How Much Money Do You Need to Retire?
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Zach – Hey everyone, Zach Holcomb here, back with this week’s blog alongside me as always I have Michael Reese, certified financial planner and president and founder of Centennial Advisors. Mike, how are you today?
Michael – Hey, doing great. I know we have a great topic this week for our conversation. I know you’re gonna wanna dive right in, right?
Zach – Absolutely and we’re gonna be talking about the age old question something we hear almost every single day here in our office. And Mike, you’ve been kind enough to print out an article on this and actually have it right here. It’s from AARP and pretty simple topic. How much money do you need to retire? But maybe it’s not as simple to answer as we think, right?
Michael – Well, what is Dr. Evil say $1 million?
Zach – With the pinkie up.
Michael – Yes, $1 million. No, that’s actually, it’s a very good question to ask because you know that the answer, honestly it’s just gonna be different for everyone because you know, no two families are the same.
Zach – Right, and you know, just to get down to it to answer that question, how much do I need? There’s some simple questions that they’ve laid out in this article that you can start to answer that can maybe help you determine that number or get close to it. So the first one is, how much are you gonna spend?
Michael – Yeah, I know this article talks about four factors, right? As you mentioned, the first one, how much are you going to spend? Now, if you do the math, if you spend $5,000 a month and your neighbor spends $10,000 a month guess what, your neighbor’s probably gonna have to have more money saved for retirement than you are. And we talk about this all the time how managing your cashflow is absolutely vital to enjoying the retirement of your dreams. And cashflow is really the relationship, Zach, between the money you have coming in and the money you have going out. So this first factor talks about, you know it really focuses on rather, the money that’s going out. How much money are you expecting to spend every month? From our perspective, we could break that down into kind of two different streams, if you will. The first would be for your basic lifestyle. When you retire, most people, they don’t want to retire into a lower standard of living. They wanna maintain standard of living. And there’s a certain amount of income or spending that you would like to engage in, if you will, in order to maintain that lifestyle. So who knows it could be anything, it just depends on you. It could be 5,000 a month. It could be 10,000 or it could be 15,000 or even more. It all depends on your circumstances. You need to identify that very clearly so you need to think about what is the standard of living? How much income or cashflow do you need in order to maintain that standard of living? Now, then the second type of cashflow that you need to think about would be the extras or the luxuries. Very often when people retire, they think, wow, I finally have time to travel. That would be an example. Or I finally have time to engage in this hobby that I’m passionate about. And so what you need to identify is first, what’s your standard of living? What kind of income do you need to support that? But then secondly, do you have additional desires that really is gonna make retirement, the retirement of your dreams? And that might be traveling, maybe once or twice a year. It might be spending time with family, grandchildren. It might be pursuing a hobby. It might be volunteering at a church, but whatever it is, if it requires money, you need to include that. So I’ll give you maybe an example here to clarify. So Zach, we had someone come in the office recently and they were working, they were earning 150,000 a year for the household, right? And so when we went through this exercise they determined, they said, “Well, gosh, we don’t know. Like we don’t know how much we’re gonna spend.” And I said, “Well, let’s kind of work backwards then. Let’s start with how much are you taking home after your retirement savings and your insurances and how much are you bringing home?” And it turned out that their take home and we did all the math. It worked out that if they could get about 8,000 a month, 96,000 a year, and we rounded that up let’s call it 100,000 a year. That would represent a good standard of living for them. That would kind of let them do what they’re doing now. And what was interesting is they said, “Wow we’re making 150 now and paying some taxes but you know that’s a lot less. Where’s a lot of our money going?” Well as we dove further, we found that they were saving about 25,000 a year in their retirement accounts. That’s where a lot of money was going and of course, a bunch of taxes as well. And we determined that, okay, based standard of living roughly 8,000 a month but they said, “You know we would love for the next 10 years to travel.” I said, “Great. How much do you think you would wanna spend traveling?” I said, “Where do you want to go?” “We wanna go to Europe. We wanna go to Australia. We wanna go to different parts of the world. Like one big trip a year.” “How much each year would you spend?” They said, “well with airfare and everything, probably oh maybe $8,000 or something.” Well, as you notice, Zach, I’ve traveled a little bit in my life and I know that could they do it on 8,000? Sure. But is that the kind of trip that’s gonna represent the retirement of their dreams? Is that going to be a true experience? And that’s not enough money. I said, “Guys, let’s do this. Why don’t we give you a budget of 12,000 a year? Let’s bump that up by 50%. 12,000 a year and you go in style, right? In fact, let’s do higher. Let’s make it 15,000 a year. For the next 10 years. We’re gonna take 150,000 of your money, set it in an account and for the next 10 years, it’s just gonna spin off. And maybe I’ll probably be like 12 years or something. We’re going to spin off 15,000 a year. You’re gonna take that 15,000 and you’re going to go you’re gonna buy first class tickets. You’re gonna stay in the great hotels. You are gonna make it a true experience and you’ve got the money to do it. Let’s do it right.” That’s an example, right? Where we said, hey, 100,000 a year pays for basic expenses an additional 15 would cover making their retirement a true dream retirement. And they don’t need it forever, they just need it for the next 10 years. So that’s an example of how this might work. So factor one, identify what are you gonna spend?
