How Much Do I Need To Retire?
Other than people asking me about my outlook on the economy or the stock market, I often get the question, “How much money do I need to retire?” It’s always a tricky question to answer with precision because there are so many variables involved.
In previous generations, many employers offered pensions to their retirees. It was not uncommon to see employees spend their entire career at one company. When it came time to retire, their employer would agree to pay these employees a pension, usually resulting in a monthly payment for the rest of their lives. To provide that retirement income, the employer had to determine how much money needed to be set aside, taking on the longevity risk of how many years they would need to fund the pension payment.
Common Planning Mistakes
While some employers still provide pensions, most people now have some retirement plan (401k, etc.) in which they build up a pool of funds to the level necessary to fund their retirement. Most people need help translating how much in assets they need to fund a monthly or yearly living amount, which can lead to two types of planning mistakes.
The first planning mistake is when someone thinks that they have saved up enough for retirement, only to find out they haven’t. Of course, if retirees don’t realize this before they retire, it becomes tough to make changes by the time they figure it out. Returning to work may not be an option, and some expenses may be tough to reduce at that point.
The second planning mistake is when someone ready to retire mistakenly believes their nest egg still needs to be larger. They keep working for additional years beyond what they need to live the lifestyle they want. Then they end up with fewer opportunities for travel, playing golf or whatever else they wanted to do during their retirement years.
How Much Is Enough?
Investors must consider many variables in determining how much is enough to fund their retirement plans. Those who are willing to keep their money invested generally can retire on a smaller nest egg than investors who prefer to keep all their funds in safer things like cash, money markets, CDs, etc. The lower your average return in retirement, the bigger the nest egg you need. Also, none of us know exactly how long we are going to live, so it’s usually not a good idea to plan on having spent all of your money by a certain age. You may live longer than that.
Suppose you are willing to keep a significant portion of your nest egg invested during retirement. In that case, most financial planning software packages will usually assume an “average” rate of return on those funds. While this can be a useful starting point, you also should factor in that you will get a return significantly different from the average for most individual years. If you get above-average returns during the first few years of retirement, you may end up in better shape than you might have initially thought (think about someone who retired in 1995) or get below-average returns during the first few years of retirement (think about retiring in 2008). It can potentially leave you in bad shape, even if you get the average return over the course of retirement that you planned to receive. The better financial planning software packages will simulate multiple different market environments and ensure you don’t run out of money if you happen to retire into a bad market environment early into retirement.
Do you plan on spending principal, or do you want to die with your principal intact? Do you have some retirement years where you plan to spend more than others? Would you stay in your home? Would you downsize? Would you buy a second home? How much of your nest egg is taxable vs. tax-deferred? It can get complicated quickly.
So, when people ask me how much they need to retire, I admit that it’s not always a simple question with a straightforward answer. But as a financial adviser, it is one of the most important questions I can help people answer.
David Jackson, MBA, CFP®, C(K)P™, is the Managing Partner at the Southern Springs Capital Group. For more information on Southern Springs Capital Group, visit www.southernspringscapital.com. Our offices are located at 2555 Meridian Boulevard in Franklin. We can be reached at 615-905-4585.
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