I recently did a Google search, “How much do I need to retire?” This is obviously a popular query since it returned 19,600,000 results.
After scrolling past the ads, I began clicking on the responses. Excluding retirement calculators, here’s a summary of the top five answers:
- Yahoo Answers – Best Answer: $750,000
- Fidelity: Save at least 1x your income at 30, 3x at 40, 7x at 55, 10x at 67.
- Forbes: Use the 4 percent rule of thumb.
- The Motley Fool: Use either 80% of income at the time of retirement or the 4 percent rule of thumb.
- U.S. News: Multiple the difference between your projected annual retirement expenses and income by 25.
While all of the articles presented simplistic rules of thumb, U.S. News’ approach of calculating a projected annual income gap came closest to the starting point for determining how much you need to retire.
There’s No Magic Number
“How much do I need to retire?” is really asking “What is the total amount of investment assets that I need to retire?” This, in turn, implies that there’s a magic number, and once you achieve it, your retirement is set.
In addition to eliciting a simplistic rule of thumb response, this question ignores a number of factors that are crucial for planning a financially successful retirement. Ten of the more important ones are as follows:
- Projected income sources, amounts, and taxation of different types of income
- Types of investment assets and taxation of same
- Timing of retirement relative to sequence of returns
- Potential sales of real estate that can be used for retirement
- Potential use of reverse mortgages to generate tax-free retirement income
- Absence or presence of long-term care insurance
- Life insurance for surviving spouses
- Large one-time expenses that occur throughout retirement
Start With the Right Question
When planning for retirement, you need to start with the right question. The key question that everyone who is planning for retirement should be asking is, “How much annual after-tax income do I need to retire?”
This question shifts the focus of retirement planning from asset accumulation to paying for expenses. It recognizes that there are three key elements that need to be addressed:
- Income is the starting point for planning.
- After-tax income pays for expenses.
- Annual after-tax income must be calculated to match changing expense needs.
Expense needs generally vary in different stages of retirement in response to physical and mental changes associated with the aging process. Travel is typically a high priority in the first several years of retirement. Uninsured extended care expenses are often a concern of individuals in the latter stage. One-time expenses for things like new cars or home improvements will also result in spikes in expenses from time to time.
No Rule-of-Thumb Answers to the Key Retirement Planning Question
Unlike “How much do I need to retire?,” “How much annual after-tax income do I need to retire?” cannot be answered with a simple rule of thumb. It challenges you instead to do three things:
- Envision your retired self and the various expenses you’re likely to incur throughout different stages of retirement.
- Design a plan for producing the required after-tax income to pay for your projected expenses.
- Monitor and make changes to your plan as you approach retirement and throughout retirement in response to changes in your financial situation.
This approach, unlike traditional rules of thumb such as the 4% rule, requires the preparation and ongoing modification of a retirement income plan. Furthermore, its success is dependent upon consideration of the ten factors cited earlier that are crucial for planning a financially successful retirement.
Ignore Rules of Thumb and Start Planning
Retirement planning is by far the most complex type of financial planning. This begins with designing a plan that answers the question, “How much annual after-tax income do I need to retire?”
Rules of thumb are too simplistic since they fail to address individual planning needs. You only get one shot at retirement. You need to be committed to planning for your retirement if you want it to be successful.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.