Articles | The Weekly Acorn
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Retirement Readiness:
The Final Chapter
In prior Acorns, we touched on diverse retirement readiness topics ranging from the practical to the psychological, but now it's time to focus on THE BIG QUESTION, the giant elephant in the retirement preparation room. And that is, "CAN YOU AFFORD TO RETIRE?" The answer for almost everyone is (drum roll, please) YES, YOU CAN...with one caveat. The caveat? You must resign yourself to a lifestyle dictated not by your wants, or even your needs, but by your resources.
And what are those resources? They vary for everyone, of course, but broadly speaking they are your:
- Financial assets including IRAs, 401(k)s, 403(b)s, annuities, trust funds, bank and brokerage accounts, etc.
- Non financial assets which may include primary and vacation residences, other real estate, and valuable personal property such as collectibles.
- Private and government pensions including social security.
- Finally, and maybe most importantly, your resources also include your ability to acquire any and all of the above through work or investing acumen.
So the question isn't really "Can I afford to retire?", but "Can I afford to retire when I planned to and enjoy the retirement lifestyle that I had counted on?" That's the $64,000 question and it has as many different answers as there are people. Just as no two families are exactly alike, neither are their retirement needs.
That said, there are some rules of thumb to help with the calculations. First, start with current income. Most people need about 85% of current income in retirement to maintain their current lifestyle. Current lifestyle can be maintained even with a lower income because some expenditures will be reduced or go away completely. For example, social security taxes and income taxes should be reduced - social security tax because that tax applies to wages or self-employment income only (which you will have less of), and income taxes because much of retirement cash flow will come from money that has already been taxed. Of course, once in retirement, the need to save for it should go away, and those dollars are then freed up for consumption. Finally, debt service should be significantly lower. It is risky to attempt to retire with a significant debt burden, and we don't normally recommend it.
Some folks are tempted to calculate their future spending needs by determining what their current expenses are and then deciding what they can do without. That only works if they have detailed records of everything that they've spent over the past several years, but not many people that we know of are that meticulous. Invariably, they tend to under count their total spending by conveniently forgetting the little things like the daily "Aroma Joe's" caffeine fix or the big one-offs like Caribbean vacations or expensive weekend getaways. We aren't saying that those things are bad. They're definitely not, because they add to the enjoyment of life. It's just that they rarely get counted in a budget. That's why we like to look at current income rather than self-reported expenses as a benchmark for retirement income needs.
Another big question in preparing for retirement is determining how much of your savings you can safely withdraw in any given year. That is certainly not an academic question, and planners have differing opinions on a specific number or a specific percentage. There are a quite a few variables that go into the calculation, but the most significant one is age. The older you are, the more you can safely withdraw, because (theoretically anyway) the money doesn't have to last as long.
That said, most planners can agree that a 4% initial withdrawal rate is "safe", meaning that (almost) regardless of how well or poorly the market does, or how long you live, you are unlikely to run out of money. The 4% figure is a rule of thumb that applies to the first year of retirement for age 60-something retirees.
A 4% withdrawal rate may seem low in light of the 8%-9% average long term investment returns of a portfolio made up of stocks and bonds. However, as we've all come to know, those annual investment returns can vary greatly, and a low withdrawal rate is needed as a buffer against bad years.
Another reason to lowball the withdrawal rate is inflation - public enemy number one for retirees living on a fixed income. It can be devastating to their purchasing power even when the annual rates are relatively mild. For example, at 4% inflation (the long term average), the cost of living will increase almost 50% in just 10 years. That means that the amount you withdrew in that first retirement year needs to have increased 50% by the 10th year just to keep your standard of living from sliding backwards. In retirement, you don't need a steady income. Instead, you need one that is steadily increasing.
So, can you afford to retire? Hopefully, this has given you some ideas. If you're not sure, let us help you try to figure it all out. We have the tools, the experience, the expertise, and most important of all, the desire to see you succeed.
