How Much Do I Need To Retire?
Ryan Kolden:
Do you know how much money you need to support your lifestyle in retirement without running out of money? In the majority of time that I ask this question to people, the answer that I usually get is, I have no idea. I have no clue. Today we're going to answer the question, Do you have enough money saved for retirement? Welcome to Retirement Simplified, where we focus on making complex retirement concepts simple. I'm your host Ryan Colden. Join us as we talk about the strategies and tactics that can help you achieve your retirement goals.
Disclaimer & Disclosure: Ryan Colden is an investment advisor representative of RPG Family Wealth Advisory. Colden Wealth is a DBA of RPG Family Wealth Advisory. The opinions expressed by the host and or guests in this podcast do not necessarily reflect the opinions of Colden Wealth or RPG Family Wealth Advisory. No information on this podcast should be construed as as investment, legal, tax, or financial advice.
Ryan Kolden: Welcome back to another episode of the Retirement Simplified Podcast. I'm your host, Ryan Colden. And today we're going to answer the question, do you have enough money saved for retirement? And the answer for this question is going to be different for each person. It can only be answered according to what's going on in your life. And we're going to talk about that today. The main driver to the answer to this question is based on personal consumption, or how much you are going to spend in retirement, how much you plan to spend. And how much you spend is going to tell us how much income you need to support your spending. which ultimately tells us how big of a nest egg that you need and how much you need to save and the target return to grow your money prior to your retirement date. Now, today we're going to be going over the framework of how I evaluate whether or not somebody has enough money to retire. And this framework is really distilled into a four-step process. Step one, determine what age you want to retire at. Easy enough. Step two, determine what will retirement cost you. And we'll go over that. Step three, this one's the easiest of them all. Write down what your pre-retirement income is or what your income is today. And step four, determine what your baseline retirement income will be on day one of retirement or your first year of retirement, whichever is easiest to think about it for yourself. So the first place that I want to start today is by asking you some of the same questions that I always ask my prospective clients or my new clients during our initial consultation. The first question is, do you know how much money you need to support your lifestyle in retirement without running out of money? Another way that I might ask that same question is, do you know what rate of return your investments or your portfolio needs to support a two-person 30-year retirement? So that is a husband and a wife for about age 60 to 90, their retirement, or 65 to 95, however you want to look at it. And finally, do you know if you would be able to retire if you had another bear market like in 2000 or 2008? In the majority of time that I ask this question to people, the answer that I usually get is I have no idea, I have no clue. So to answer our question of whether or not someone has enough money to retire, we have to start with a goal, a target age we want to retire at. Because you're not going to be able to answer any of the questions that I just asked unless you first know the age at which you want to retire. So the first thing you need to figure out is when you and your husband or wife want to retire. Because a retirement plan is going to be completely different for a business owner who is working part time throughout their retirement and has a substantial amount of income coming in compared to a couple who decides that they're not going to work at all and they're going to live completely off of their retirement accounts. Again, this that we just talked about is step one. Now, step two. or the next thing that you need to determine or figure out is what retirement is going to look like for you. In other words, how much is retirement going to cost you? And this consists of two parts. The first part is pretty simple. It's just your current fixed monthly expenses, figuring that number out. And this is what you need in order to pay the bills each month. Things like property taxes, insurance, groceries, entertainment, healthcare mortgage, or rent if you have it, et cetera, et cetera, et cetera. Now the second piece is going to depend on what you want or wish to do in retirement. Do you plan on taking multiple vacations each year? How much do you want to dedicate to funding those vacations? Let me give you a quick example. Let's say that you want to take two vacations each year at $10,000 a piece. Does your retirement plan support that in addition to the income that you need to pay your bills each month? Do you need to travel to see your family at times like Thanksgiving, Christmas, the 4th of July? Now for someone who just wants to maintain their lifestyle in retirement, that retirement plan is going to be completely different than someone who wants to take multiple international trips each year. Now I've said this before or I've done this exercise before with clients but here's a simple exercise. for you to try to help you determine what your retirement is going to look like. Because a lot of people have never really thought about this before. You may have thought about it on an individual level, but maybe you've never thought about it and taken your husband or your wife's opinions into consideration. So here's an exercise for