Zach – Right, great answer, Mike. So the second factor that we’re gonna be talking about is how much are you gonna earn on the money that you’ve saved for retirement? Because you don’t just want it to sit there. We want it to grow a little bit.
Michael – Yeah, you wanna invest it, right? And in the financial industry, as you know, I can truly guarantee Zach that you’re gonna earn 20% a year, right?
Zach – Oh yeah, absolutely.
Michael – Yeah, no, no, no, no, no, no, no. Obviously not.
Zach – I wish that was the case.
Michael – In my world, we don’t know what markets are going to earn during your retirement. We don’t know what they’re gonna earn next week, next month, next year. Here’s what I can tell you would make some sense though. We have found that it makes a lot of sense to take your retirement savings and break your savings into two categories and category one would be an income category and category number two would be a growth based category. And this is where we sit down with people and really help them identify how much needs to go into each of those categories. But we only assume that you’re going to earn 3% per year on the income side and we only assume that you’re gonna earn five or 6% a year on the growth side. Those are pretty low hurdles and if you can structure things where everything works at 3% on the income side and 5% on the growth side, if you can structure it where that works, then you tend to be in pretty good shape. We like to say, put enough money in the income side where at 3% you cover your spending needs for the next 20 years or so, next, 20, 25 years, and if you leave the balance in your growth accounts, hopefully if you have enough money saved, those growth accounts will grow to replace everything you’re spending in the income accounts over that 20 year period. So again, 3% of the income side, 5% of the gross side I think are reasonable targets. Always assume low. Don’t make the mistake of going into retirement and assumed too high of a rate of return. Don’t assume that, hey, just because I got 10% a year or seven or 8% a year, the last 10 years or the last 15 years that you’re gonna get that going forward, because you might not. From January 1st, 2000, for the entire first decade of the 2000s markets lost money. I mean, if you’re assuming you’re gonna earn seven or eight or even more percent rate of return and the markets lose money the first 10 years of your retirement, you are in the tank, you’re up the creek, you’re in huge trouble. Always aim low. Set low targets. You know, what do they say, you wanna hope for the best, but what do you do? You plan for the worst.
Zach – The unexpected, yeah. Or the worst, yeah. Exactly. Great answer Mike. That’s pretty cut and dry and to the point. So factor number three. Now this is a question that some people might not wanna answer, but you have to. You have to plan for how long you’re going to live.
Michael – Yeah Zach do you think most people, imagine that you talk to people who are in their 60s. Do you think the majority of people are assuming that they would live longer than their life expectancy or shorter than their life expectancy? Recognizing most of them don’t know what life expectancy is for someone their age. Now we do because we live in that world. But most people, if you’re 62 years old, you probably don’t know what average life expectancy is for a 62 year old. And the longer we live the longer your expectancy goes. So would you say, Zach, that people overestimate typically or underestimate how long they’re gonna live?
Zach – For the most part it seems like people underestimate their expectancy especially when they retire. Every single day I hear Oh, maybe another 10 or 15 years but they really just don’t know.
