1. Two Retirement Questions
Submitted by Larry Frank Sr. on Fri, 08/10/2012 - 3:00pm
The two most common questions working people have about retirement:
When can I retire? How much do I need?
Most online calculators begin by assuming an income cut for you when
you retire. Is a pay cut really what you want? How about starting with
maintaining your current standard of living, and then entertaining possible
cuts only if needed later. You can give yourself a pay cut now, by saving
more, which will make reaching retirement easier.
In two previous articles (see below), I discussed portfolio withdrawal rates
– the money you take out of your retirement kitty to live on. Note in the
figure below that the withdrawal rates go up as you get older. The later
you choose to retire, the more you may withdraw. And by waiting, you
need less to retire with.
Let's look at an example, where you want to maintain today’s standard of
living into retirement, i.e., no pay cut based on some ratio. How can you
determine your standard of living number? From your tax return. Without
getting too complicated, simply begin with your adjusted gross income
(AGI) number. This is your total income, which is what you make minus
tax deductions, such as retirement plan contributions.
Say your AGI is $125,000. You then reduce that by the annual payments
you receive from Social Security and pensions and then calculate what
your portfolio requires to sustain the unfunded need. Assume your Social
Security is currently estimated to be $25,000 a year at age 65.
Would you like to retire at age 60, 65 or 70? Look at the figure below
using the upper panel numbers (previously discussed in Withdraw 4% in
Retirement?) We’ll use expected values, which are based on projected
longevity. The concept is the same with the other numbers, except your
retirement goal is consumption (higher draw down rates), or bequest
(lower draw down rates), of your retirement funds.

2. How much do you need to retiree with? Bear with me for some basic
math. At age 60 the expected value is 4.11%. That’s the $100,000 (AGI
minus Social Security and pension income) divided by .0411, equals
$2,433,090. That is how much you would need to comfortably sustain
an unfunded $100,000 standard of living as long as you may live. To
sustain $100,000 at age 65: 4.52% equals $2,212,390. And $100,000 at
age 70: 5.29% equals $1,890,360.
Note that the sustainable portfolio value goes down with age, and
continues to do so as you continue to age. This means that it is okay to
consume some principal when you are retired. This method helps you
determine just how much principal you may use (assuming down
markets haven’t done so first). This method also shows the value of
waiting longer before you retire since you need to save less for fewer
remaining years.
The value of an advisor enters the picture when you refine your AGI
number based on other factors in your life. For example: Medical
insurance and costs? Other retirement goals that are not currently
included in your standard of living?
When can you retire? Answer: When you have saved enough to sustain
your current standard of living. If you save more now, that means three
things: First, you have thus lowered your standard of living (because you
are saving, not spending). Second, as a result, you need to save less to
sustain less. Third, saving more gets you to your savings target faster.
To see how saving more works, let’s say you reduced your standard of
individual living (SOIL) through saving an additional $10,000 a year. Now
your unfunded SOIL is $90,000 and for a 65-year-old your target savings
is $1,991,150, not $2,212,390 from above. More importantly, you do not
have to save an additional $221,240 to sustain your comfortable
retirement. The choices you make today directly effect when and how
you retire.
How do you save up for your target amount you need to retire?
Everything you do has an impact on everything else you do when it
comes to the dynamics of retirement. And the uses of draw down
concepts are handier than you may have previously thought. We have
now come full circle in this series of articles to see that Consistent
Savings Tops Returns.

3. This is the fifth article in a retirement series. The first series
article: Retirement Planning Mistakes. The second series article: Moving
Your Retirement Goal Posts? The third series article: Withdraw 4% in
Retirement? The fourth series article, Bear Market Retiree Income,
discusses the use of the lower panel in the figure above. Other articles for
the not-yet-retired: In What Should the Young Invest? And Consistent
Savings Tops Returns.
By the way, your income cut assumption originated from the concept of
"income replacement ratio," first done in 1980 and updated periodically
since then, by looking at regional and national averages. I believe that you
first seek to replace the income you are currently spending by calculating
that dollar number directly. (And yes, this is probably a bit less because
you aren't paying Social Security payroll taxes once you retire – but could
be a bit more if you have spending plans once retired that you don't have
while working.) This is instead of applying some percentage ratio that
probably has little to do with your specific situation.
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Larry R Frank Sr., CFP, is a Registered Investment Adviser (California) in
Roseville, Calif. He is the author of the book, Wealth Odyssey. He has an
MBA with a finance concentration and B.S. cum laude in physics with
which he views the world of money dynamically. He has peer-reviewed
research published in the Journal of Financial
Planning. www.blog.BetterFinancialEducation.com.
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Topic:
Retirement Planning
Spending
Withdrawals from 401Ks