the two of you to do together. And just a real quick disclaimer, if you're listening while driving right now, do not do this. Do it at some other time. I don't want you to get in a car accident. But what I want you to do is set a timer for five minutes, then go ahead and close your eyes. I want you to imagine yourself at 90 years old reflecting on the last 30 years of your What had to happen in order for you to say that you had a successful and fulfilling retirement? Did you travel to the places on your bucket list that you've always wanted to go to? Did you buy a vacation home in the mountains like you always said you wanted to? Did you get to watch your grandkids grow up and be a part of their life? Maybe you were able to gift money to your kids or your grandkids so they could use it as a down payment on their first home. Or maybe simply you're just philanthropic minded and you were able to give a gift to an educational institution or a charity that you have a deep belief in. Now go ahead and open your eyes. When you're done with that exercise, open your eyes and write those things down. Have your husband or your wife do it as well. And when they are done, go ahead and share it with each other. Now, figure out the dollar amount that you will need to accomplish all of that. Once you have that number, you're going to need to see if your portfolio can actually support that. You know, if you can spend your portfolio to achieve that. And if not, that's okay. There's a variety of different ways that you can pay for it. The first one is really just, Hey, you've been a diligent saver. You've done well enough. The numbers work out. You're all good to go. Right? you have no issue and you're able to just use your investments, your portfolio, your retirement income to pay for something like that. The second kind of area you could be in is, hey, maybe we're close right now and all we need to do is a few couple tweaks. Maybe we just need to change the allocation of our portfolio in order to meet in certain target return to get to where we need to be. Or you could be severely behind, right? And there's a couple different options here and it's going to be individual to you, but maybe we need to work an extra year or two in order to fund our retirement and an additional year or two. Or maybe we're going to need to decrease our spending right now so we can save more over the next couple months, years, whatever it may be, right? And the final piece with all this is you have to account for inflation. So whatever number you come up with has to be adjusted for inflation. And this point is huge. So I want to take a minute to explain inflation. The Central Bank of the United States has an inflation target of about 2% to 3% each year. And what this means is that the prices of goods and services and assets should go up by about that inflation rate each year, about 2% to 3%. And growing up, I know this is not uncommon for everyone, but my grandmother actually used to really do the whole, I used to be able to buy a loaf of bread for a quarter when I was a little girl. So, she used to tell me that all the time. And she would just say it over and over and over and over. So, that's where I got my first dose of what inflation was like. But anyways, whether you like it or not, the US dollar erodes in value by about 2% to 3% a year. So, you need to learn to combat it. You could call it a feature, you could call it a bug of the US dollar, but either way, this is how the US dollar works. And you need to learn to combat it, not complain about it. And the way that we combat it is by prudently investing our savings and assets that earn a return that's higher than the long-term rate of inflation. Some people like to use 3% as that number for the long-term rate of inflation. I personally like to use 4% as my inflation benchmark because it's more conservative. And the reason that I use this rate is just in recent history from 1961 up until present, so 2024, the annual rate of inflation comes out to be 3.8%, which also includes two relatively high periods of inflation, the 70s and 80s, and our recent period post-pandemic. Now going back to our retirement goals and adjusting for them, let me give you a quick example of why we need to adjust for inflation. Let me give you some numbers. So let's say that you want to retire in 10 years from now and you want to spend $50,000 in your first year of retirement to buy an RV. That RV costs $50,000 in today's dollars. If I had $50,000 right now and I want to buy it Today, instantaneously, it's going to cost me $50,000. But in 10 years from now, it's going to cost me more because of inflation. So in today's dollars, it's $50,000. But in 10 years from now, it's going to cost more because of inflation. So let's do this quick mathematical explanation. If we assume an inflation rate is going to be 3% over the next 10 years, that same RV is really going to cost $67,000 when you want to buy it. And this isn't just true for major capital purchases, things like homes, boats, cars. It's also true for your daily living expenses, groceries. So it also affects pretty much every piece of your income, everything that you touch on a day-to-day basis. Everything that you buy is going to be more expensive in the future because of inflation. You are going to need more income in the future to support the same level of lifestyle and spending that you're living in today. So it's very important to understand the severity and magnitude of inflation, because it's counterintuitive for most people, especially people who are approaching retirement age. It's very, very, very, very common for pre-retirees and retirees to keep their money out of