In our experience, people tend to spend as much in the first decade of retirement as they did in their pre-retirement years. This is primarily due to increased travel and active lifestyles involving high level spending.
Therefore, the process of figuring out how much is needed in retirement begins with an accurate budget that specifically delineates spending habits in the years just preceding retirement.
For example, let’s look at a couple who is getting ready to retire and have been spending $10,000 per month on living expenses. Let’s assume they would receive $2,000 per month from Social Security, and the rest of their retirement income would come from their 401-K/IRA investments. So, how large would their investment accounts need to be to generate the remaining $8,000/month they need to meet their expenses?
A rough rule of thumb is that a client needs to have about 25 times the annual retirement income needed. In our example this would be 25 times $96,000 ($8,000/ month times 12 months per year) or $2,400,000. A safe withdrawal rate would be no more than 4% per year, so 4% of $2,400,000 would be $96,000 per year or $8,000 per month.
However you do the math, the amount needed is huge and usually surprises the average person approaching retirement. It is one of the main reasons that saving for retirement should begin early in life, so investors have many decades to achieve “critical mass.”
Those who fail to save enough before retirement are faced with tough choices in order to bring expenses in line with retirement income. This might involve moving to a smaller home in a less expensive community, reducing travel and entertainment costs, or even exploring the possibility of a reverse mortgage. None of these changes are ideal, but recognizing the need to spend less than what is available as income is critical to financial stability in retirement.
The above example is simplistic, and most retirees need to go through a financial planning process to evaluate their unique situation. It is never too late to go through this process, but we encourage our clients to start as early in life as possible so the significant savings necessary for retirement security can be built over a lifetime, and reduce the need for radical change as their retirement date approaches.
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