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Planning For A Secure Retirement

By Walter L. Guertin, CFPTM, CPA/PFS
Senior Vice President, Financial Planning

With ongoing turbulence in the financial markets, many individuals may be starting to wonder whether their long-held plans for retirement are still on track. Were they too optimistic about the future? What impact will this have on their plans?

Much of the anxiety associated with this could be reduced significantly by addressing four key questions:

  • How much money will you actually need each year to support a comfortable retirement?
  • How long will your retirement last?
  • How much will you be able to take from investments each year without depleting them?
  • What will these investments need to earn for you to achieve your retirement goals?

By exploring these four areas, you will have a better idea of whether you're "on track" or whether there's some work to do.

How Much Will You Need?

There is considerable disagreement as to how much retirees spend in retirement. Traditional rules of thumb suggest that retirees spend between 70 to 80% of their pre-retirement income. The assumption is that they spend less on clothes, transportation, taxes and savings than they did before. The TIAA-CREF Institute surveyed two thousand individuals to see how much pre-retirees expected to spend in retirement and also how much current retirees actually spent. Over half (55%) of the pre-retirees expected their spending to decline in retirement. On the other hand, the study found that only 30% of those actually in retirement experienced a drop in spending, while 20% found it went up! Furthermore, those whose spending declined found that, on average, it declined significantly less than they thought it would. However, the authors of a study entitled "Retirement Consumption: Insights from a Survey", attribute much of it to the fact that during the time of the TIAA-CREF study, the stock market was booming. Retirees, watching their nest eggs grow, felt richer and spent accordingly. The authors suggested that spending has probably declined in the wake of the current down market.

Another recent study by Georgia State University and Aon Consulting, found that while retirees spent less than they did before retirement, household expenses remained about the same. The main savings came because taxes were less and they were no longer saving for retirement. A different wrinkle was provided in a 1999 article in the Journal of Financial Planning, which noted that while initial retirement spending can be higher than pre-retirement spending, it declines as retirees grow older and do less traveling and entertaining. The study found that retirement spending declines 20 percent between the ages of 65 and 75, and even health care costs are more than offset by other declining costs. The point of citing these studies is to illustrate that it's best not to use rules of thumb to plan your retirement. Everybody is different. So, how are you different?

The best way to find out is to determine what you spend now. If you're not into tracking your expenses with any kind of detail, try this:

  1. Add up your current income sources such as salary, self employment income and other money you may be receiving. Don't count your investment income unless you have been spending it rather than reinvesting it.
  2. From this total, subtract the total income taxes that you have withheld and/or that you pay in estimated taxes. This includes federal, state and FICA. Add in any taxes you paid in April or subtract any refunds you received.
  3. Also subtract the total amount that you actually save each year. This would include contributions to a retirement plan as well as any after-tax savings earmarked for the future. Don't count money set aside to pay for trips or other big ticket items during the year. These should be considered expenses. You should also subtract out any gifts that you may have made to family members during the year.

The result should be what your current expenses are. By using your check register, you could probably start to categorize expenses such as mortgage or rent, utilities, insurance, etc. The next step is to subtract out the expenses you won't have in retirement. These may include your mortgage, any child related expenses such as college, expenses associated with your work (transportation and clothing) and any other expenses related to going to work each day.

Finally, you need to consider additional expenses that you may have as a result of being retired. Do you intend to travel more? What will be the costs associated with maintaining your health insurance coverage? Although your children will likely be grown at this stage, do you anticipate that you will still need to help them financially?

Now look at your potential income sources. If you are like most individuals, you will have Social Security and/or some type of government or private pension. You also may decide to continue to work on at least a part-time basis for a period of time during your retirement years.

The difference between your planned expenses and retirement income is what you will need to take from investments each year.

How Long Will You Need It?

Like it or not, you may live longer than you think! According to the Society of Actuaries Mortality Tables, a healthy 70-year old male has an average life expectancy of 86.3 years, while a healthy 70-year old female has an average life expectancy of 90.0 years. Together, a healthy couple has a joint life expectancy of 93.6 years. Since these figures represent averages, half live longer!

When preparing financial plans for clients, we typically assume an average life expectancy of at least 90 years. So if you're retiring at 65, you need to be planning for at least 25 years.

How Much Can You Take?

Assuming that your income needs are greater than your income, you will likely have to fund the difference through your investments. In years past, the traditional way of doing this was simply to use dividend and interest income to supplement income. As more and more people go into retirement without the benefit of a company pension, this has changed. Now, retirees count on taking a certain amount from their investments each year. The trick is to know how much to take out without running the risk of depleting retirement savings (Remember, you're living longer now!). Studies in this area have concluded that if you withdraw no more than 4% of your retirement capital each year, you will have little risk of running out.

What if you need more? Surgent and Associates, LLC, a Philadelphia-based accounting firm has done extensive analysis on this subject. This included measuring the impact of selected investment allocations and withdrawal rates over various time periods based on actual market performance from 1926 through 1995. While the various charts the firm produced were very detailed and complex, one can draw the following conclusions from this analysis:

  • The longer the retirement period, the more important it is that you have a greater percentage in stocks than in bonds. This is particularly true if your annual withdrawal rate is six percent or greater.
  • For shorter retirement periods, the opposite is true. In this case, a greater reliance on bonds over stocks may be more appropriate. This is particularly applicable for individuals who are well into their retirement years.
  • Early retirees who anticipate long payout periods should plan on lower withdrawal rates (four to five percent).
  • For stock-dominated portfolios, withdrawal rates of three to four percent are considered conservative. At these rates, retirees wishing to bequeath large estates to their heirs will likely be successful.

An important point to remember is that if most of your money is invested in retirement tax-deferred accounts such as IRAs, a larger withdrawal rate may be necessary to cover the additional income taxes that would be due on the withdrawal of these funds.

What Do Your Investments Need to Earn?

Once you have identified how much you will need and over what time period, you will be better able to determine an appropriate asset mix and, thus, a target investment return. The cornerstone of every retirement plan is to determine the investment return necessary to achieve one's financial goals. This is the key. It's not about attempting to achieve the "highest" return but, rather, the "best" return given your tolerance for risk and what you will need to achieve your retirement goals. The study cited above highlights the importance of asset allocation in retirement distribution planning. During the late nineties, those who took the all-equities route met with considerable success- then watched most of these gains evaporate over the past two years. Individuals who took a more moderate approach and established an appropriate (for them) allocation among stocks, bonds and money market funds probably suffered less anxiety and are likely to be much closer to their overall investment return target.

Getting Started

A retirement research study recently performed by the Employee Benefit Research Institute, a nonpartisan benefits think tank found that those who have tried to figure out what they need for a successful retirement appeared to be doing a better job of preparing for retirement than those who did not try at all. Over the years, we often have commented to clients that doing a retirement plan wasn't necessarily "rocket science". Let's face it, with so many "financial calculators" available today, people could do it themselves and spare the time and expense of a professional planner. However, planning is more than just "crunching" numbers. It's about touching all bases by gaining the insights of experienced planners who have worked with a variety of clients and who can relate to your personal situation. A financial professional will help you to see if you are still "on track" and, if not, can help you to identify strategies for getting there.

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