the market and to put it in the majority of conservative assets, things like CDs, bonds, stuff it under the proverbial mattress, so to speak, right? But unfortunately, this could be a recipe for getting beat up by inflation if it's done long enough or with enough assets, right? And again, this all comes back to knowing what rate of return you are going to need in order to number one, support your income and lifestyle in retirement. And number two, preserve your nest eggs purchasing power by investing to outplace inflation. I know I said a lot, but to summarize our second step, we need to figure out how much we're going to spend, how much we want to spend. And the way that we do that is by adding up all of our monthly bills and expenses, as well as any money required for our retirement goals and figure out how much we need an income on a monthly and annual basis to do so. The third step is to figure out what your income is today. And this step is pretty straightforward. How much do you take home before and after taxes today? Prior to retirement, go ahead and write that down. If you are already retired, you could also do this step as well. If you're trying to figure out how much can I spend without running out of money, you can also do this step. So go ahead and write that number down or think about it in your head. And the fourth step here of this four-part framework is to figure out what your baseline income is gonna be on day one or the first year in retirement. How much income will you be receiving the day that you retire? Now, the majority of people have two main sources of income in retirement. Number one, what they get from social security and what they draw from their retirement accounts. To figure out, so that's the first one is social security and the second one is what they draw from their other sources of income. That would be things like, you know, retirement accounts, rental properties, business ownership, part-time, et cetera, et cetera, right? So social security, and then basically everything else. That's what most people have for sources of retirement. Now, to figure out what your baseline income in retirement is going to be, I like to think of it in terms of two pieces. your non-portfolio income and your portfolio income. So let's break down that first piece, non-portfolio income. So non-portfolio income would include things like social security, pensions, annuities, and possibly rental income, just depends how you think about it. But basically everything outside of our retirement accounts and even including part-time work. So generally speaking, The non-portfolio income sources of retirement income are things that are gonna be dependable and that you can count on. They're independent of the stock market and they're not affected or modestly affected by market downturns. So go ahead and add up all of those sources of non-portfolio income and compare it to your expenses to figure out the baseline income that you're going to need to pull from your portfolio to pay for your bills. So let me give you an example here. Let's say that you have $8,000 in monthly expenses. But you only have $6,000 in income from social security. You also don't have any pensions and you don't have an annuity, right? Or anything like that. It's just, I have $8,000 of expenses and I have $6,000 in non-portfolio income. So $6,000 from social security. In this case, you're going to fall $2,000 short. of your expenses, right? So in this case, we have to pull $2,000 a month from our retirement accounts just to get to the point where we're covering our monthly expenses. And this is not including any other goals. We're not funding any other vacations, trips, anything like that. So now we've walked through the four steps, and this brings us back to the question of how much money do I actually need for retirement? So I want to answer this question by explaining an example of a hypothetical couple, right? So let's say that we have a couple that wants $100,000 in retirement income and that they're both 65 years old. They have a million dollars in their retirement accounts and they're retiring this year. Combined they are going to receive, again this is just an example, but they're going to receive $67,000 a year between the two of them from social security. They don't have any other sources of non-portfolio income, so no annuities, no rentals, anything like that. Now, if we take the $100,000 of income that they need, and we subtract $67,000 of that social security that they're going to get, this leaves us with a difference of $33,000 that we're going to need to make up and that we have to pull from their portfolio. Now, at this point, there's a retirement thumb rule called the 4% rule, which I strongly just want to urge you. It's just a thumb rule. It's a good starting point, but please don't rely on it. But what the thumb rule allows you to do is just make a quick and easy retirement income assumption that you can withdraw 4% of your portfolio's value each year without ever running out of money, right? Assuming that you're invested correctly. Again, that is a thumb rule. Please do not take it. for gospel. So in this case with our couple, the 4% rule states that they can withdraw $40,000 a year and they only need $33,000. So a million dollars may be enough for this couple to retire. At this point, they would need to start thinking about some other things. They would need to start fine-tuning their retirement plan and start thinking about more advanced planning concepts, things like creating a tax-efficient withdrawal strategy and possibly Roth conversions, how to mitigate the major risk of retirement, things like sequence of return risks, how