Have you ever been watching TV only to be interrupted by a commercial asking you to figure out your “retirement number?” You know, everyone has one – the amount of money you need to retire. In the commercials, cheery folks walk around with their figure under their arm, smiling, while a calming voice instructs you to meet with a financial advisor today (and they just happen to know one – if you call their 800 number).
But the truth is there is no magic “retirement number” for planning your retirement income. And figuring out what kind of money you need to comfortably retire with is a process that would bore most people to sleep. It’s important to understand the complexity of your situation and realize retirement is not a one-size fits all program. Numerous factors and what-ifs must be considered in your retirement plan and most of us need to be flexible.
Let’s talk about why this is so important. And to start, we need to address the elephant in the room: interest rates.
The Big Challenge to Retirement Income: Interest Rates
In case you don’t read the papers, interest rates are low. Very low. Some countries are even offering negative interest rates on their bonds. No joke: as we write this in Fall 2016, you have to pay to lend money to Germany for 10 years. That means you may be better off hiding cash under your mattress than investing in German bonds.
Rates haven’t gone quite that low here in the U.S., but low interest rates are challenging the traditional ways of investing in retirement. A few years ago, we created this cartoon to illustrate the situation:
Once upon a time, we could put a client in a nice conservative bond portfolio spitting out between 4% and 6% a year – an income amount that would allow our clients to live comfortably while their nest egg (or principal) stayed untouched. Well, the income party is over. Anyone offering you yields of greater than 2% to 3% while guaranteeing safety of principal is likely either lying or they somehow succeeded in inventing a time machine.
Let’s take a look at a simple example:
Bob and Betty have saved $2 million for their retirement. They live in a nice area, but have modest spending habits – they need an income of $80,000 a year after taxes. If they can earn 2% on their money, they will get $40,000 a year while earning 3% will get them $60,000 a year. To reach $80,000 annually without tapping into principal, they would need to earn 4%, which could be a challenge. But wait, this is all pre-tax. Once the government takes their piece, 4% won’t be enough either. What can they do?
The short answer: they need to adjust.
Flexibility Is Key
Whether it’s low interest rates, a recession, a costly illness, or something equally catastrophic, your retirement plan should have flexibility built into it. Retirees can still have large dreams as long as they have smaller obligations.
Unfortunately, after years of spending increasing with your income, you might need to make sacrifices. Maybe you work an extra year, downsize your home, pick up a part-time job, or reschedule that trip to Europe for another year. These aren’t simple decisions. But the good news is that even small changes can have an enormous impact on how long your nest egg lasts.
Your financial advisor should be proactive in helping with these difficult conversations around building flexibility in your retirement plan – rather than focusing too much on a single number.
Retirement Income Planning: It’s More Than Just A Number
At this point, you should be asking, “Okay, but what about my retirement number?” While traditional rules of thumb can be a valuable starting point, they shouldn’t be the guiding force behind your plan. That means tossing aside the 4% spending rule. Even if you and I have the exact same spending habits, our portfolio needs could be different. For example, if your money is in taxable accounts and mine is in tax-deferred accounts, different tax rates come into play and affect how much you can ultimately spend.
There are other factors that can affect your retirement budget as well, such as: age, expected longevity, life insurance, long-term care insurance, life goals, family money, cost basis on taxable assets, geographic decisions, state taxes, estate law, and more.
The truth is, your “retirement number” is a moving target – a ballpark figure. To put it bluntly, planning for retirement isn’t a simple process at any age.
Please meet with a qualified professional, ask lots questions, and never let an advisor assign you a simple number; retirement is and always will be much more.