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 Retirement Planning: Progress & Confidence by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc. June 19, 2008 Dear Carrie, My wife and I almost max out our 401(k) and do max out contributions to our Roths annually. We are currently 46 and will have approximately $1 million put away by 62 for retirement. Am I naive in thinking that based on a 5% conservative return ($50k/yr) at retirement and Social Security at about $36k/year we should be able to live comfortably? Our house will be paid off at 62, and at age 50 we will invest in long-term care insurance. —A Reader Dear Reader, Just around the time I got your question, I read about the results of a recent survey of Americans' confidence in their ability to enjoy a comfortable retirement. The findings were eye-opening, both with respect to people's expectations about retirement and their actual financial preparations. (I'm referring to the 18th annual Retirement Confidence Survey conducted by the Employee Benefits Research Institute.) To cite just a few of its findings: Nearly half of the workers surveyed had less than $25,000 in total savings and investment. About 25% of the respondents believe they'll need less than $250,000 in capital when they leave the workforce. As that figure suggests, too few people have made the effort to figure out what they're going to need, as you're trying to do. In fact, just 47% of the respondents have tried to calculate what it would take to have a financially comfortable retirement. All of which is another way of saying: Give yourself a pat on the back for your terrific efforts, both in terms of saving and planning for retirement. Clearly you’re way ahead of the average American. I only wish more people would approach this challenge with the seriousness and dedication you've demonstrated. But at the same time, your story demonstrates just how complex the retirement challenge can be. For example, you estimate that you'll have $1 million in retirement savings when you're 62, but is that a valid assumption? You hope to be able to generate $50,000 per year from your portfolio, but would that, coupled with your Social Security benefits, be sufficient? And if it is, how big a nest egg will you need to generate that income for what will hopefully be a lengthy retirement? Here are a few thoughts to get you started: Start with your retirement budget: I suggest starting with an estimate of what your retirement lifestyle will cost. The basic (and most conservative) rule of thumb is to assume you'll need roughly the same level of income in retirement you enjoy now (or will enjoy when you're nearer to retirement). Most people assume they'll need less money than when they were working, but what they discover is that they don't really want to cut into their standard of living. Of course there are a couple of factors that could lower your expenses. In your case, you expect your house to be paid off by the time you retire, so that could help considerably (but remember you'll need something in your budget for repairs and maintenance along with property taxes and insurance). And if you've done a great job at saving, then you'll probably not need to save at the same rate you are now. On the flip side, some expenses may increase: healthcare costs, particularly if you have to buy your own insurance, and travel or other leisure activities. (I should mention here that your idea of buying long-term care insurance when you're 50 is probably a good one—but that is also an added expense.) Also remember to factor in inflation. You're hoping that you'll have $86,000 in annual income in 16 years ($50,000 from your portfolio; $36,000 from Social Security). But $86,000 in 16 years will be worth a lot less than $86,000 in today's dollars. If you're currently living on $86,000 per year, then you may need more than that when you retire (in fact, assuming a 3% annual inflation rate, you will need $138,000 in 16 years to have the same purchasing power as $86,000 provides today). Now you can figure out what kind of capital you need: Just as an example, let's say you're going to need $100,000 in inflated (i.e., 2024) dollars every year. From that figure subtract any known income sources, like Social Security and pensions. For illustrative purposes, let's use your assumption that your Social Security benefits will be $36,000 a year. That would mean your retirement portfolio needs to generate $64,000 annually. The Schwab Center for Financial Research has developed a useful rule of thumb: Assuming a retirement lasting 30 years, we believe you should be able to maintain your standard of living and keep pace with inflation as long as your retirement portfolio is 25 times as big as your first-year withdrawal. Put another way, you could withdraw up to 4% of your capital in year one, increase that amount every year for inflation, and feel reasonably sure that your money will last for another 29 years. As with all financial projections, this 4% solution isn’t a guarantee. But it's a good way of gauging your chances for a comfortable retirement. Let's apply the 4% rule to our (hypothetical) situation: If you need to withdraw $64,000 in year one, multiply that figure by 25 to get $1.6 million. In other words, if you turned 62 with $1.6 million in your retirement account, you could take out $64,000 in year one, increase that amount every year by the inflation rate, and be pretty confident your money would last for 30 years. I should point out here that this forecasting tool does not mean your portfolio would generate $64,000 every year. Some years it might grow more; some years it would grow less. What the 4% rule is saying is that you can most likely withdraw that amount each year, adjusted for inflation, for three decades and not outlive your money, provided you have a diversified portfolio with a moderate asset allocation of roughly 60% stocks, 35% fixed income and 5% cash equivalents. Finally, how are you going to get there? Don't panic if the $1.6 million figure frightens you. Remember, I don't have all your data or know much about your desired standard of living; the numbers above are all very much hypothetical. Also, I think it's important to revisit your assumptions about your portfolio's growth. Even if you started with $0 saved today but were able to save the max in your 401(k) plans and Roth IRAs—a pretty significant $41,000 per year—you could exceed $1 million in 16 years. Remember, too, that when you and your wife turn 50, you can save an additional $10,000 per year under the IRS's catch-up provision ($5,000 each). And of course there are all kinds of other ways to change the parameters of this equation. For example, if you work just a few years longer, your Social Security benefits will increase. Working a few more years also gives you more opportunities to save and gives your portfolio more time in which to grow. Many folks also embark on a second career, perhaps part-time, when they leave their current job. This can be a great boon to your financial well-being. So here's my advice. First, keep doing exactly what you're doing: saving and investing prudently for the long-term goal of retirement. Second, revisit your numbers, paying particular attention to what you think you'll need in terms of income after you've left the workforce as well as to how much your portfolio will grow over the next 16 years. This is an ideal time to sit down with a financial advisor who has expertise in retirement planning. Then you can decide if you need to save more or if you’re clearly on the path to success. Bottom line? I only wish more people thinking about retirement would follow your great example. Normally, I sign off with "good luck." But you're making your own luck. Keep up the good work. Important Disclosures The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of investment strategies mentioned may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for informational purposes only and not reflective of results you should expect to attain. (0608-4084) Return to Top |
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