Can I Retire Yet? (Part I)

“How much money do I need to retire?”  Just about everyone anywhere near retirement asks themselves this question – as do younger people planning ahead and, sadly, too many folks who are already retired but have some nagging doubts.  Perhaps you’ve been faithfully saving and investing via your 401(k) plan or IRA and have accumulated a nice nest egg — maybe $250,000 or $500,000 or even more.  Seems like a lot of money.  But is it enough?  How can you know? 

Countless places — easily accessible on the Internet — are all too willing to provide the answer. Unfortunately, many of them are also eager to sell you financial products or services, such as annuities that lock up your money, or account management that costs 1% or more of your entire stash each year.  Nifty retirement calculators promise to tell you how you’re doing if you’ll just take five minutes to answer a few simple questions.  Unfortunately, in my experience the calculators don’t all seem to give the same answer. 

Right now, the Internet is ablaze with the writings of the FIRE (Financial Independence – Retire Early) brigade, whose evangelical acolytes argue that you can retire much earlier than you might have thought – at 50, maybe, or even 40, if you play your cards right.  Intriguing, yes, but maybe you don’t want to live in a tiny house off the grid, or you’re already too old to retire young.  Does their advice apply to normal people who’d like to travel and don’t raise their own chickens?

To be fair, many retirement/financial planning blogs, books and web sites provide great advice. Still, it takes some work to sift through the chaff and find the wheat.  Having done this threshing fairly recently, let me share what I have learned. But first, a story. 

A Cautionary Tale

In a 1995 article in Worth magazine, legendary investment manager Peter Lynch proposed that retirees withdraw 7% a year from their nest eggs as a retirement spending strategy.  He argued that if the portfolios were invested 100% in stocks, which historically have returned 11% per year, that withdrawal rate would not only be sustainable, but would also generally result in an increase in principal after 20 years.  This didn’t sound quite right to financial writer Scott Burns and some retirement planners he consulted.  Looking at all the 20-year periods between 1960 and 1995, they found that investors would have lost principal almost half the time with Lynch’s 7% withdrawal strategy.  In a few instances, investors would have completely run out of money following this reasonable-sounding approach!  

What was wrong?  In a word, timing — sometimes called sequence of returns risk.  While it’s true the stock market has returned more than 10% over time (7% after you account for inflation), that average return masks huge variations in yearly returns. If you are unlucky enough to retire at the wrong time, you can withdraw so much from your portfolio in the first ten years or so that your poor, beaten-down nest egg never recovers.  If you are 30 years from retirement, the stock market will likely provide solid returns despite these vicissitudes.  But if you are close to or in retirement, you can’t afford to take this risk.  Unless you’re a riverboat gambler, you need a more certain strategy. 

A nice postscript to this story: once Lynch saw Burns’ critique and recognized its validity, he pulled his own article and hired Burns to be a columnist for Worth!  A rock star investor and a mensch, too!

So how much money do you need to be able to retire and still sleep at night?  Or is this an unknowable Zen question, only clear in hindsight? Fortunately, it isn’t difficult to come up with an answer with reasonable confidence.  You’ll need to crunch a few numbers, but nothing very complicated, and the resulting peace of mind you’ll get from understanding your own financial situation is well worth the effort.  It’s your money and your life.  Why rely on some other supposed expert for something so important or, worse, dive into retirement just hoping for the best? 

Ready to roll up your sleeves?  Pour yourself a cup of Joe and let’s get started.  

Pay Yourself a Salary

It turns out that looking at your retirement savings as a lump sum really isn’t that helpful.  You need to think in terms of assembling a regular income, much like a salary, except that in retirement your income is coming from social security, any pensions you have earned, and money you ‘pay yourself’ from savings.  Pulling money out of your nest egg after years of saving to build it up can be difficult psychologically.  Your anxiety will be much reduced if you do the work to convince yourself that you have a solid strategy for making your money last through your lifetime. 

Estimate Your Spending in Retirement

Planners often suggest estimating the typical household’s retirement spending need (a.k.a., your budget) at somewhere between 70 to 85% of pre-retirement income.  Since few people are truly typical, a better approach is to track your own budget (online tools such as Mint or similar financial software offered through banks and brokerages make this fairly painless).  You can then adjust your pre-retirement spending for things you know will change once you’re no longer going into the workplace: you will no longer pay into Social Security, Medicare or retirement savings accounts, for example. On the other hand, your spending may go up on some things: health care (at least until Medicare benefits kick in at age 65), travel, recreation and any expensive hobbies you plan to take up. Remember to include any special circumstances or one-time costs (or expected windfalls) with big financial implications – such as paying for a kid’s college expenses or caring for parents or relatives. 

If you haven’t got your budgetary information lined up, go ahead and use the 85% rule of thumb estimate for now – but start tracking your spending so you have better data a year from now.

Add Up Your Sources of Income

Once you have your retirement spending estimate, identify any sources of income you expect in retirement.  Most people who have a work history can expect some Social Security benefits.  The annual statement the government sends you includes a projection of what that benefit will be, or you can sign up on my Social Security (https://www.ssa.gov/myaccount/) and take a look. 

If you’ve had a peripatetic (OK, rich and varied) career, you should locate old pay stubs, discharge papers or other records that may help you recall dates that have been lost in the mists of time.  Then sit down and reconstruct a chronology of who you worked for and for how long.  Have your spouse do the same (if you’re having difficulty getting the spouse to do this, schedule an interview). 

If you’re lucky enough to have worked in a job that offered a defined-benefit pension (mostly government workers, these days), inquire what that annuity will be.  You may or may not be vested; also, you might have withdrawn your contributions.  (I learned this the hard way.  Guess how much it costs to pay back a few thousand dollars, plus interest,  withdrawn from a retirement plan 30 years ago?)  

Add up your (and your spouse/significant other’s) sources of income, and subtract them from your estimated expenses.  The remainder is the unmet need that must be met with retirement savings.  Here’s a simple illustration:

Example

Your household’s expected annual retirement spending:      $100,000

Your expected annual Social Security benefit:                     $24,000

Your spouse’s expected annual SS benefit:                            $18,000

Your spouse’s expected pension from teaching job:              $6,000

Your expected pension from government job:                      $12,000

Total expected SS benefits and pension income:                          $60,000

Unmet need (spending less expected income):                              $40,000

In this example, both halves of this couple expect to receive pensions.  In other cases, expected income will be made up of Social Security only.  

Believe it or not, you’ve already done most of the work. 

Read on to Part II to get to the exciting conclusion.

References

Burns, Scott.  (1995, October 1).  Dangerous Advice from Peter Lynch, AssetBuilder.

Lynch, Peter.  (1995, September).  Fear of Crashing, Worth magazine.