A Three-Part Series on Making the Most of Your Retirement Dollars - Part I
In this post, we’ll explore the most important factors to consider when learning about how to make your retirement dollars last longer
Part I: Determining your income needs
Part II: Understanding different types of Income and Taxes in Retirement
Part III: How to pay less in taxes overall
I love finding a deal. No really.
Whether that’s through selling an item on OfferUp or making a big purchase like a house or a car, there are few things in life that bring me greater satisfaction than knowing I scored a deal. Even if this requires hunting and researching for hours … the payoff and reward is always worth it. Why?
Because at our core, nobody wants to pay more than they really need to. It’s never a good feeling knowing you could’ve gotten the same item for less had you waited another week, done more research, or gone to the competitor down the street.
And those same principles hold true when it comes to your retirement.
Once you’re retired, your spending will be limited to whatever amount of money you’ve managed to save and accumulate during your working years, and you’re going to need to make it last.
In this three-part post, we will explore how and where to pull your retirement income dollars from so that you can save yourself from unnecessarily paying more than you need to in taxes over your entire retirement and instead result in having extra money leftover to spend, travel, and give generously.
But first, we’ll want to start with figuring out how much retirement is going to cost.
Step1: Determine Your Income Needs
Research from multiple sources like Fidelity and CNN Money tells us that most retirees can expect to spend somewhere between 55%-80% of their previous earnings to live comfortably in retirement. This means that for a majority of retirees, their day-to-day spending won’t look all that different than before.
The traditional spending path of most retirees can be broken up into “stages” where spending is higher in earlier years then falls off as research suggests.
Financial Planner, Ty Bernicke, published in the Journal of Financial Planning that retirement spending decreases by 15% every 5 years. And that by the time a retiree reaches their late 70s, spending drops to less than half of what they were spending in their late 50s.
The one major change when it comes to your finances in retirement is that you’ll no longer have a paycheck coming in every two weeks. Making up for this lost income is going to need to come from somewhere. For most, retirement income is a combination of social security, a pension, rental income, part-time work, and distributions from investment accounts.
Now I know the word “budget” isn’t the most popular nor appealing word when it comes to personal finances. In fact, a recent study revealed over 45% of people would rather visit the dentist instead of making a budget.
Yet, here’s why it’s important … we need to know how much you’re spending so that we can accurately predict how long your investments will last and determine how best to invest your assets.
Let’s check out the example below for further context:
Step #1 - Determining Your Budget
(+) ADD UP ALL OF YOUR DIFFERENT INCOME SOURCES
(-) SUBTRACT OUT YOUR MONTHLY EXPENSES
The remaining amount you are short by is called your “Burn Rate”
Your Burn Rate is the income you’ll need to replace each month by taking withdrawals from your Investment portfolio
Helpful Pointer: When planning out your retirement budget, be sure to include room for taxes and health care as these two areas can often times be forgotten and are key players when considering expenses in retirement.
Financial Planner, William Bengen created the famed 4% Rule back in 1994 stating:
The 4% rule is a rule of thumb that suggests retirees, by having a 50% stock and 50% bond portfolio, can safely withdraw an amount equal to 4 percent of their savings during the year they retire and then adjust for inflation each subsequent year for approximately 30 years. The 4% rule is a simple rule of thumb as opposed to a hard and fast rule for retirement income and aims to provide a rough estimate of the amount of steady income a retiree can receive without depleting their retirement account.
Though once considered safe, recent research suggests that with the prior low-interest rate environment, the rule should be lowered to a 3% withdrawal rate. In my opinion, I believe the 4% rule should be nothing more than a starting point for discussions about retirement spending and safe withdrawal rates.
Here’s how the 4% rule plays out using some basic math:
EXAMPLE: If your total annual retirement spending needs are $100,000/year
The asset size of your retirement portfolio needed in today’s dollars:
Under the 4% Rule: $2,500,000
Under the 3% Rule: $3,333,333
*These numbers can be reduced to account for other Income sources such as:
Social Security, Pensions, Rental Income, and Part-time work
Taking It One Step Further Than the 4% Rule
Tip # 1: Save more today and spend less tomorrow
Seems obvious right? Unlike the stock market, this part is completely within your control and is the number one way for you to retire sooner. We understand that each season of life brings about its own host of challenges and that it is not always possible to save more, but when you can, try your best. With rising costs of living, higher inflation, and health care getting more expensive, more Americans are finding themselves working longer than previous generations.
Tip # 2: Be flexible
Retirement comes in all shapes and sizes and sometimes it requires going back to the drawing board and adjusting. Whether that be taking on a part-time job in retirement, holding off on a major purchase, or delaying retirement by a year, the key is to place yourself in the best possible position to ensure long-term success.
Tip #3: Stay invested and diversify
Let your stocks act like stocks and your bonds act like bonds. Diversification is a team effort and spreading out your investment risk will allow you to ride out market volatility and reap the benefits of long-term appreciation.
Like in life, the only thing certain is change. Whether that’s the annual return of your portfolio, inflation, or you find yourself spending more than you had planned in retirement, changes to your plan and life will occur. When this happens, it is critical to keep an eye on your spending and remember to go back to the drawing board every so often to see how future changes could have an impact on your plan.
Stay tuned for Parts II next week on understanding the various types of income and taxes in retirement.
Disclaimer: The views and opinions expressed are made as of the date of publication and are subject to change over time. The content of this website is for informational or educational purposes only. Website content is not intended as individualized investment advice, or as tax, accounting, or legal advice. It is not intended to be a recommendation or endorsement to buy or sell the specific investment. This information should not be relied upon as the sole factor in an investment-making decision. Website users are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.