How to figure out what you’ll need for retirement
You'll need to answer three questions: How much you have, what you plan to spend and how long you might live.
Dave Ott hears that question often from his graying clientele who are thinking of retirement. "I'm ready to quit working, but I'm not sure I can. And it would be so hard to go back to work if I had to," said Ott, partner at Acropolis Investment Management in Chesterfield, Mo.
Deciding if you can retire requires peering deep into your own soul. What would you do with yourself all day? If you plan to tour the world's finest golf courses, your budget will look a lot different than if you'll be feeding geese in the local park.
"Lots of people think of it as a number: I need X number of dollars," said Ott. "I think of it as a ratio: How much do I have, relative to what I need to spend."
So, the first step is to figure your spending. A few of us are Quicken or Mint junkies; we track every penny in and out. The rest should study their checkbooks. Look at 12 months of bank statements to get a handle on what you're spending now, advises Rick Hill, a founder at Hill Investment Group in Clayton. Figure a budget, then adjust it for your new life of loafing.
We often assume that we'll spend less in retirement than when we're working. But that's not always true. You may spend less on clothes and gas once you're not working. Your car insurance may go down. Your income taxes will be lower, too, and there's a special tax break for Social Security.
But your gas and electric bill may go up once you're hanging around the house all day. Do you plan to travel? Better budget for it. Don't forget the big-ticket bummers. How soon will you have to replace the car, or need a new roof?
You'll spend the most when you're first retired, while you're spoiling grandchildren and chasing around the countryside. You'll spend less as the knees and back give out. JPMorgan Asset Management, quoting federal estimates, says a typical 65-year-old retiree spends a little less than $49,000 the first year, dropping to $30,000 by age 75.
Medical costs may go up once you're off the company health plan. Medical spending averages 14 percent of a retiree's budget - a little higher than among younger people. A 65-year-old retiring today will spend about $4,000 a year on health care, and that will rise to $12,218 by age 85, according to the Employee Benefit Research Institute.
If you're under 65, Obamacare may be in your future. You'll be eligible for a private health insurance policy come New Year's Day no matter what your health condition. Your shrunken income may qualify you for federal subsidies. But insurance companies haven't set the premiums yet, and cost is still a great mystery.
For those age 65, Medicare doctor coverage, called Part B, costs $104 per month for most people. You'll pay more if you earn more than $85,000 per year for singles and $170,000 for couples. Uncle Sam judges your income by your tax return from two years earlier.
Part A hospital coverage is free for most people, but you'll pay a $1,184 deductible per benefit period in a hospital, and higher costs for very long hospital stays. Medicare pharmacy premiums vary.
Smart people get a Medicare supplement plan to pick up some of the things Medicare skips. The most popular Medicare supplement insurance, called "Plan F," costs $134 to $266 per month in St. Louis. Neither covers nursing homes.
Get out the calculator
Next, look at your income and savings. Add up your Social Security and pension payments. (Social Security no longer mails out annual estimates; you can get one from their website at ssa.gov.)
Subtract that from your expenses. The big number remaining is what you'll have to make up from savings.
Do you have enough? To find out, think Monte Carlo. Not James Bond's favorite gambling resort, the statistical simulation.
A Monte Carlo simulation takes the amount of money you have, looks at how it's invested, and how quickly you plan to spend it. Then it runs your portfolio through hundreds of possible investment results: bull markets, growling bears and in between. It comes out with a percentage chance that your money will run out before you plan to die.
And just when should you plan to die? There is a 45 percent chance that one spouse will live to age 90. So, better use a higher age when calculating how long your money has to last.
You can find several Monte Carlo simulators on the Internet. The illustration below is from the simulator at T. Rowe Price, (tinyurl.com/TRPMonteCarlo) the big mutual fund company.
Take a 64-year-old couple, making $80,000 per year at retirement, with $500,000 saved for retirement, mainly in a 401(k). Their savings are invested half in stocks and half in bonds. Including Social Security payments, they can spend about $4,000 a month and have an 80 percent chance of having money left at age 95.
Reduce their income to $50,000 (which means smaller Social Security payments), and their savings to $100,000, and they'll have to get along on $2,200 per month if they want an 80 percent chance of making it to age 95.
Simulations aren't guarantees. They rely mainly on how stocks and bonds have behaved in the past, and make assumptions about the future.
Today's rock-bottom interest rates are highly unusual, and could affect simulation accuracy. The low income from bonds and bank accounts makes it more likely that a retiree will be raiding his principal in the first years. That's like eating the seed corn; it can lower future returns.
The rule of thumb used to be that retirees could spend 3 or 4 percent of their savings per year, and adjust that up with inflation. Low interest rates have made that rule much more risky.
The bucket approach
Some advisers urge a three-bucket approach to investing your money. The first bucket is for money you won't be spending for many years. That bucket contains mainly stocks. You'll expect a higher return over the long run from stocks, but you'll have some crashes along the way, too. The long horizon lets you ride out the bad times.
The second bucket is for money you'll need in a year or more. That sits mainly in bonds, which are less volatile than stocks.
The third bucket is for near-term spending. It's in bank accounts, short-term bond funds, money funds and the like. That bucket should hold perhaps a year's worth of living expenses.
When the stock and bond markets slump, you live off money in the short-term bucket. When investments are doing well, you refill it.
Don't be afraid of stocks, advisers say, but don't fall in love with them. "If you're going to live for decades, you need stocks for growth," said Ott. But stocks lost half their value in 2008, and there have been five 20 percent drops since 1990.
Some retirees buy fixed annuities with their savings. These insurance company contracts guarantee a fixed monthly check for life. But today's low interest rates make them less attractive. Keep them in mind if rates rise.
What if you just don't have enough money to quit working? "Save more, spend less, work longer," Ott said. "If you're concerned, why don't you just work another year?"
Your alternative is to live a little meaner in retirement -- be the goose feeder rather than the traveling golfer.
Realize that retirement may come sooner than you think.
About 70 percent of Americans plan to work beyond age 65. But only 28 percent of current retirees actually did, according to the Employee Benefit Research Institute. In fact, most people knock off work before 65.
Nasty surprises,such as sickness and layoffs, force people out sooner than they expect. Happy surprises happen, too. At some companies, a lot of older workers have danced out the door with big severance checks.
So, for planning purposes, better figure you'll retire at 65 or a little earlier.
How much money do you need to retire? To get an idea, we ran some scenarios through the retirement income calculator at T. Rowe Price.
We assumed a married couple, just turning 65 and planning to retire this year. We assumed that both earned equal incomes, and had equal amounts saved, mainly in their retirement accounts, and expect to live on their savings and Social Security with no other income.
The resulting number is the amount they can spend per month with an 80 percent chance of their saving lasting until age 95.
Couple 1: Income before retirement, $40,000 per year. Savings, $75,000. Spending per month in retirement, $1,872.
Couple 2: Income before retirement, $60,000 per year. Savings, $100,000. Spending per month in retirement, $2,363.
Couple 3: Income before retirement, $60,000. Savings, $500,000. Spending per month in retirement, $3,638.
Couple 4: Income before retirement, $90,000. Savings, $400,000. Spending per month in retirement, $4,028.
Couple 5: Income before retirement, $150,000. Savings, $600,000. Spending per month in retirement, $5,855
Couple 6: Income before retirement, $200,000. Savings, $1 million. Spending per month in retirement, $7,661.
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