March 2019: What does it take to retire
Retirement, for some of us is right around the corner, for others it is just a dream in the sky. But, have you ever actually tried to calculate out how much money you will need to retire or how much you should be saving monthly in order to retire with that amount? There are many variables involved and not everything will go as you planned; however, going through the process we provide today will at least give you an estimate of the amount needed. There are numerous retirement calculators available with complex formulas that account for various variables that are beyond the scope of this article; however, the steps below will give you an understanding of the process. Determining your Income First, let us begin with how much you will be spending during retirement. Depending upon your age and current economic situation, predicting your expenses during retirement can be very difficult. If your current expenses are in a range of where you think they will be for the foreseeable future, you can use that as a starting point. Your expenses during retirement can be completely different than what you currently have. Perhaps your home will be paid off, you may have two homes, you could have only one car. All of these potential variables depend upon the individual’s situation and what they foresee for the future. In addition, you should consider overestimating the cost for your hobbies and medical cost. When people have more time, they tend to spend more. As people get older, their medical bills tend to increase. Then, project those expenses by a minimal inflation rate (2-3%) by the number of years until retirement1. Second, how much income will be required to pay your potential retirement expenses? When considering your potential retirement income, you may be planning on relying upon multiple streams of income. Potential income streams may include Social Security2, pension, withdrawing from investment account(s), real estate, passive business interest, etc. Therefore, it helps to identify which streams of income you already have in place and what you project those to be. For many, the gap between their non-investment income streams, like Social Security and pensions, and their annual expenses can be supplemented by withdrawing from their investments. It is at this point that we try to figure out how much you should withdraw from your investments to supplement your other income sources. Typically, we recommend clients only withdraw 3-5% of their total investment account(s) value for income. This withdrawal rate varies based upon your age, risk tolerance, dependency on the money, and if you plan to leave any of these funds to your heirs. Using this rule of thumb should give your portfolio the purchasing power to protect it from inflation and other unplanned events. At the end of this article, we provide a link to a withdrawal matrix of suggested withdrawal rate, which should give you an idea of a good withdrawal rate for your particular situation. In addition, we provide two examples linked below. The first one shows how you can solve for your withdrawal amount based upon the value of your total investment account(s). The second example shows how you predict your required total account value based upon the annual withdrawal you require. Determining How Much to Save Once you have an idea of how much your total investment account(s) should be, the next step is to calculate how much you have to save to achieve that goal. First, consider finding an online savings calculator as the math requires a financial calculator. For the purpose of this article, we will use a calculator provided by Charles Schwab here. Enter the amount you can save a month. Then, enter the number of months you plan on saving. Lastly, enter your projected annual return over this time period. This return projection should be reasonable based upon your risk tolerance and investment allocation. Using returns of 5%-8% is a reasonable starting point. After entering the projected return rate, the calculator will produce an estimated total account value. After solving for the total account value, apply a withdrawal rate using our matrix linked below, which should then give you a projected dollar amount you can potentially generate upon in retirement. As we stated in the beginning of this article, predicting your exact retirement economic situation can be very difficult. However, there are tools and resources available online that will give you an educated prediction as to what you should expect. In addition, there are many professionals out there that can offer professional support that should aid you in achieving your retirement goals. Please let us know if you have any questions about anything mentioned in this article. Thank you for reading. 1. If you would like to learn about compounding and applying that to inflation, click the link here. 2. If current Social Security planning tools and assumptions stay the same, the younger generations will still receive their projected Social Security benefit, but it will only be around 70% of it. Contrary to popular belief, they will still receive something. This is all assuming nothing changes with Social Security in the future.
Withdrawal Matrix and Examples 1 & 2
Schwab Calculator Instructions