The Planner's Perspective: The Million Dollar QuestionSubmitted by US Wealth Management New Haven on November 5th, 2018
By Paul Morrone CFP®, CPA/PFS, MSA
We’ve been asked hundreds of times, “how much do I need to retire?” I think some folks may be caught off guard when I initially respond with, “I have no clue.” This may first sound like more of a quip than anything, but it is overwhelmingly true, at least without some in-depth conversations. There are a multitude of factors and assumptions that go into a comprehensive retirement plan, many of which are overlooked by online calculators and investment drawdown analysis tools. Contrary to some headlines you may read that say ‘You need $1.0mm to retire’ there is no magic number that has a uniform guarantee of success.
The biggest component of a retirement plan that varies by individual is their spending habits, and this is just one of many factors that needs to be considered. Cash flow requirements can make or break a retirement plan, and the timing of large expenditures or future purchases also have a material effect on portfolio drawdowns and overall plan success rates. A spending analysis is further complicated by long-term factors such as inflation, which essentially means we expect many things to cost more in the future than they do today. Additional uncertainties such as future income tax rates, healthcare expenditures, insurance premiums and the stability of social security and pension benefits exponentially increase the range of expected outcomes.
To illustrate this point more dramatically, we’ve seen several wealthy individuals living off little more than their social security income. They are faced with (the good problem of) having ‘too much’ money that they will never spend, at least barring anything unforeseen or a material change in spending habits. Conversely, we’ve also seen many folks with million-dollar portfolios that will blow through their entire savings within a period of 10 years or so without making drastic changes to their current spending habits – and trust me, it’s not fun to deliver that news.
In addition to spending, there is also the income variable. While most individuals are eligible for social security, some may have state, federal or private pensions in lieu of social security or as an additional retirement income stream. Each plan’s provisions, benefits and eligibility criteria vary immensely, adding additional considerations to the retirement planning process. Often, making an election to receive benefits is irrevocable and can’t be changed once made. Others may have investments that are income generating such as interest-bearing notes, rental real estate or private annuity payments that also need to be considered as long-term retirement income sources.
Once we’ve determined how much you spend and how much income you have, we need to evaluate what you have saved. This includes your financial assets, including the equity in your home, retirement plans, business assets, taxable investment accounts, etc., all of which can be used to generate retirement income. To determine expected returns on those funds, we need to evaluate your investment risk tolerance, time horizon and timetable for cash needs to figure out how much income those funds can reasonably generate annually. This is all further compounded by factors that are completely out of both the advisors and clients control such as your anticipated life expectancy, sequence of portfolio returns and unforeseen events that can alter the original plan and base assumptions.
As you can see, there is no one-size fits all approach, and definitely no one-size fits all answer what is seemingly a simple question. Making reasonable assumptions is a prudent start to the process, but more importantly than creating a plan is keeping it tailored and relevant to your ongoing needs. Changes occur each year, even if you are oblivious to them. Market returns vary, spending/savings habits change and unexpected events occur more frequently than we all like to admit. Staying on-top of your retirement plan and managing not just your assets, but your expectations as time passes, will help you prudently manage your retirement plan and not just your retirement savings.