for an entire 20 years?“ ”
Of course not!In addition to that you would actually need TWICE THE AMOUNT of income since inflation will reduce your buying power by 50% every 20 years.
So what rate of return does you current wealth need to earn for you to have a wealthy retirement?
2HOW MUCH DO YOU HAVE TO SAVE EVERY YEAR?
So the SECOND QUESTION you need to answer in order to have a wealthy retirement is
“How much do you need to save every year in order to retire so that you are certain that you will not run out of money?”
The biggest fear of people retiring right now is not death, but that they will outlive their money – that they will run out of money. So when you see your paycheck, what percentage of that needs to GO TO GROW FOR YOUR RETIREMENT? 10%? 30%? 50%?
If you are like me you might be thinking ‘oh no, David, all of my paycheck goes to living expenses. I can’t spare any for a future nestegg.’ If you are not putting aside money for the future then your future will be very difficult and painful. It may be time to radically reduce your expenses (sell you car, downsize your house) or significantly increase your income (get a second job, invest in real estate on the side).
Let’s say you are living on $150,000/year. If you want to retire in 20 years and be able to have $150,000/year (in today’s dollars, in other words, adjusted for inflation) to live on for 30 years of retirement you will have to save almost $100,000 a year at 8% growth.
Would you be able to reduce you lifestyle in order to live on 20% of your income? Most would not.
Scenario 2
Can you expect a growth rate of more than 8% every year on average? “ ”
That may be risky.Can you live on less in retirement? Or will you have to work a decade more than you hoped to have the lifestyle you want?
How much do you need to save every year?
3HOW LONG WILL YOU HAVE TO WORK?
When will you retire? ---- or put another way ----
HOW LONG WILL YOU HAVE TO WORK in order to retire at you current lifestyle being certain your money will not run out?
So if you keep living like you are living and saving like you are saving when can you retire at your current lifestyle?
Let’s take the example of the family making $150,000/year and saving $20,000 for retirement averaging 8% growth. They want to retire at their current standard of living in 20 years and expect to enjoy retirement for 30 years. If they started by saving $40,000 per year for 20 years they would only have the equivalent of about $55,000/year in today’s dollars.
They would have to work and save an additional 10 years to have the income they want, leaving them only 20 years to enjoy it.
Scenario 3
Is it realistic to get 8% every year? Is it realistic for a family like this to fund their retirement at a bit over 26% of their income? Could they settle to live on less?
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Numbers don’t lie.Use this calculator to find out how long you have to work before you can retire. https://bit.ly/2zzcSJq
4HOW MUCH WILL YOU HAVE TO REDUCE YOUR LIFESTYLE?
This week we have been considering the numbers involved in how you can retire wealthy, or at least at the same lifestyle you enjoy today.
To keep your current standard of living requires you to play with 3 numbers: your annual rate of return on retirement savings, how mucy you are saving annually for retirement and how many years will you keep working and saving before you can hang up the cleats.
An alternative to ONLY using these numbers is lowering your expectation. Perhaps you were too ambitious to hope to retire at your lifestyle level (you weren’t by the way, you should hope and plan for a wealthy retirement!). So lower your number, settle for less. This, by the way, is what most traditional financial advisors tell their client to do – ‘live on less and you will be fine?’
Back to our earlier example of the family making $150,000 and saving $20,000 for retirement at an average of 8% growth. If they save for 20 years and plan for 30 years in retirement they will have about $28,000 annually to live on (this is adjusted for inflation which cuts their savings dollars’ buying power in half every 20 year). YIKES! That’s scary. Let’s say they work an additional 10 years.
Now they have almost $173,000 to live on per year for 20 years – this is equal to about $86,500 in today’s dollars.
Scenario 4
So will you save more, increase your rate of return, work longer or reduce your expectations? Or will you play with all 4 numbers?
“”
TWO ROADBLOCKS TO A WEALTHY RETIREMENT
Your plan for a wealthy retirement can be specific and clear, but if you forget to plan your route around the 2 roadblocks of inflation and taxation your trip can be delayed or undone.
InflationROADBLOCK 1
Your money will buy less each year. In fact, inflation cuts the value of your dollar in half every 20 years. Retiring on $200,000 per year may sound extravagant to some. However, if you are making $100,000 per year now and plan to retire in 20 years, that $200,000 will buy you the lifestyle that the $100,000 today buys you. It would be a critical error to not plan for inflation into our calculations.
TaxationROADBLOCK 2
Taxes are the biggest overall expense of your life. Most Americans invest most of their retirement dollars inside tax-deferred plans like 401Ks, IRAs, 403b’s and more. If you ask someone ‘how much is in your retirement account’ they might say ‘$500,000.’ And then if you ask them ‘how much of that is yours?’ most will look at you a bit odd and say ‘it’s all mine.’
This is a fatal financial mistake. In these tax-deferred plans, the government is your ‘business partner’ - a partner that expects to get their share of your retirement when you retire. Your retirement account is growing for your future expenses and for the government’s future tax revenues you see? It is not all yours.
So the person who has $500,000 in their 401K comes to retirement. Most of her life she has been taxed at 30%. She is expecting the same tax rate in retirement. This would mean that 30% of her $500,000 will not be there for her to live on – $150,000 of it or more will go to taxes.
Unfortunately, all economists agree that tax rates will go up. If this happens and at retirement this same lady finds out that her tax rate is going to be 40% now she only has $300,000 to live on. Do you think that would effect her lifestyle? Absolutely. So we have to factor in taxes, and more importantly rising taxes into our calculations.
It can be overwhelming thinking about rates of return, inflation, taxation, savings rates and more when planning your retirement. Even so, if you fail to plan you plan to fail. We at Drive Planning would love to help get you off to a good start.
MESSAGE ME for a free one one one consultation to figure out what it will take for you to arrive safely in a wealthy retirement.
