How much money do you need to save for retirement? While it’s a simple question the response is complicated...
If you're planning to retire soon, a good back-of-the-napkin estimate is to have a retirement portfolio that's roughly 25 times the value of your annual retirement income. It goes like this: Consider how much money you want in annual income. Then subtract Social Security benefits and any other guaranteed income, such as a pension, and then multiply by 25.
For example, if you need $150,000 in retirement income, and you'll receive $30,000 from Social Security, you'll need ($120,000 x 25) roughly $3 million in savings.
There are a lot of common questions when it comes to retirement, but the most common question of all is: "How much can I safely take from my investment portfolio each year?" The answer: "It depends."
Here are few common strategies:
The 4% Rule
Likely, the 4% rule is the most common online technique in retirement income projections. This approach applies a 4% withdrawal rate to your total retirement portfolio in year one, and then increases that amount by the rate of inflation each year thereafter.
So, if you have a $2,000,000 portfolio and retired today, you would withdraw $80,000 in income for your first year of retirement. Moving forward, regardless of what happens in the markets, you'd withdraw your base amount plus the corresponding rate of inflation. So, for ease of illustration, if we assume an annual rate of inflation of 3%, you'd withdraw $82,400 in year two, and then $84,870 in year three, etc.
The research behind the 4% rule suggests that during the past century, investors would not have exhausted their assets during any 30-year period. The criticism of the 4% rule is that the withdrawal schedule isn't flexible and is too conservative, and for some it may create a large end-of-life surplus.
Market-Based Approach
Another popular approach used by some planners is to base the withdrawal rate on both the level of stock market risk in the total portfolio and the overall valuation of the markets. This one is a bit more complicated, but in practice it dictates a higher withdrawal rate – typically the rate starts around 4.4% and can go as high as 5.7% for a moderate risk investor. For a more conservative investor, the rate starts at about 3.9% and goes as high as 5.0%.
The Custom Approach
The custom approach places significant emphasis on your personal objectives and goals. It should also take into consideration your investment risk tolerance, current market valuations, and the timing of your income and expenses.
In practice, retirement planning is different for everyone. For that reason, the custom approach can be far better than the alternatives. For retirees in need of flexibility, the above methods could pose problems. For example, if your dream was to live abroad and travel extensively in the early years of retirement and then simplify your life when in your 80s, the above methods would likely lead to a surplus of funds late in life that should have been applied more effectively to living your retirement dream to it's fullest potential.
Flexibility is the most important aspect of many soon-to-be and current retirees' plans. For experienced advisors who specialize in retirement planning, some flexibility is usually built into their clients' plan. For example, you can often anticipate the sale of a property, or a transition from one residence to another. You might also be able to conservatively factor in an expected inheritance. And it's common to expect retirees to spend less money on lifestyle in their later years.
The custom approach involves conversation and counsel. It also includes experimenting with "What If" scenarios designed to test the limits of a plan and provide the pre-retiree, or retiree with a much clearer perspective of what's possible.
Look Beyond Your Rule of Thumb
In the end, retirement-income calculations and planning are likely best addressed by looking beyond a cookie-cutter formula, or what's considered the rule of thumb.
Optimal retirement planning is ultimately about defining where you are today, envisioning what your tomorrow could look like, and then implementing a well-thought-out customized plan to turn that vision into a reality.
