One of the first questions pre-retirees have when they think about retiring is, “Will I have enough money to retire?”
This question tends to be one of the major reasons why pre-retirees come to professionals like us for help.
But determining whether you have enough money to retire isn’t a simple process.
To help clients know whether they have enough to retire the way they want, we take them through an in-depth analysis to see what they can and cannot do based on their wealth.
Today, we’re breaking down how we help clients discover whether they will have enough money to last them throughout their retirement so that they can enjoy their second act of life to the fullest.
Read on to learn all about it!
Determining Your Retirement Spending
While you probably more or less know what your monthly bills look like now, you can never fully know what the future will hold. That’s why we say that retirement planning is not an exact science. Instead, we look at your retirement picture by taking all the different variables that could impact your retirement into account so that you have the best possible idea of how your second act of life could look.
One of the major variables to look at is how much you will be spending in retirement.
That’s why one of the first things we do is encourage clients to figure out their current spending patterns. Why? Because when you’re calculating a retirement plan that can span over 30 (or more) years, a difference of a few thousand dollars a month or year could have a huge impact on your overall success. The more you know about how much you’re going to spend, the more accurate your retirement plan will be.
When looking at how much you’re spending, consider fixed expenses like your mortgage or insurance payments, along with other variable expenses like entertainment, eating out, and travel.
When calculating your retirement spending, you also don’t only want to only look back at your spending patterns. You should also look ahead at how you’ll want to spend your time and money during retirement. After all, retirement will give you more leisure time, which often translates into more time to spend money — especially in your early years of retirement. The more that you factor in, the better off you’re going to be when looking at the numbers to see if you have enough money to retire.
Considering Your Income Streams
Another variable to consider is how much money you’ll be bringing in during retirement.
What will your income streams be? These include fixed income streams like a pension and Social Security payments.
Also consider, when are you going to take that income stream — and how much, for how long?
After you figure out what your expenses are, you can then look at the difference between your income and expenses to see the amount you’re going to have to withdraw from your investment portfolio during your lifetime, which we like to call your net cash flow.
Other Variables to Consider
Right now, we are in a time where we’ve seen 30 years of falling interest rates. Are they going to stay low? Are they going to rise? How do you factor that into this mix for the retirement plan? These are just a few things we need to factor into your portfolio as we prepare it for your retirement.
Another factor to consider is inflation. It’s very likely that things like groceries, healthcare costs, and other things you’re spending money on are going to rise with inflation. Will you have enough money to keep up with inflation?
Here are some other questions to ask yourself when determining how much money you’ll need for retirement:
Do you need to allocate your investments for future healthcare costs?
Do you have a long-term care insurance policy?
How long are you going to live? There is a very high percentage that if a husband and wife are healthy in their sixties, that one of them is going to live into their nineties. That’s why we often use a life expectancy of 95 when planning
Where are you going to live? Will you live in a place with higher costs of living and higher taxes or a low-tax state?
Are you going to move?
Determining Your Distribution Strategy
Once you figure out your net cash flow, you can then look at how to create an investment portfolio that will fit your spending needs.
What we like to do is determine what your withdrawal rate is. This is the rate at which you need to withdraw from your portfolio. In the beginning of retirement, we often do something like a 60/40 allocation, with 60% of your investments in equities and the other 40% in bonds and cash. With this, your rate of return might be 6 or 7%, depending on the time.
We’ll also factor in what happens if you’re retired right before there’s a big drop. For example, if you retired in 2007, your retirement plan could look a whole lot different than if you retired in 2009 because there was a big drop in the stock market. By factoring something like this in, we can run the numbers to see what would happen if this were to happen with your retirement. This will give us an idea of whether you have enough money to retire so that you never run out of money.
If we run the numbers and they say that you will run out at 85, then that’s when we revisit some of your objectives and goals to figure out adjustments we can make, like working longer, saving more, or cutting your expenses. That’s when it becomes a back and forth between what you want to do and what you’re comfortable with during your retirement.
The 4% Withdrawal Rate
In the 1990s, Bill Bengen did a study back on 30-year retirement periods based upon 60/40 asset allocation to see if you will run out of money using this asset allocation.
If you had a million dollars and withdrew $40,000 a year, would that million dollars the rest of your life? According to Bill, if you invested your money and kept this allocation of 60/40, you could withdraw 4% of your money each year and will likely never run out of money. It doesn’t mean that the million dollars wouldn’t go down during that 30-year timeframe, but instead means that you would never run out of money.
However, not everyone is comfortable with putting 60% in stocks and living on the ups and downs of the stock market, especially with big swings like we’ve seen recently. So if your allocation is different, then your withdrawal rate might need to be different as well.
Budgeting for Retirement
How do you know how much you’re going to spend without going through each one of your expenses and constantly making a budget?
One thing you can do is to recreate your paycheck in retirement.
When you get a paycheck during your working years, the same amount is typically put into your bank account, which you use to pay your bills and spend on your day-to-day costs. If you have anything left over, you could then move whatever is left into your savings account.
So, if you are taking $8,000 a month from your investment portfolio into your checking account, at the end of the 12 months, we can get together and see how much of that $96,000 you spent for the year. This will allow us to see whether the amount you’re transferring from your investments each month is working well for you. If your checking account is too high at the end of the year, we will know that you’re spending less money than you’re transferring in and don’t need to take as much and can then adjust your monthly withdrawals accordingly. Or, if you’re constantly running out of money, we know we need to add more.
While these steps will give you a better idea of what you’ll need to spend in retirement — and whether you’ll have enough money to live the retirement you want — we also recognize that life changes. That’s why we revise and revisit your plan on an ongoing basis to make sure it’s reflecting where you’re at and what you need at the time.
In order to be successful, you don’t just want to create a plan one time. You want to look at it at least each year and see if anything has changed, whether it’s in your life, health, or family. The rest of the time, you can just live your life without the constant worry about money.