Bob and Carol wondered if they could afford to retire. “What,” Carol asked, “is our magic number? How much do we need to retire comfortably and not run out of money?”
I answered that it’s all a matter of sound planning. “Your projected yearly spending,” I said, “has to be matched by yearly returns on your investment portfolio. Fortunately, you can begin with some handy guidelines.”
General rules, called safe withdrawal rates, have proven to be highly reliable through 30 years of extensive research, originated by financial planner William Bengen. They point to a diversified investment portfolio of 50 to 60 percent stocks and 40 to 50 percent fixed-income holdings (bonds) and cash. From these assets, retirees withdraw 4 percent a year, which includes a measure of protection from inflation.
“So there is a magic number,” Carol said.
“Not quite,” I said. “First, you should determine how much money you’re spending now and whether you can maintain this level in retirement.”
Bob and Carol own a home with no mortgage. Of course, they have to account for taxes and upkeep. In all, they spend $10,000 a month on their comfortable lifestyle. But what happens when they stop working?
They’re both eligible for Social Security benefits. “Now it’s time to do a little homework,” I said. “Let’s get an overview of what you might spend.”
Leisure activity spending will likely increase. But expenses for clothing, transportation, income taxes and contributions to retirement plans — as well as health insurance when they go on Medicare — might go down.
“It could be a wash,” said Carol. “I’m thinking that there is a magic number after all, and it’s $10,000 a month.”
Here again, I raised a cautionary flag.
“Maybe we have something of a fix on what you think you can spend, but we have to figure the total value of your assets along with pension money and Social Security to predict whether you can generate that level of income.” Social Security claiming strategy is a major component of deciding what income level Bob and Carol could achieve to support their lifestyle through retirement.
As to income, we looked at the numbers. Bob’s Social Security benefit will be $2,500 a month, Carol’s $2,100. That’s $4,600. After deducting Medicare Part B premiums of $250 per month, their net will be $4,350. That means they’ll need another $5,650.
Based on the safe withdrawal rates, Bob and Carol will need assets of about $1.5 million to fund the gap between Social Security benefits and anticipated spending. This raises an important question: Are their assets outside or inside retirement accounts? Money withdrawn from standard IRA or 401(k) plans is taxed at ordinary income rates. Their net will be less than their gross withdrawals.
Bob and Carol also will need to consider whether their spending will change when they retire. Will they retire when asset values are high or low? Will interest rates be high or low? They’ll also have to evaluate their risk tolerance, particularly on equities.
What’s more, how will they plan for long-term care expenses? And how might their income and spending change when one of them passes away? The survivor will receive the higher of their two Social Security payments but will only receive that single payment. Will remaining income support the surviving spouse?
I also pointed out that if Bob and Carol spend more money early in retirement, they’ll need enough control and confidence to reduce spending later if necessary.
At this point, Bob and Carol added questions of their own. “Will one of us want to keep living in our home when the other dies?” Bob asked. “Would we be willing to sell the house?”
“There’s work to do,” I said. “But three basic principles will help: First, create a budget, then review it every year. Second, make thoughtful decisions about Social Security and pensions. And third, be conservative in your assumptions.”
Carol smiled. “I guess there isn’t really a magic number. But with a little effort, we can get our retirement finances under control.”
Ira Fateman is a certified financial planner at SAS in San Francisco who conducts free personal finance workshops for Hebrew Free Loan (http://sasadvisors.com/). Reach him at firstname.lastname@example.org.