to, things like estate planning and how to fund other major risks like the long-term care risk. Now, in the example I just talked about, we use the ending balance of a retirement account, multiplied it by 4%, so that was a million dollars multiplied by 4% to give us an income. That's one way to use the 4% rule. But if it helps you, you can actually think about it a completely different way to get the same money that you're going to need in retirement to get to the same answer. So let's say that you did all of the steps that we just talked about. You calculate your non-portfolio income, you calculate your expenses and your retirement goals, and that you find out you're going to need an additional $80,000 from your investment portfolio. you can take that income, so that $80,000, and divide it by .04 to get the amount of money that you are going to need in retirement, the lump sum. So in this case, if you can take that $80,000 divide it by .04, and you're gonna get $2 million. That is the nest egg that you need. So this is the same exact 4% rule, it's just mathematically expressed in a different manner. You can use either, whichever one's easiest for you and sticks best for you, helps you think about it. Neither one is right. Now, I wanna discuss some finer points. The first is how taxes play a role in your retirement income. Because everything that we just went through, all those examples, is basically a very quick and non-exact way to figure out the big picture. How much you're going to need to retire on. We can't actually talk about income without discussing tax implications. Now taxes are going to be highly variable independent on your unique situation, right? So for example, maybe your income will be that we talked about in the example is coming from an ordinary 401k or an IRA, which means that income will be treated as ordinary income for tax purposes maybe. your income is coming from something like a Roth or cash value life insurance or municipal bonds. And even in that case, that income is most likely tax-free, but not necessarily. It's all depending on all these different rules, right? Or maybe that income is actually coming from the sale of an asset, things like selling of a large property or equities or any other type of capital assets that's been held greater than 12 months. And in that case, your what you could be, your asset could be subject to long-term capital gains rate. And assuming that it's been held for greater than 12 months and qualifies, right? So just keep in mind that depending on what tax rate you fall into and how that income is taxed, you're most likely going to need more income than what we calculated in this past example or what you get from the 4% rule to compensate what you'll be paying for in taxes, right? The second thing to keep in mind is how market downturns can affect your portfolio through something called sequence of returns risk. And this can actually increase the probability of running out of money too soon in retirement if you don't address it. The first point is to understand this, and this is true all the time. It doesn't matter if you're drawing from your portfolio or not. How investment losses affect the value of your portfolio. If you lose 1% of the value of your portfolio, you only need to make back about 1% to get to where you started. Easy enough. If you lose 5%, you only need about 5% to get back to where you were. At a 10% loss, you need 11% to get back to where you started. Doesn't seem too bad, right? But after that 10% loss, the gains required become exponential to get back to where you started. So if you lost 50% of your portfolio, you would need 100% gain to get back to where you started. And by the way, if you were in the S&P 100%, in the S&P 500, This actually happened twice in the 2000s. So first was a dot-com crash, and then finally was the great financial crisis or the mortgage crisis, right? Both had downturns in the S&P 500 of about 50%. And during that timeframe, if you were 100% in the S&P 500 from around the year of 2000, 2001, it wasn't until 2013 to where you actually regained all your principal. So an entire decade lost of returns. So sequence of returns takes this concept, and it magnifies it. Because in retirement, we are actually withdrawn from our portfolio for the first time. So I want you to think of the consequence as a double negative. But in the case of sequence, this is a math joke. I'm about to expose myself as a nerd. But in the case of sequence of returns, a double negative doesn't give us a positive like it does with regular math. So let me give you an example. Let's say that your portfolio has a 7% loss in that same year. You also had to withdraw 5% to pay for your living expenses in retirement. That means your portfolio went down by 12%. You lost your 7% and then you pulled another 5%. So not only did your portfolio suffer a loss, but you also withdrew money from it. And that's just year one. What happens if you have a two or three year period of market losses where the same exact thing happens? Now, a period of a year of two or three years of losses in a row is uncommon, but it has happened. A good example of when that last happened that I can think of was 2000 through 2003, the S&P 500 declined effectively for three years in a row. And it averaged at about a loss of 15% a year for those three years. So imagine that you lose 45% plus over a three-year period, and you're withdrawing money for retirement income at the same time, you would need over 100% gain or more just to recover from that, which would almost be impossible to do while you're withdrawing income for retirement purposes. So basically, if you retire during bad market