One of the great fears facing many retirees is if they have saved enough to retire. And by extension, once in retirement, it can be stressful to spend the money they’ve spent their entire working lives accumulating. I attribute much of the financial angst retirement to one primary issue.
Many investors have never taken the time to write down how much they anticipate spending or what their guaranteed incomes will look like in retirement. Once you’ve taken the time to establish estimates, it should be pretty easy to determine whether you’ve saved enough to retire confidently or not.
It may surprise you to know that the size of the portfolio isn’t necessarily indicative of the probability of success. I’ve seen people with really large portfolios that aren’t on track for retirement because they have become accustomed to significant spending and I’ve seen folks with smaller portfolios that spend well within their means and are on track for their philanthropic goals.
What matters is the size of the portfolio relative to the expected withdrawals. Ensuring those two items are in balance is likely to determine your preparedness for retirement.
Running the numbers can have the additional positive effects of helping you establish a realistic age to retire as well as further understand the role that various incomes play in your retirement income plan. I have attached a Retirement Budget Worksheet to save you time putting your numbers on paper so to speak.
Essential & Discretionary Spending
When it comes to establishing expense estimates, it is my belief that you should define your expenses as essential and discretionary. Essential expenses are those that you need to cover no matter what. You might call essential expenses the “need to have” expenses. Discretionary expenses are items that are “nice to have”.
How you define what is essential and what is discretionary is up to you. Invariably, there are some expenses that might fit in both categories. Let’s look at some examples.
Potential Essential Expenses:
- Mortgage payment (if applicable)
- Property taxes
- Utility bills
- Medicare & health insurance premiums
- Prescription drug costs
- Auto & Homeowner’s Insurance
- Transportation expenses
Potential Discretionary Expenses:
- Dining out
- Country club dues
- Additional vehicles
- Recreational vehicles
There are some expenses that are split between both essential and discretionary. For example, if you have a travel estimate, you might consider part to be essential (such as designated funds to go visit grandchildren) and part to be discretionary (your international trips for example). So, it’s not one or the other in all cases, but how much in each.
Now you should have an estimate of how much you need that you’ve deemed essential and how much is discretionary.
Estimating Your Retirement Income Streams
Once you’ve established your retirement expense estimates, the next step is to evaluate your income streams.
Examples of various retirement incomes streams in order of (assumed) reliability are:
- Social Security for you and your spouse
- Military or Federal pensions
- Company pensions
- Annuities with guaranteed lifetime income riders
- Rental property income
- Business income
Once you add your various incomes together, you will have a baseline for what you can expect in terms of retirement income before you even consider your portfolio. Ideally, in my opinion, your essential expenses would be covered by your various streams of income, preferably by the more reliable incomes.
Covering the Essentials
If you find that a shortfall exists between your “essential expenses” and your various income streams, you may consider evaluating an annuity with income guarantees to cover the shortfall. The idea behind this is to provide you with the reassurance that if the market falls substantially, your essential expenses are still comfortably covered.
A quick word about annuities: Annuities get a bad rap. Frankly, a lot of this is the fault of the industry. This is mainly because annuities often come with high expenses and are often sold, not bought. There are “advisors” (salespeople) that view annuities as the only way to invest (because they often pay big commissions). And then, there are advisors that think annuities are the worst thing in the world. As usual, I believe the truth is somewhere in the middle. Annuities are great if and only if they are a good fit for your personal situation. Period.
As such, the types of annuities I’m thinking of are there only to provide a lifetime of income regardless of market conditions. Assuming that is the case, it’s the same essential value as a pension. And for what it’s worth, I don’t hear too many people complain about their pension. The sole purpose behind adding an annuity with a guaranteed lifetime income is to provide peace of mind. At least with regard to clients and prospects that I meet, many are okay with giving up some potential performance for ensuring their essential expenses are met. It’s truly a personal choice.
Note: If you decide to explore the world of annuities to address your essential expenses, I’d encourage you to speak with a financial advisor that places your best interests first.
On the other side of the coin, given that thought process, one might raise the question, “Why not guarantee the entire income or place most of their assets in these types of guaranteed products?” While the peace of mind that is provided by annuities is valuable, there are plenty of drawbacks that need to be considered such as the overall cost, lack of flexibility, but most of all, most do not track inflation particularly well.
And at the end of the day, I believe that the inflation that accompanies living a long life is the most underestimated risk in retirement planning. Therefore, for many retirees, keeping the lion’s share of wealth invested in more traditional savings vehicles (IRAs, taxable accounts, etc…) will likely lead to a better long-term outcome.
