Note: This post was originally published in September 2013; however, the below still has relevant principles.
How much money does it take to retire? It’s a question every financial adviser is asked. It’s probably a question you’ve asked yourself every time you open your 401(k) or IRA statements. The short answer is, “If you have to ask, you probably can’t afford to retire today.” The real answer to the question is a bit more complicated.
The answer depends on the type of retirement lifestyle you want. Will you want to be able to pay for weekly golf lessons and a country club membership? Will you be able to afford traveling to see your grandchildren? Will you be able to afford long-term care should you fall seriously ill in 10 years? Now consider your assumptions about how long you will live in retirement, market growth and inflation. Those are some pretty big uncertainties.
How long you will live in retirement is determined by what age you retire and your life expectancy. Today’s average 65-year-old American will generally live to age 84. You could live nearly 20 years after you retire. Likewise, if you retired early at 55, you could expect to live another 27.3 years—almost as long as your working years. Regardless of when you retire, you generally must wait until age 59½ to take distributions from tax-deferred savings without incurring an early withdrawal penalty (there are a few exceptions). At age 62 you can receive early Social Security benefits, and at age 65, you will be eligible for Medicare. While these benefits were designed to make retirement financially feasible, living on a fixed income for 20 or more years takes considerable planning.
Generally, we use a conservative 8% market return for examples. Historically, Large-Cap stocks have an annual total return of 11.8% from 1926 to 2012, according to Ibbotson Associates 2013 Yearbook. If you were to invest 5,000, annually, from age 35 through age 65, assuming an 8% return, your portfolio should generate $566,416. However, if you assume an 11.8% return, you could yield $1,160,838. The difference is $594,442! Your optimism about market performance alone could greatly affect your retirement planning. If you wanted to hit that million-dollar mark by age 65, and the market only returned 8%, you’d need to save approximately $9,000, annually.
When saving for retirement, you are faced with the challenge of maintaining investment portfolios that can withstand the current economic challenges, while providing a hedge against future inflation. Inflation is the reason that your withdrawal rate during retirement is so important. If your $1 million portfolio yields 5%, it should provide $50,000 of annual income. However, if inflation runs at 4% annually, the next year, you should need $52,000 to maintain your retirement lifestyle. In 10 years, you should need more than $74,000 to preserve your purchasing power.
Unfortunately, there is no magic number for retirement assets because there are so many variables in the equation. Aside from the above, you may want to consider the future of Social Security, increased taxes, increased medical costs, and prolonged economic downturns. Of course, once you have all the variables identified and planned for, prepare for change. Nobody knows what the future holds, but working with a financial planner should help you tailor your plan for your specific situation.
At Henssler Financial we believe you should Live Ready, which includes understanding all the variables that may affect your financial future. If you have questions regarding your savings strategy, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
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