If you are leaving to go on a road trip, it is a good idea to know where you are going. Retirement is no different. Many people work hard for many years during a career, making sacrifices, raising families and doing the right things. If you are getting that itch to make that transition from working and accumulating assets to retirement and withdrawing assets, here are some basics on how that works.
Start tracking your expenses. The purpose of this exercise is not to put you on a budget, but to get you to start thinking about what you will need on a monthly or annual basis in retirement. Try and include everything and track it for about 3-6 months to see how consistent your spending is. Keep in mind, some expenses are not paid monthly, but annually. For annual expenses like vacations, HOA dues, insurance premiums or property tax, divide them by 12 so you can include that in your expenses as a monthly item. You can even further break down your expenses into two categories: Essential and Non-Essential. For some people, an expense like a well-deserved vacation is essential and non-negotiable! Be sure and label the items properly.
The next step would be to get a good handle on what sources of income will be available to you in retirement. For most people, Social Security will be their only source of guaranteed income. If you do not have a current estimate, go to www.ssa.gov to create an account and download your current estimate. If you have a spouse or partner, make sure and have them get their estimate too. Some other sources of income may be rents, royalties, pensions, deferred compensation payouts and annuity payments.
Now that you know what your expenses and income sources are, you can start thinking about what you will need to take from your portfolio during retirement. Example: Jim and Jane have determined that their monthly income need is $7000 per month. Their only source of income in retirement will be Social Security. Jim’s Social Security benefit will be $3000 at 67 and Jane’s will be $1500 at 67. Given these facts, we can see that they have a $2500 monthly “gap” in their retirement income vs. expenses.
Jim and Jane have a combined investment portfolio of $1 million and their income need from their portfolio to close the “gap” is $2500 per month, or $30,000 per year. 30,000/1,000,000= .03 or 3%. You may have heard the term withdrawal rate. Jim and Jane are planning are having a 3% withdrawal rate in retirement. Much is written about withdrawal rates. Many experts advise clients to spend roughly 3-5% from their retirement portfolio to theoretically never run out of money. There are many other factors, such as age and asset allocation, but this is a good guideline.
If you do this exercise on your own, and your withdrawal rate is way higher than 5%, you may want to reconsider your expenses or think about moving that retirement date out a bit to allow for the accumulation of more retirement savings. If your withdrawal rate is very low, you may want to think more about things that you want to do in retirement for yourself or others, such as travel or gifts.
If a person knew that they needed $30,000 to be available to them to spend on an annual basis, and would like to have it available to them within the next five years, what should they do? Just like we do not need to worry about the ups and downs of the market with money we do not need for a long time, we should worry about money we need to spend in the short term. Some would argue that 5 years away from retirement is a long time, but why take that chance. If you had retired in 2007, not knowing that a devastating recession was around the corner, and everything that you had invested was in stock, you would have had to sell shares at very low prices to accommodate your monthly spending needs. It may have even changed your plans to retire. This is not a scare tactic, but many would suggest that a safer route would be to take a few years’ worth of expenses and keep them in a safe place. If it is your company’s 401k, consider moving some of the money to a bond fund or stable value option. Call your 401k provider to see what safer options are available with part of your money. If you work with a financial planner, call them to let them know what you are thinking about and they should be able to provide that advice to you.