So, much like everything else, balance is essential.
Covering Your Discretionary Expenses
Once you are sure your essential expenses are taken care of, you can evaluate where you stand with regard to your discretionary expenses. How much of your goal expenses are still unaccounted for on a monthly basis?
For example, let’s say that your estimated expenses are still exceeding your total incomes by $2,000 per month. If this is the case, then multiply $2,000 times 300 to identify a ballpark estimate for how large of a portfolio you might need to provide for the remaining expenses. In this case, you would need an estimated $600,000 to provide for the shortfall. ($2,000 x 300 = $600,000) - As an FYI, if this is getting too complicated for the written word, the downloadable worksheet at the end will do all of these calculations for you.
This is using a very ballpark estimate assuming a 4% first-year withdrawal rate. Note: I am not a fan of the 4% rule as there are major variables that are seemingly unaccounted for in such a simple calculation such as market volatility, taxes, and portfolio construction. I only use this as a ballpark estimate, in this case, to help identify if you’ve potentially saved enough to retire in the way that you desire.
Once you’ve done this basic math, you should have an idea of where you stand. At this point, there are two possible outcomes.
- Your incomes plus the 4% withdrawal meets or exceeds your expenses
- Congratulations, you’ve likely saved enough and have reached financial independence!
- Your incomes plus the 4% withdrawal do not meet your expenses. If this is the case, you essentially have three options.
- Work longer.
- Part-time work (i.e. consulting) in retirement.
- Reduce your planned spending in retirement.
By putting everything “on paper”, you can begin to get a sense for where you stand. Regardless of how the numbers come out, I’m hopeful that this exercise will help you make more informed decisions when it comes to your retirement.
Here again is the link to download the worksheet - Retirement Budget Worksheet.
What I’ve Been Reading:
How you answer this question will determine how well you live in retirement (cnbc.com) - “Every decision you make with regard to your retirement plan hangs on one question: How long am I going to live?”
How to “bunch” charitable contributions via a donor-advised fund to receive immediate tax benefits (cnbc.com) - “Donating to a private foundation or a donor-advised fund may enable individuals to benefit from a current-year deduction, while having the time to carefully plan out charitable distributions.”
Three common misconceptions about the upcoming Medicare annual election period (forbes.com) - “Each year these plans experience policy changes, and seniors will need to look at their policy in comparison to the policies offered in their area.”
The Psychology of Sitting in Cash (awealthofcommonsense.com) - “It turns psychological warfare in your own head because there are always going to be good reasons to wait for a better buying opportunity. When stocks go up, you tell yourself you’ll wait for a correction and when stocks fall, you tell yourself you’ll wait for them to drop just a little further.”
Dear Future Me (rpseawright.wordpress.com) - “Since I’m blessed with children who are smart, honorable and financially literate, this is a reminder to my future self simply to listen to them and to keep listening to them when they tell me I need some help.”
GM’s Cruise CEO: Honda Partnership Will Accelerate Timeline for Self-Driving Cars (cheddar.com) - “A partnership of this size between two multinational auto giants shows the importance of scale as legacy manufacturers and tech start-ups jockey for position in a field that has the potential to revolutionize huge swaths of the economy.”
Thanks for reading!
Disclaimers: Any opinions are those of Ashby Daniels and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
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Future performance cannot be guaranteed and investment yields will fluctuate with market conditions.
Variable Annuities: Any withdrawals may be subject to income taxes and, prior to age 59 1/2, a 10% federal penalty
tax may apply. Withdrawals from annuities will affect both the account value and the death benefit. The investment
return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less
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Annuities: While a contract owner may benefit from tax deferral under an IRA or other qualified plan without the
use of an annuity contract, annuities may provide additional investment and insurance or annuity benefits to
individual contract owners. The tax treatment may not be important for purchasers using the contract in connection
with certain qualified plans. A fixed annuity is a long-term, tax-deferred insurance contract designed for retirement.
It allows you to create a fixed stream of income through a process called annuitization and also provides a fixed rate
of return based on the terms of the contract. Fixed annuities have limitations. If you decide to take your money out
early, you may face fees called surrender charges. Plus, if you’re not yet 59½, you may also have to pay an additional
10% tax penalty on top of ordinary income taxes. You should also know that a fixed annuity contains guarantees and
protections that are subject to the issuing insurance company’s ability to pay for them.