years and you're fully exposed to the stock market, your nest egg principle can dwindle so much as you're taking those withdrawals that it become incredibly, incredibly difficult to get the investment gains that you need to recover from this loss due to the fact that you're taking withdrawals or distributions, which doesn't happen for most people prior to retirement. I'm going to go ahead and cover sequence of returns in another episode, but you can protect against this by effectively bucketing your money. And there's no right way to do it. and setting aside a piece to be protected from the market or not exposed to the market. In this case, if this were to happen, or creating an all-weather style portfolio or an endowment type portfolio. Again, there's multiple different ways to do it, no correct way. And the third thing to think about are cost of living adjustments or COLA. So social security receives a cost of living adjustment each year that is normally based on the on CPI or the consumer price index, meaning your social security amount may go up each year. Now, if you're a federal or state employee and you receive a pension, most of these times these pensions are also also receive coal adjustments. It's not always the case, but they usually do. However, if you have a private pension or even an annuity pension or a company pension, Most of the time, these types of annuities or pensions, private, don't have a cost of living adjustment. It all just depends, right? Not every company or annuity company is created equal. So you just need to account for that in your plan when evaluating whether or not… So you just need to account for that in your plan when evaluating what your target rate of return will be on your investments. your portfolio can keep up with inflation and make up for those coal adjustments that you may or may not receive. The last thing to think about is your expenses in retirement. What you're going to find in retirement is that some of your expenses are going to go up. You may now be paying for things like Medicare, And some of your expenses may be going down. It's really important to track your spending each month. And a lot of people get really weird when I say that, but it doesn't have to be complicated and doesn't have to be something you fear. It doesn't have to be time consuming. With all the modern technology that you can simply just connect all of your accounts to one source and let a software do all the hard work for you. And this is something that I do for all of my clients is tracking the averages of their expenses. It's something that I allow them to do, right? I make it available to them. They don't have to, but most of them enjoy doing it once I show them how easy it is. And it's important to understand that expenses in retirement are not static. They're going to be dynamic. It's commonly said in retirement that your 60s are referred to as your go-go years, your 70s are your slow-go years, and your 80s and beyond are your no-go years. Meaning you can expect to spend more at the beginning of your retirement when you're active and healthy and doing things like traveling, right? And as you age and you aren't as mobile, you might be slowing down on the spending and traveling. Maybe instead of two, three vacations a year, you're maybe taking one or two. So remember that while your expenses in retirement will be dynamic and not static, it helps to track them. That way you can just kind of see the averages over time. So to wrap this up, to answer the question of how much money do we need to retire? To recap, we need to figure out number one, at what age we want to retire. Second, we need to add up all of our monthly expenses and our retirement goals. Third, figure out what our baseline retirement income will be. And then number four, figure out how much income you need to pull from your portfolio while considering for things like taxes, investment returns, inflation, expenses, et cetera. So if you can go through those four steps and get your number, and you are in the positive, Congratulations, you are well on your way to being able to retire. If you go through all those steps and you get a number for retirement that is greater than what you have now, that isn't necessarily a bad thing. Depending on your time horizon, you may just need to tweak a couple of things here and there to make it work like your savings rate, your investment returns, or considering extending your retirement date. There's a couple of things. that you can do. It's different for everyone. And that's really a wrap for today's episode. Please do me a favor. And if you found this podcast, this video useful, please go ahead and subscribe and share it with someone else that you think would find it useful. If you have any questions, please leave a comment. Please let me know. Until next time, take care. Hey, real quick before you go, thanks for listening and please remember to hit follow on your podcast player. You won't miss any episodes and it helps support us bring you the show. Today's show notes and resources are available to you by clicking the link in the description. The opinions and views expressed here are for informational purposes only and is not tax, legal, financial, investment, or accounting advice. This material is educational in nature and should not be deemed as solicitation of any specific product or service. All investments involve risk and a potential for a loss of principal. Should you need such advice, please consult with a licensed financial, tax, or legal professional. Neither host nor guest can be held responsible for any direct or incidental loss incurred by applying any of the information offered.