Michael – Yeah, they underestimate like crazy. I was talking to a couple, they were both age 61, both husband and wife, 61. And I asked them, I said, “When you think about your planning for your future, what kind of life expectancy do you think is reasonable?” And the husband said, “Well, you know all the men in my family have died before the age of 80. So if I live another 20 years, I’ll count it as a bonus. Anything past that is just, you know, like house money.” And the wife on the other hand, her family has lived into their 90s so we think she’s gonna live a long time and she was in great health. But here’s the thing is I asked a couple more questions. I said, “That’s interesting that you think you’re gonna live like anything past 80 for you.” Let’s call him John. “John anything past 80 for you is house money. John, you look like you’re in pretty good shape.” I was visiting him on a Zoom meeting like we’re talking here. I said, “You look like you’re in pretty good shape but do you have any health issues on the inside that don’t seem to show up on the outside?” He said, “No, I’m actually in great health.” And I said, “Is that different maybe than all the men in your family? Did they maybe engage in different activities? For example, did they use tobacco? Did they drink a lot? Did they not exercise? Did they not eat right? What was their health status when they were 61?” And it was interesting to watch his face, Zach because he leaned back and you could see like a light bulb go off in his mind. And he said, “Gosh, you know, this is a really good point you’re bringing up Mike, because every one, all the men in my family, it seemed like they were chain smokers. I don’t smoke at all. They were all overweight and I’m not. They’d never exercised. I exercise every day.” So I said to him, John, I said, “John, you know do you think it’s reasonable for you to assume that you’re going to have similar life expectancy as them? You take care of yourself, you exercise, you eat right, they didn’t. Do you think that you’re really comparing apples to apples there?” And he’s comment is he’s like, “Yeah, you’re right. You’re right, I’m nothing like them.” “And if you’re nothing like them do you think your life expectancy is gonna be like theirs? Yeah, it’s not, is it?” And so I said to him, I said, if I were in your shoes, and by the way, dealing with the hundreds of families that we deal with, we see this, I said, my experience has been that people who take care of themselves I mean, late 80s, early 90s is very reasonable to expect for life expectancy and when you’re married, it might go longer. But what does that mean? That means if you’re retiring at 61 and actually they were wanting to retire in the next couple of years so let’s say they retire at 63. They could be looking at 30 years, life expectancy together. That’s a long time for your money to last. And not only does it need to last it needs to grow because you also have to account for inflation over that period of time. So we call it, that’s like the hidden threat to your purchasing power is inflation and it really does add up over time. And over a 30 year retirement, it definitely plays a role.
Zach – Right, definitely. We always have to plan for the unexpected. Great points Mike. Now the fourth factor that you need to consider is how much you can withdraw from your retirement accounts each year.
Michael – Yeah, so this is the age old question. Just to give you a little history. In fact, I saw the article actually references this but in the mid 90s, I guess it was in the 90s, we saw a bit of a sea change happen. And that was that people started retiring but instead of retiring and living for 10 years, they were retiring and living for 20 years and longer. And suddenly this question, and by the way at the same time, pension plans were going away, right? So people started to retire with social security and money in their 401k. Naturally people start asking the question how much can I take out of my retirement accounts? I don’t know how long I’m going to live. How much can I take out of my retirement accounts? Or what can my withdrawal rate be and have confidence that I’m not going to run out of money? That was the question. And there was a number of studies started taking place in the 90s but the most famous came from a certified financial planner by the name of William Bengen and he was out of California. He used to be, interestingly enough, he was actually trained, he went to college as a rocket scientist, Zach. So this guy, when you talk about it takes a rocket scientist to figure something out, honestly, that’s what this guy did. He was a rocket scientist before he got into the financial industry. Anyway, what he did is he downloaded all kinds of data, historical data, and he just started looking in the past and he started asking the question how much could a person start withdrawing each year, and assume you put roughly half the money in stocks and half the money in bonds. How much could you withdraw and have your money last for a, and what he did is he did a 30 year retirement. So he wanted to say, look a lot of people are living 20 years. Let’s go longer, let’s go 30 to make sure we give ourselves a lot of wiggle room, a good margin for error. And his answer was, it depends. It depends on when you retire. In certain historical periods you could retire, you could actually withdraw 11% a year and never run out of money over 30 years. Can you imagine that?
Zach – Wow.
