A major freak-out for anyone looking at retirement—and 40 is not too young to start worrying—is the amount they need to save toward the day they stop working. Lewis Walker, a financial planning and investment strategist at Capital Insight Group in Peachtree Corners, Ga., takes us through this knotty question.
Larry Light: Having enough money in retirement is a concept that causes many people to lose sleep.
Lewis Walker: How about sleeping well when you retire, knowing when you awake at morning’s dawning that you have sufficient income and financial reserves to fund a life of meaning and purpose while meeting your needs and those of loved ones? What’s your retirement number, the amount of money you need to live comfortably and securely, in sync with your vision?
Google the “number question” and you’ll find a range of opinions. Some sources suggest a percentage of pre-retirement income, say 75% or 85%. Why not 100%, so you don’t take a lifestyle cut? Or take your yearly retirement budget, less Social Security, pensions, etc., and multiply the remainder by 25, i.e., the oft-touted “4% rule.”
Light: Tell us about how the 4% rule works.
Walker: In year one of retirement, you withdraw 4% of your portfolio value and in subsequent years 4% plus inflation. Theoretically this should sustain a 30-year retirement. I said “theoretically.” Based on a portfolio of 50% bonds and 50% stocks, a rigid approach offers no guarantee.
But even this simple rule is a shocker of sorts. If you want $40,000 a year from such a portfolio and beyond Social Security, for example, at 4% you need a $1,000,000 portfolio. What about inflation and taxes? Applying the 4% guideline, if inflation is 2% annually, you need to withdraw 6%. To handle taxes, say at an average tax rate of 20% on ordinary income applied to qualified retirement plan withdrawals, your gross pre-tax withdrawal comes to 7.5%.
Light: A lot of folks on the verge of retirement have something to be worried about.
Walker: A 2012 Society of Actuaries survey indicated that 65% of baby boomers worried they won’t have a comfortable retirement, 72% feared they’ll have to delay retirement, and 50% thought they’d never be able to retire. The data is dated, but we suspect not much has changed. And the idea that to generate a net $40,000 a year, $3,333 a month, you need $1 million or more, sounds like fantasy. Think about this if you’re 50, and want to retire by at least 70─ it now takes $1,462,209 to buy what $1,000,000 bought 20 years ago, in 2001.
Light: What other challenges are there in retirement planning?
Walker: What’s your plan to be debt free by retirement so as to lower your need for cash flow? While you maintain adequate cash reserves and other lower-risk investments so as to ride out stock market volatility, how do you plan to grow a healthy and diversified stock portfolio to target the overall growth rate desired over time? Does your strategy include real estate or other alternative investments?
Light: Business owners have their own set of issues.
Walker: If one of your largest investments is a closely held business interest, what’s your strategy to grow the value of the enterprise so you can monetize your investment to meet your financial independence and peace-of-mind goals as you transition into whatever you see as “retirement”? As a business owner, are you aware of value acceleration strategies that grow a true enterprise with significant value as opposed to a pure lifestyle business? Do you manage your business as an investment asset?
What happens to loved ones and those who depend on you if you don’t make it to retirement?
Light: This is very sobering.
Walker: These questions are important to creating and sustaining a dynamic life centered financial plan. As we transition out of the pandemic and the economy revives, forecasters see possibilities for rising inflation and tax increases, especially for high earners, those with a propensity to save and invest. With stocks sporting high valuations in some cases, periodic dips and bouts of investor reallocations from one asset class to another are to be expected. How does all this play into your long-term financial independence quest?
Light: What else do you need to look at?
Walker: Whenever you transition to whatever you define as “retirement,” your post-career adventures, how much do you want to see in your nest egg? How much do you want in your IRA, 401(k), or other accounts to sustain a comfortable retirement? If you own a business or business interest, how much do you need to sell it for to fund the life you envision?
Relative to investments you have to consider time frames, realistic rates of return, tax rates now and future, inflation rates, and the risk you must take to reap the envisioned reward. With a business interest, how do you build value into the firm so you can sell your ownership at a price that meets your goals? With a closely held business, “value acceleration” is a key concept.
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