- 47% of survey respondents guessed,
- 23% estimated based on current living expenses,
- 11% used a retirement calculator or did some other kind of calculation and
- 5% indicated that they were given their number by a financial advisor.
Is $1 million of Savings Enough to Retire on?
The answer to this question, of course, is: It depends. The savings you will need at retirement to enable you to feel financially secure will depend on many factors, including:
- Are you single or are you planning as a couple?
- How old are you (and your spouse) and how long do you expect to live?
- How much are you (and your spouse) eligible to receive from Social Security (or your country’s social insurance program)?
- Do you have sources of income other than your savings and Social Security?
- Do you own your home and if so, how much home equity do you have?
- What are your estimated future non-recurring expenses?
- What are your estimated future recurring expenses?
- What rates of investment return will you earn on your invested assets?
- What are your spending goals and your spending strategy?
- What is your tolerance for risk and how much do you fret about your finances?
- Other factors, including actual future experience as it emerges in the future
Tom and Gina’s data and goals
Tom is currently age 66 and Gina is 63. They both are currently employed, but both are very interested in retiring in the near future if it is financially feasible. Tom’s current gross pay is $75,000 per annum and Gina’s is $50,000. They have combined savings of $1 million with roughly 50% in pre-tax accounts and 50% in after tax accounts. Tom estimates his current Social Security benefit is $21,556 per annum payable immediately and Gina estimates her current Social Security benefit (in today’s dollars) will be $18,174 if it commences at her Social Security Normal Retirement Age of 66 and 4 months. They have no pension benefits or other sources of retirement income.
Tom and Gina currently have a mortgage on their home. Their mortgage payments are $20,000 per year and they have five years of payments remaining on the mortgage. Their children are grown and off the payroll (for now) and their parents also appear to be reasonably self-sufficient. They have no significant bequest motives. They have recently been saving about $20,000 of their combined gross income per year.
Tom and Gina plan to use the equity in their home to fund their future long-term care costs. They have also set aside a reserve of $50,000 for future unexpected expenses and $25,000 in today’s dollars for funeral expenses. They would like to travel more after they retire, but have no desires to purchase a vacation home or boat, and with the exception of wanting to travel more, they would like to enjoy about the same standard of living after retirement as before.
For purposes of determining whether they can afford to retire in the near future, they decide to model what their finances would look like if they were to retire today. Based on average spending in recent years, they estimate their recurring expenses before and after retirement will be as shown in the table below.
* Expected to decrease by $20,000 per year after 5 years
** Expected to decrease by about $5,000 in two years
*** Expected to decrease by $15,000 in today’s dollars in 14 years
As shown in the above table, some of Tom and Gina’s recurring expenses are expected to be less after retirement (taxes and work-related expenses, for example) and some expenses are expected to be more (Gina’s healthcare cost, until she becomes eligible for Medicare, and travel expenses). Note that before retirement they are spending all of their gross income except for their savings of $20,000.
They have identified three of their current expenses as “non-recurring” expenses, as discussed in the footnotes to the above table. Instead of assuming that these non-recurring expenses will be incurred for the rest of their lives, they use the ABC for retired couples’ workbook to fund these non-recurring expenses over shorter expected time periods. Matching their spending to their expected expenses will increase their short-term total spending budget and decrease their long-term recurring spending budget, all things being equal.
Tom and Gina have decided that even if they both retired today, they would defer commencement of their respective Social Security benefits until they reach age 70. They determine that in order to “pay themselves” constant dollar Social Security benefits during the periods of deferral, they would have to set aside a Social Security bridge fund today of about $266,000.
The screen shot below shows the input/results tab from our ABC for Retired Couples with default assumptions and Tom and Gina’s information. A few notes:
- Tom and Gina’s Social Security benefits expected to commence at age 70 are equal to their estimated normal retirement benefits increased by 2% inflation per each year deferred and also increased by the 8% per year deferral factor for years and partial years after normal retirement age.
- Tom and Gina estimated the present value of the spousal benefits Gina is expected to receive on Tom’s death will be about $15,876.
- Tom and Gina have assumed that spending needs will decrease by 33% upon the first death within the couple
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The screen shot shows a total spending budget for the current year of $105,037 – the sum of a recurring spending budget of $65,037 and a non-recurring spending budget of $40,000. Since they plan to defer commencement of their Social Security benefits and they have no other retirement income, they anticipate that this entire amount would need to be withdrawn from their accumulated savings if they were to retire today.
Tom and Gina then go to the Asset Reserves by Expense Type tab of the workbook. For this tab, they determine which of their estimated post retirement expenses are essential and which are discretionary. For this purpose, they determine that their extra $15,000 per annum in travel costs are a discretionary expense. Their total recurring expenses (after subtracting expected non-recurring expenses) are $62,500.
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This tab shows Tom and Gina that if all the assumptions made in the workbook are realized in the future, they defer commencement of their Social Security benefits and those benefits are not reduced as part of future Social Security reform, they will have sufficient assets to fund their expected recurring and non-recurring expenses (with $56,774 left over as an additional unallocated reserve or “rainy-day fund”). It also tells them that the size of their “floor portfolio” (which includes their Social Security Bridge payment fund) should be about $1.5 million with about $.5 million available to be invested in riskier assets in their “upside portfolio.” Thus, under the floor and upside strategy, about half of their accumulated savings would be invested in low-risk investments (with sufficient liquidity to provide for their estimated Social Security Bridge payments) and about half could be invested in more risky assets.
Comparisons with other spending strategies
As noted above, because they would defer commencement of their respective Social Security benefits until age 70, they would need to set up a Social Security Bridge fund of about $266,000 to provide Tom and Gina with annual “Social Security replacement” benefits of about $52,000 per annum in today’s dollars until their Social Security benefits actually commenced. Under the 4% Rule, Tom and Gina estimated that their initial spending budget would be about $81,000 ($52,000 + .04($734,000)). It would be even less if they used the RMD approach or the 3.5% modification of the 4% Rule. Their financial advisor’s Monte Carlo model indicated that they have a 92% probability of achieving a constant-dollar spending goal of $80,000 per year. Because these other spending strategies did not separate Tom and Gina’s recurring and non-recurring expenses, they did not provide as robust information to facilitate Tom and Gina’s retirement decision.
What did they decide?
While the real purpose of this post is to illustrate the process we recommend you consider if you are contemplating retiring in the near future, we will provide some closure to our hypothetical example for the few people who have made it this far in the post. While Tom and Gina decided that they could probably afford to retire at this time and meet their spending goals under the default assumptions, they weren’t all that comfortable with spending a fairly large portion of their accumulated savings on Social Security bridge payments in the near term. There were also non-financial reasons why they did not want to fully retire today. They, therefore, performed more number-crunching exercises with our workbooks assuming different retirement dates and part-time employment alternatives. Knowing that they could actually retire today actually made them feel better about working and they decided that they could afford to increase their travel prior to retirement.
Summary
As discussed in many of our previous posts, we believe the Actuarial Approach, with its separate consideration of recurring and non-recurring expenses in retirement, is a powerful and effective tool for developing a spending budget and for making other financial decisions. We encourage you to crunch your numbers with our tools rather than simply guess or rely on results produced by less robust tools.
