by Robert Powell
Researchers and others say only half of households in the USA are financially prepared for retirement. The other half, not so much.
Other research, however, shows that only one in 10 households — if you factor in less spending after your children move out and falling expenses in retirement — are at risk of not enjoying the same standard of living in retirement as in their working years.
So who’s right? And, more importantly, does it matter to you?
The short answer, in a way, is that it doesn’t matter who’s right. What matters, say experts, is whether you are financially prepared for retirement. And to do that, you might need to do some number crunching.
Here’s a look at the some of the more common ways to tell if you have enough money socked away for your golden years.
But first, let’s start with a few assumptions. Let’s say your household presently socks away $7,000 toward retirement per year; you and your spouse have pre-tax income of $100,000 or $83,000 after federal taxes; you and your spouse have $1 million in various accounts earmarked for retirement; and you and your spouse are at full retirement age and you both plan to start collecting Social Security (let’s call it $2,000 per month in total) as soon as you retire this year. Let’s also assume that you and your spouse don’t plan to work full- or part-time after retiring and that you don’t have a defined benefit pension plan.
So let’s do the numbers, and some triangulation.
The 80% income replacement rate. One of the most common retirement rules of thumb would have you replace 80% of your pre-retirement income, or $80,000, in retirement. That number accounts for a lower tax bill and no need to save for retirement.
So, can it be done? The short answer: No. You’ll get $24,000 from Social Security, leaving you with a shortfall of $56,000 that has to come from savings, earned income, or a pension.
And the simple hard truth at the moment, in the absence of a pension and/or earned income, is that you’ll have to make up the difference with your assets earmarked for retirement. And that’s going to be a push. Why so?
The systematic withdrawal plan. Well, to make up the difference, you’d need to withdraw 5.6% from your portfolio on an inflation-adjusted basis to maintain your lifestyle.
And the research suggests that your nest egg won’t last for 30 years at that rate.
By way of history, the research suggested that you could — at one time — safely withdraw 4% per year and have it last for 30 years of retirement. But now, in light of the still-low interest rate environment and relatively high stock valuations, experts including Larry Swedroe, director of research for Buckingham Asset Management in St. Louis, say you shouldn’t plan to withdraw any more than 3%, or even 2%, from your nest egg if you want your money to last 30 years of retirement, or even less if you want your money to last longer than 30 years. “The old rule of 4% systematic withdrawal rate is now 3%,” says Swedroe.
In other words, you should withdraw only $30,000 pre-tax from your retirement accounts if you want to manage the risk of longevity. And that means this: The income from your retirement accounts, when combined with $24,000 in Social Security benefits, still leaves you with a $26,000 shortfall.
Bottom line: You’re underfunded; you’re not financially prepared for retirement, and you need to sharpen your pencil and tackle your numbers and plan, again.
But what if you use a different rule of thumb?
Assets over liabilities. Another rule of thumb suggests that you need at retirement 11 times your final pay in your retirement account, or $1.1 million in your nest egg. Read Aon Hewitt’s The Real Deal.
By this measure, you’re closer, but your nest egg is still $100,000 shy of the benchmark.
And some might even say you’re way underfunded. “A recent or prospective retiree will need investment assets amounting to 33 times the difference between prospective annual retirement spending and fixed retirement income from Social Security plus any defined benefit pension payments,” says Michael Edesess, author of The Big Investment Lie and chief strategist of Compendium Finance, an online financial services firm based in Washington, D.C.
What might you do given that you’re financially unprepared for retirement based on these three rules of thumb? It might not be fun, but experts say there’s no substitute for putting pencil to paper (or finger to calculator) and figuring out, as accurately as possible, your retirement expenses — your lifestyle — and sources of income.
Calculate your household’s retirement lifestyle. Rules of thumb are nothing more than benchmarks, says Farrell Dolan, a principal with Farrell Dolan Associates who’s now retired.
“They may be good guideposts and have an importance because most people aren’t even in the right church, never mind the right pew,” he says. “So the idea of a 4% inflation-adjusted number as a rule of thumb to determine how much your assets will provide to you, even with some risk, is a fair benchmark simply because there is so little understanding of how to approximate appropriate pools of money that will be needed to live off in retirement.”
Brent Burns, president of Asset Dedication in San Francisco, agrees: “Though very useful for policy making, to give a broad view of retirement readiness in the aggregate, workers need to get very specific on how they plan to spend their money in retirement.”
Many experts aren’t fans of the 80% income-replacement ratio either. “Ask someone in their late 50s who’s still employed if they spend more during the work week or more on weekends,” Dolan says. “Where I live every day is Saturday.”
And Larry Frank, author of Wealth Odyssey, says the 80% ratio is an average of what people tend to be forced to do in the past rather than what they need to plan for retirement ahead of time. “If people under save, then they need to reduce spending, or continue working,” he says.
Some research does, however, suggest that you might need as little as two-thirds of pre-retirement income, according to Edesess.
The truth, however, is this: Whether you’re financially prepared for retirement is “a very personal endeavor with each of us having different things that we’ll do,” says Dolan.
Others agree. “Each individual needs to be apprised of estimated amounts available to spend each year under various base-case, reasonable worst-case, and other scenarios,” says John Craig, a retired tax attorney who blogs about retirement from Plymouth, Minn. “The individual then must decide if and how he could live with the computed annual available spends by comparing these amounts with his current spend, adjusted as he deems appropriate.”
According to Dolan, the best way to determine if you have enough money for retirement is to calculate your essential/lifestyle and discretionary retirement expenses, and determine whether you have enough sources of guaranteed income to meet your essential/lifestyle expense.
And other experts share that point of view. “Bottom line is that there are no magic formulas,” says Craig. “Each pre-retiree must evaluate the best estimate of the amounts available to him in retirement, compare this to his best estimate of retirement needs, and make his own judgment, ideally with the assistance of a skilled financial planner. Benchmarks and percentage of pre-retirement income are crutches for unskilled financial planners.”
Dolan also says you’d be wise to not only create a plan but to update it each year, or as circumstances change. “The right approach is to get started, because the plan is never done, just updated and changed as life changes,” he said. “Your financial ‘answer’ will change over time. What you do in your 60s to finance your lifestyle may be very different when you’re in your 70s or 80s”
Read ‘Are Retirees Falling Short? Reconciling the Conflicting Evidence.’
Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch, and teaches at Boston University.
Source: USA Today