Life is full of epic questions that demand answers and define the future. Which college should I attend? What should I do for a living? Should I marry her? How many kids should we have? And, of course, how much do I need to save for retirement?
As a financial planner, I get that last one a lot. My answer is the same for everyone who asks: enough. Contrary to much of the retirement advice that comes from Wall Street and the financial media that serve as its megaphone, there is no one-size-fits-all retirement savings number.
Take, for example, investment firm Legg Mason’s recent insistence that you need $2.5 million in savings to ensure a comfortable retirement. That’s a dubious number that I suspect was based on data from high-income people residing in areas with high costs of living. Promoting such a figure does nothing but cause anxiety for most Americans, who simply can’t amass that kind of portfolio. But that’s OK. I’ve worked with countless retirees who are enjoying wonderful, secure retirements on much smaller nest eggs.
Of course, there are two sides to the retirement funding equation: how much you save during your working years, and how much you withdraw from those savings each year in retirement. These are equally important, interrelated figures. It’s important to get both of them right – as defined by your particular situation.
Fortunately, there are a couple of tools that you can help you plan for both sides of the equation.
The first is the 1,000 Bucks a Month Rule, which says that for every $1,000 per month you want available from your portfolio in retirement, you need at least $240,000 in savings. To build a portfolio of that size, you’ll need to prioritize saving. Really prioritize it. I tell my clients they should strive to save 20% of their gross income. If you can’t hit that mark right away, commit to restructuring your spending, debt, and finances over time so you can get to 20% as soon as possible.
The second tool is less specific. Let’s call it the 5% Guideline. It suggests that someone who has saved in accordance with the 1,000 Bucks a Month Rule and retires at 65 or 66 should be able to annually withdraw approximately 5 percent of their investments during retirement, without running out of money.
I call this a guideline because there are both exceptions to the 5% figure and some debate among professionals about whether 5% is the optimal withdrawal rate. For example, early retirees, those in their early 60s, and super-early retirees in their 50s should throttle back to a lower rate of 3% to 4%, to help ensure their money lasts over that longer time horizon. And, in years (or a stretch of years) when the market is struggling, even those who retired at 65 may need to reduce their withdrawals to below 5%.
MIT finance expert William Bengen is among those who would disagree with the 5% Guideline. He says retirees who withdraw 4.1% of their initial retirement portfolio balance, then adjust higher each year for inflation, should see their money last 30 years. Retirement income expert Wade Pfau of The American College argues that a withdrawal rate of roughly 3% is more appropriate given today’s investment landscape, which is marked by low-interest rates.
Does this 3%-5% withdrawal rate surprise you? If so, you’re not alone. A recent Fidelity Investments survey found that 20% of the 55-to-65-year-old respondents thought the suggested withdrawal rate was 10% to 15% a year.
It does take some effort to implement the 1,000 Bucks a Month Rule, but it’s worth it. And the first task is the fun part. You need to decide what you want from your retirement. Where will you live? How will you spend your time?
Based on those answers, calculate the monthly expenses in retirement. Then, subtract from those expenses your income from Social Security, as well as what you expect to generate from pensions, a part-time retirement job and/or rental income. The remainder is what you need from savings on a monthly basis. Multiply that by 12, and you have your annual shortfall. Now, multiply that number by 20 years, and you have a rough savings goal.
Here’s an example that seems to resonate with many people:
– Projected monthly expenses in retirement: $6,000
– Monthly Social Security benefit – $2,300
– Monthly pay from retirement job – $700
– Monthly rental payment from condo – $1,000
Monthly shortfall: $2,000
- $2,000 x 12 = $24,000, your annual shortfall
- $24,000 x 20 years = $480,000
In keeping with the 1,000 Bucks a Month Rule, that $480,000 should provide the $2,000 per month necessary to cover the shortfall in this example.
While 20 years is quite a chunk of time, we are generally living longer, more active lives these days. So, you may want to increase that number in your plan. A 30-year timeline isn’t unreasonable, depending on your health. And what if you want to leave something to your heirs, or the community? This is where income-investing comes into play.
Income investing is a strategy to generate consistent cash flow from your investments. An income-focused portfolio generates revenue from dividend-paying stocks, interest on bonds and distributions from other assets, such as real estate investment trusts and preferred stock.
If your investment portfolio yields 3% to 4% annually, and you get an additional 1% to 3% growth/appreciation from your income assets, you stand a good chance that your money will provide a life lived on your terms.