Here are the 4 steps to find the amount you need to retire comfortably.
A married couple came to me recently to make sure they were ready for retirement. Like many other clients, their main question was “when can we afford to retire?”
I spent a few minutes going over their situation, including how much income they will need to replace and what they already have saved. After I did a bit of mental math, my answer was simple.
You could have retired two years ago.
Their situation isn’t unique either. Most pre-retirees don’t know what it will actually take to retire. This leads some to underestimate the amount of savings required, while others go the other direction and save significantly more than necessary. Both options come with their problems.
It’s hard to know when you’re truly ready to retire, I get it. Let’s be real, the unknown about retirement is kind of scary.
Most people only retire once, so it’s not exactly something you get much experience doing. Likewise, money is a taboo topic in our society so it’s likely that you aren’t talking with your retired friends about how much they had saved prior to retirement.
That’s where I come in. Today I’m going to give you the tools to assess if you’re ready to retire.
Jeb
Emotionally Preparing for Retirement
It’s common to focus on the financial aspects of retirement planning, but don’t overlook the mental side. I’ve talked to many, many clients who had trouble making the transition to retirement.
It’s understandable. You spend 30-40 years building your identity around your job and then you retire. There’s often a sense of loss, as that part of your identity is gone. Instead, you have to figure out who you want to be during the next chapter, when you’re not defined by your title.
I often ask clients what they want to be when they grow up. It usually elicits a smile, but it also gets them thinking. The great thing about retirement is that you don’t have to trade your time for money to live. Instead, you have the freedom to spend your time doing things that are valuable to you.
Going back to Maslow’s Hierarchy of Needs, our highest need is self-actualization. You don’t get that from sitting on the couch, watching Judge Judy. You can get that from volunteering or working at a part time job. Maybe you want to spend time with your grandkids or traveling. All these are great options.
Before you submit your retirement paperwork, you need to be able to answer these three questions.
How do you envision your daily life in retirement, and what steps have you taken to cultivate hobbies, interests, or social connections that will fulfill you when you no longer have work-related commitments?
What role has your career played in your identity, and how do you plan to navigate the potential changes to your sense of self or purpose when transitioning away from your professional life?
Do you have any concerns or fears about leaving the workforce, such as loss of social interaction, lack of purpose, or feelings of isolation, and how do you intend to address these concerns to ensure a positive emotional well-being in retirement?
Assessing Financial Readiness
Assessing emotional readiness is qualitative, whereas assessing financial readiness is quantitative.
The process here is simple. Look at your spending to estimate how much you’ll spend in retirement, then see if you have enough savings, when combined with guaranteed income like Social Security or pensions, to cover your spending.
Here’s the back of the napkin math I go through to see if a client is on track to retire.
Determine Monthly Spending in Retirement:
Some advisors make this entirely too complicated, using replacement ratios of pre-retirement spending or budgets. My experience is that’s a waste of time.
Simply, I look at monthly net income, then subtract how much is left over at the end of the month. It’s a rough number, but it’s surprisingly accurate. The other good part is this assumes that you’ll keep the same standard of living in retirement. No one wants to retire into a life of tight budgeting.
So here’s a real example.
Bob makes $85,000 per year. That breaks down to $7,083.33 per month.
After his tax withholdings ($1,299.42) and 10% 401k contribution ($708.33), his net pay is $5,075.58.
Bob typically has $500 left at the end of the month, which he transfers to his savings account.
For our purposes, I would estimate that Bob needs $4,500 monthly, after taxes, in retirement to keep his current standard of living.
Using the 4% Rule to Determine Savings Needs:
Once you know your spending, you can use that to determine how much total savings you’ll need. I typically use a rule of thumb known as the 4% rule to estimate income in retirement.
The 4% rule suggests that you can withdraw 4% of your portfolio in the first year of retirement, and then adjust that amount for inflation each subsequent year, while expecting your savings to last for 30 years.
To apply this rule, multiply your anticipated annual spending by 25. The resulting figure represents the total savings you'll likely need to support that level of spending.
One item to note is that the 4% rule doesn’t take into account guaranteed income like Social Security or a pension. We correct for this by subtracting the monthly Social Security or pension benefit from the monthly amount needed.
Another Example
Our friend Bob needs $4,500 net, monthly, in retirement. He will receive $2,000 monthly in Social Security when he retires.
His net monthly need is $4,500 - $2,000, or $2,500.
To find the lump sum he needs to have saved, take $2,500 and multiply it by 12 to get his annual spending, which is $30,000. Then multiply $30,000 by 25.
Bob needs $750,000 to retire and keep his same standard of living.
Additional Considerations
Remember that the 4% rule is just a guideline and won’t suit everyone's situation. For some clients, I will use a 5% withdrawal rate. Sometimes it makes sense to have a higher withdrawal rate (6-8%) in the years leading up to Social Security eligibility, with the expectation that the withdrawal rate will drop when Social Security payments begin.
Factors such as investment returns, inflation rates, life expectancy, and changing spending needs can influence the actual safe withdrawal rate for an individual. You should consult with a financial professional who can personalize this approach based on your specific circumstances, risk tolerance, and retirement goals.
By assessing your expected monthly expenses and utilizing the 4% rule as a starting point, you'll gain valuable insights into your financial readiness for retirement. These assessments should be revisited periodically, especially after significant life changes, to ensure continued alignment with your evolving retirement vision.
Here’s what I’m reading
-Jeb
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