If there is one topic where it’s possible to find an answer you want to find, it is retirement income planning. No wonder people get confused. No wonder so many people trying to figure out their retirement are stressed – and too frequently enter retirement unprepared for the future.
The typical retirement plan assumes a thirty-year period – 65 to 95, but these days I hear more about individuals who plan to retire in their fifties. The younger one retires, the more difficult the planning – and the more money needed.
The income you need in retirement is the income you are living on immediately before retirement. You are not going to spend significantly less. In fact, during the early years of retirement you may spend more. That accounts for elimination of payroll taxes, reduced – but not elimination of – saving and even no work related expenses. Forget the advice you can live comfortably in retirement on 70-80% of pre-retirement income. Those amounts leave nothing for discretionary spending, limit your ability to deal with inflation or financial emergencies – or require a reduction in your standard of living.
Accumulate sufficient assets so that your assets – not just retirement funds – together with Social Security or other steady income – generate 100% income replacement.
Following is an excerpt from an interesting article. The article also contains a table showing prudent withdrawal rates based on investment mix and years expected in retirement.
The most difficult and important issue among those near or in retirement is “How much of my savings can I spend each year without running out of money?” Morningstar, the financial research company, has done some outstanding work recently to answer this question. Hint: It’s not the same for everyone. The research was published in The State of Retirement Income: Safe Withdrawal Rates, by Morningstar experts Christine Benz, Jeffrey Ptak and John Rekenthaler.
Benz told me this is such a difficult issue because of four critical unknowns:
What will future market returns be for stocks and bonds?
What will the rate of inflation be during retirement?
Will we spend more or less as we age?
How long will we live and, therefore, need our nest egg to last?
No one knows the answers to these questions. I’ve found that people who retire young tend to spend more money than when they worked, as they now have more time to do things that cost money, such as travel.
And while no one knows how long each of us will live, it’s clear that a 90-year-old will, on average, have a shorter life expectancy than a 60-year-old. That means the 90-year-old can spend a higher percentage of his nest egg than the 60-year-old.
There are a couple of critical points to understand. The first is that when estimating how much one can spend, we must take inflation into account. If we have an average of 2.21 percent annual inflation (assumption used by Morningstar), what costs $100 today will cost an estimated $155 in 20 years. The second point is that while stocks will, on average, produce higher returns than bonds, stocks are also riskier than bonds.