Michael – I mean, that’d be amazing, right? But he found what was the worst. He said, “look, I don’t care about the best. I wanna know the worst because like what’s the worst that could happen?” And he learned that the worst was about four and a half percent. And then he dropped that down, due to his conservative nature, and it was called the 4% rule. So the idea was, if you retire with say a million dollars and you might have more money, you might have less money. I’m using a million as our example, because it’s a round figure, if you retire with a million dollars saved you could withdraw 4% or $40,000 in the first year and then each year thereafter you could increase your withdrawal based upon inflation. Now, so the 4% rule was born. Then what happened after that? The 90s, great period of the markets but what happened in the early 2000s? We ended up with 10 years of the market losing money on average. And so in 2013, Morningstar they basically replicated his study. They said, look, if you take 4% and you know, think about it at that time, interest rates had dropped dramatically. Markets had lost money, Morningstar found out, they said, look, you can’t take 4%, that’s that’s too high of a number. Worst case scenario is now 2.8%. Now what’s kind of interesting is I listened to a podcast recently where William Bengen was actually interviewed. This was just in the last few weeks. And he was asked the question, cause he’s retiring right now. You know, this guy who came up with the rule, he’s now retired. And the question he was asked, well how do you treat this for yourself now? He says, “well, I started at 5%.” And his comment was the reason he thought he could start a little higher even though interest rates are a lot lower. Even though the market is crazy volatile. He said two reasons. Number one, inflation is not likely to increase as much so my future increases are not likely going to be as high as my previous study. Second is we now have technology today that can help us to recognize when markets are crashing so what we can do is we can, when markets are crashing, we can move money out of our market positions into safer positions and ride it out a little bit and those two factors allow me to increase my distributions. Now, I’ll tell you this. Unfortunately, most of the financial industry, they tend to be a little lazy. And what I mean by that is if you look at what most of the financial industry is doing, Zach is they’re simply using that. They’re still recommending the 4% rule. They’re still just setting up a static portfolio of roughly half stocks, half bonds and they don’t really change it at all. Even though the founder of that rule now says that that is not how you should be doing it. That there are better ways. We follow this very closely, as you can imagine, because this is our specialty. I tell people, if you wanna retire, you can pull 5%. You can start out at 5% provided that you structured your accounts the right way and provided that you have someone actively managing the growth side of your portfolio, the market side of your portfolio so that you are getting out of the way of those big market drops, but participating as it’s rising. So long answer to a short question but 5% is the number, the withdrawal rate number. It could be higher if you have a shorter life expectancy but that’s kind of the magic number of these days.
Zach – Right, so Mike, I have about two takeaways from this after hearing your insight on these different factors. Number one, everybody’s situation is different. We say it all the time because it’s true. Number two, you need a plan. You need a plan that works for you because what works for your neighbor might not work for yourself. So you need something tailored specific to your needs, your goals and your wants in retirement.
Michael – Yeah, that’s a great point. Everybody is different and having a customized, a personalized plan that fits your unique circumstances, that is obviously the way to go. As you like to say, Zach, an investment plan is not a retirement plan and this article right here that we’re talking about today, Really good article from AARP. I thought they did a great job on it and I thought it was certainly worthwhile for a conversation. Zach, before we wrap up today do you have any final thoughts that you can think of?
Zach – If you wanna have a customized retirement plan tailored for you, reach out to us. You can give us a call here at our office, 512-265-5000 or you can also go to our website to learn a little bit more about what we do for individuals and families going into retirement and that’s iwanttoretirewell.com. We’d love to have you reach out.
Michael – You bet and cen by the way that’s spelled C as in Charlie. C-E-N and then the word advisors A-D-V-I-S-O-R-S, iwanttoretirewell.com. I do wanna just make one last comment as we wrap up today. I’m a big believer that you work your whole life and you sacrifice and you save. I believe that retirement is the time that you truly enjoy life to its fullest. You truly deserve the retirement of your dreams. Now, in order to make that happen you just have to make some smart financial choices. You need to get a plan put together to support that dream retirement. Your money is a tool to provide you fulfillment, meaning and just all those experiences that make life great. So your best is yet to come. Make sure you take advantage of it and with that, I think it’s good time to wrap up, don’t you Zach?
Zach – Absolutely. Thanks Mike, great conversation as always. We’ll see you next week there buddy.
Michael – You bet. Enjoy your week everyone.