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The Modern Road To Retirement - How Much Do I Need?

March 5, 2018

In retirement, assets, which are in a lump sum, need to be turned into a cash flow stream sufficient to fund your desired lifestyle for life.  This withdrawal rate is the source of the biggest concern to everyone in retirement.  No matter the level of financial resources, there is always the fear of running out of money.

Rules of Thumb

How much money do I really need and what is the withdrawal rate?  This question is frequently asked, but rarely has a definitive answer.  The problem is that everyone’s needs are different, and dependent on their unique vision of retirement.

Rules of thumb can sometimes be helpful as a place to start.  One common rule of thumb states that you will need about 80% of your pre-retirement income during retirement.  While perhaps valuable to provide a quick estimate, it’s far from perfect, as some people may actually need even more money in retirement depending on what they plan on doing.

Another rule of thumb claims that assuming a 60/40 mix of stocks and bonds, withdrawing 4% of your retirement savings in year one, and continuing to increase that amount to match inflation each year, is a safe strategy to protect your principal from being depleted.

Based on that assumption, $1,000,000 of assets can be counted upon to provide $40,000 per year of cash flow for life. Thus, if your lifestyle requirements call for $100,000 per year and you are retiring today at age 65, Social Security might be expected to provide about $40,000 per year for a husband and wife, requiring $1,500,000 of retirement savings to provide the balance.  In addition, an emergency fund for unintended expenses, such as medical expenses of 5-6 months’ income, is commonly recommended.

These rules of thumb might be a good starting point for younger people, but as you approach retirement it is important to take a serious look at how much money you’ll really need.  The best way to estimate how much money you’ll need is by looking at your expected expenses based on your lifestyle goals.  Once you start to tally up your estimated monthly expenses in retirement, you will begin to see what withdrawal rate is required.

The Cost of Health Care in Retirement

In looking at the cash flow and capital requirements, it is important to factor in the potential cost of health care. Some retirees incorrectly assume that turning 65 and being Medicare-eligible means that health-care costs automatically go away, but Medicare covers only about 60% of the health-care expenditures for retirees.

Factoring in supplemental insurance premiums and out-of-pocket expenditures, Fidelity Investments recently estimated that the typical 65-year-old couple will need $220,000 to cover health-care expenses during their retirement years.  Importantly, that figure does not include long-term-care expenditures, which should be addressed separately.

Income Taxes in Retirement

Many individuals have concluded they will be in a lower tax bracket in retirement, thus minimizing the effect of taxes.  This conventional thinking should be examined closely, as the income needs in retirement are net of income taxes.

First of all, the federal government has huge underfunded liabilities in Social Security and Medicare programs that grow larger by the minute.  In addition, tax rates are at historically low levels.  Historically low taxes rates, combined with increasing government debt, could cause future tax rates to increase.

Second, the major tax deductions you have enjoyed during your working years, including mortgage interest, child care, retirement plan contributions, and charitable contributions, are likely to be reduced or vanish entirely during retirement, possibly pushing you into a higher bracket.

This is combined with the fact that most traditional thinking has lead people to believe that maximizing contributions to their 401k Plan and deferring income into the future is the best strategy to accumulate for retirement.  If a majority of your spending requirements in retirement are met through qualified plan withdrawals, they will be taxed as ordinary income.

Large amounts of taxable income, with fewer deductions potentially taxed at a higher rate, could provide some unexpected and unpleasant results.  Two of those unpleasant results are the negative impact income in retirement has on the taxation of your Social Security benefits and your cost for Medicare, increasing capital and cash flow requirements.


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