Do you know how long your current retirement savings will last? Most American households have far less than they need for retirement. According to a study by the National Institute on Retirement Security, “62% of working households ages 55-64 have retirement savings less than one times their annual income, which is far below what they will need to maintain their standard of living in retirement.”
Running out of money in retirement can be a personal tragedy for you and your family. Consider the following factors when determining how much to save now so that you can have the financial freedom you deserve in your later years. (For related reading, see: How Much Should You Contribute to Your 401(k)?)
How Long Do You Need Money to Last?
The Centers for Disease Control publishes its Life Tables periodically. If you are 50 years old today, its chart suggests that you can expect to live until you are age 82. However, these are averages across the entire U.S. population. Because about half of us will live longer than the average, planning for the average will leave a lot of us without money at the end of our lives. Your health and your genes will be significant factors in understanding your life expectancy, and therefore, the time horizon of your portfolio plan.
What does this mean to you? It’s always better to plan for a longer retirement. Saving too much and leaving a legacy for your family or favorite charity is much better than coming up short.
Working Against You: Withdrawals and Inflation
Since the 1920s, the average annual rate of inflation has been very close to 3%. One dollar in 1920 has the same buying power as $12.69 in 2017. We see inflation in our everyday lives – a gallon of milk this year costs more than that same gallon last year. Inflation keeps a steady march day after day, year after year and it’s coming after our savings! While you may need $70,000 annually to live on when you’re age 65, that number jumps to $108,000 about 20 years later when you’re 85 years old. So you must factor inflation into your retirement plan.
Taking money out of your retirement funds will have a negative impact on the funds as well. Of course, we all expect to use those funds in retirement. But how much are you planning to withdraw each year? A common misconception is that the market averages a 10% return, so we can withdraw 10% without decreasing our funds.
It doesn’t work that way. While the average annual return for stocks is about 10%, the market value of your savings will fluctuate up and down. In down years, a 10% withdrawal can be devastating to the value of your savings and will shorten the life of your portfolio. Even in up years, a withdrawal as high as 10% will reduce future growth in value. Also, your retirement portfolio may include bonds, which have lower returns than stocks, making the impact of a large withdrawal strategy more profound.
Consideration must also be given to the cost of your expected lifestyle in retirement. Having a financial plan for retirement before you get there, including how much money you need to live on and sticking to the plan in the early years, will pay off in the long run. (For related reading, see: 4 Keys to a Satisfying Retirement.)
Another important factor in determining your investment strategy for retirement is your plan(s) for leaving a legacy beyond your own lifetime. There are generally four scenarios to choose from:
- Using all of the assets. In this scenario, you have no desire to leave any assets behind.
- Leaving a specific amount. While you may draw down a portion of the principal, you desire that your family, friends and charities receive a specific bequest. Therefore, you’ll need to plan ahead to have that amount remaining.
- Steady value. You desire to have enough saved to live off of the interest and growth and still maintain the value of the portfolio throughout retirement. Remember to take into account the impact of inflation.
- Growth. You want your portfolio to grow as much as possible during your retirement.
Choosing one of these scenarios will impact your current savings plan as well as your decision regarding withdrawals during retirement.
The Bottom Line
Each of these factors must be considered when establishing your retirement plan. Your plan must be right for you.