The Fear of Running Out of Money
Financial planning is focused on setting goals and making decisions that put you on the path to achieving those goals. Enjoying a secure and rewarding retirement is a common goal for many, and we are often asked by our clients whether they have saved enough money to retire.
How do you know if you’ve saved enough? How do you know if you are spending too much during retirement? The fear of running out of money has been especially relevant over the last few years as we have all felt the effects of higher prices caused by inflation. Additionally, it can be difficult for many individuals to shift their financial mindset as they enter their retirement years, when they begin spending the very money that they worked so hard to save during their working years.
There are a few rules of thumb in financial planning that can help offer a general idea of whether you are on track for a financially secure retirement.
Start early, and save 15% of your salary in your working years:
If you are someone just starting out in your career, one of the first things you should do, if you can swing it, is save 15% of your income. Automate the savings and learn to live without that portion of your paycheck. Start with your employer retirement plan and make sure to take full advantage of any match they offer. You may have access to a Roth account through either i) your employer retirement plan, or ii) a Roth IRA, provided your income is below the IRS phase out limits for Roth IRA contributions. There is no income limit for contributing to a Roth 401(k). We recommend building a foundation of Roth assets early in your career when your tax bracket is likely lower. The power of compounding will work wonders the earlier you begin saving, and the more you have saved in Roth accounts, the more funds you can withdraw one day in retirement, tax free. If you get a later start to saving and investing, such as in your 30’s, the percentage of your income that you allocate to retirement savings should be even higher.
How much should I save by retirement?
One way to identify a goal for the ideal minimum asset level at the time of retirement is to think of it as a multiple of your gross income. If you retire in your mid 60’s, various studies recommend having assets that make up approximately 10-17 times your gross income. For example, at the time of retirement, a person in their mid-60’s earning $100,000 annually, would need investments totaling $1,000,000 to $1,700,000. This is a very general rule of thumb to use, and in reality, your success depends on many factors, including your age at retirement, and what kind of spending habits you will have in retirement. How do you envision your lifestyle in retirement? Do you plan to travel? What do you think your budget will look like? Gaining a better understanding of your current expenses can help predict what kind of income will be necessary in the future, and then you can determine a level of investments that will support that income need. Social security and a pension, if you have one, would cover part of those expenses as well.
How much can I spend? The 4% Rule
This rule was proposed by William Bengen in 1994 and is based on a diversified portfolio of stocks and bonds. The idea is this: with the proper asset allocation, you can spend 4% of your total investments in the first year of retirement, and for each subsequent year increase the dollar withdrawal amount by the rate of inflation. The answer for you may be more nuanced because it is important to think about your runway. If you retire early at age 55, or late at age 70, your reasonable withdrawal rate will track lower or higher than 4%, all depending on your length of runway. For any retiree, it is important to monitor your withdraw rate from your portfolio each year, and you can use the 4% rule as a general guideline. Being aware of your withdrawal rate can help predict whether you are on the right path during retirement.
Comprehensive Financial Planning
These are simple rules of thumb, and everyone’s individual situation will dictate what is best for them. That is what makes retirement planning so unique and specific to the individual. If you want to take it a step further, working with a financial advisor to create a personalized comprehensive financial plan is one of the best tools to help determine if you are on track to meeting your retirement goals. During the cashflow planning process we drill down to the details specific to the individual, including:
- Create a balance sheet and determine net worth
- Project income: social security, pension, part-time work
- Project expenses: discretionary and non-discretionary
- Project growth of the portfolio
- Stress test the plan with higher inflation, lower returns, higher expenses, etc.
- Discuss recommendations
- Revisit the plan periodically to monitor and update
Certified Financial Planners are equipped to answer the question ‘am I going to run out of money?’, and if you learn you are not on track, a planner will suggest changes in your life that will help get you back on track. At the end of the day, the future is unknown and there are plenty of things to worry about in life, but with the proper planning and financial guidance, the fear of running out of money doesn’t have to be one of them.
About the Author: Martha P. Callahan, CPA, CFP®: Martha is a Certified Financial Planner™ practitioner and brings over 17 years of professional experience to FBB through various roles in finance, business development, and accounting. A Certified Public Accountant since 2012, she enjoys working closely with clients to provide comprehensive and customized planning advice to help them achieve their financial and personal goals. Martha previously worked for a registered investment advisor as the Vice President of Operations, where she focused on operations, trading, and compliance. Her multifaceted career also includes work in commercial real estate and retail development in Easton, Maryland where she had the opportunity to work with local small business owners. Martha earned her MBA from Georgetown University’s McDonough School of Business and her Bachelor of Science in Mechanical Engineering from Virginia Tech. Martha works in FBB’s eastern shore office located in Easton. She and her husband Patrick have two boys and reside nearby in Oxford, Maryland where they enjoy spending time on the water.