This was the question I was asked recently by a couple. They have wonderful income. They are great savers and have amassed a great deal of savings. And yet, they had the question: Are we financially secure for retirement?
IT’s A STATE OF BEING
For some individuals, the mode of saver is always there. They are natural at it. Whatever they make, they will save. For others, they just want to spend every cent.
A historical study by Stanford University professors looked at four year olds. The kids were offered a marshmallow. If they choose to wait, they would get a second marshmallow. If they immediately opt for the first one, that was it. Years later, the children who got two marshmallows noted that they were happier, more successful and still are married.
The answers are always open for uncertainty, but you can improve your odds for a secure retirement by knowing how much you spend, how much you have to draw on and what other income you have.
PERSONAL BALANCE SHEET
Getting back to our couple from New Jersey, they have assets worth $3,400,000. We reviewed their situation with our Certified Financial Planner, CFP, and we went through the rest of their assets. This includes their primary residence in New Jersey and their second home (future retirement home) in Florida. They have multiple retirement accounts and investment accounts. With $2,500,000 in investable assets, you would certainly think they are secure. But no, they are not.
Their income is $475,000, as he is an executive in New York in a public company. They live on less than half their income and save the rest. At 57 and age 56, they look to retire in 10 years. With this income you would think they would feel secure. Again, no, they are not.
INCOME IN RETIREMENT
They don’t have a pension. They only have social security. At today’s rates, they will receive $60,000 in Social Security each year. While they are likely to stay active, they are likely to spend less in retirement if only because they will not be paying for a daughter and son to attend school. Still, having $150,000 of income is a large nut to break. They are not feeling secure.
WHAT WILL IT TAKE TO FEEL SECURE?
For some, by nature, no matter the income or the size of the pot to draw from, some will never feel secure. Where do you start? We know now how much our couple from New Jersey is spending, and will eventually receive from Social Security. From this, we can check back into what they will need, $90,000 a year ($150,000 less $60,000 from Social Security = $90,000). On investable assets of $2,500,000, this is less than 4%. A 4% withdrawal rate has historically worked out to provide for individuals for 30 to 40 years. Another way to look at this is that the amount you need to withdrawal, $90,000 for this couple and multiply by 20, equalling $1,800,000.
For most historical time periods, this works. As a chartered financial analyst, CFA, I realized when starting retirement with high stock market valuations, followed by potentially low interest rates (high bonds prices), or a series of high inflation, 4% or 20 times the amount you need may not be enough. For our couple, they should have more than enough. There will be surprises along the way and decisions to make, but having gone through this exercise and asking what if questions, should allow this couple to feel more secure.
Preparing for retirement is not an exact science. Your plan will change the very next day after you write the plan.
But it is only in creating a plan will you realize what decisions you will have to make in the future and prepare for them now. Individuals gain comfort by making a plan and learning if they are financially secure for retirement.
By James Cornehlsen, CFA
Key Words: Income, Financial Plan, Secure for Retirement, Balance Sheet, Income