How much money do you need to retire? That’s the hot topic of discussion among physicians across the country. Many of them use online tools, some simply make a guess based on what their colleagues or relatives have done, while still others follow what they have read or seen in various financial media. Unfortunately, these cookie cutter, one-size-fits-all approaches are unlikely to achieve your specific goals, and you may risk running out of money too soon or leaving money on the table that you could have used to enhance your quality of life.
To increase your likelihood of being able to enjoy retirement without financial worries, you need to have enough money saved based on your own unique situation. A variety of factors should affect your analysis, and inaccurate estimates for any one of them can leave you with way too little or too much in savings. Some of the more significant factors to focus on include:
Retirement Income Needs:
You can find various rules of thumb indicating you need anywhere from 60 percent to more than 100 percent of your pre-retirement income. On the surface, it seems like you should need less than that higher amount.
However, look carefully at your current expenses and how much you plan to spend each month or year before deciding how much you’ll need. If you pay off your mortgage, stay in good health, live in a city with a low cost of living, and engage in inexpensive hobbies, then you might get by with less than 100 percent of your pre-retirement income. However, if you plan to travel extensively, pay for health insurance, and maintain significant debt levels, even 100 percent of your previous income may not be enough. Also, depending on age, can you rely on Social Security being available for you? You need to take a close look at your cash flows, expenses and planned retirement activities to come up with a reasonable estimate.
Retirement Age:
When you plan to retire determines how long you have to save and how long investment returns can compound. Many physicians would like to retire before age 65, but that typically requires significant personal savings. You want to be sure your retirement savings and other income sources will support you for what could be a very lengthy retirement. Even reducing or extending your retirement age by a couple of years can significantly affect the ultimate amount you need.
Life Expectancy:
Most people consider the average life expectancy when estimating the length of their retirement. Keep in mind that an average life expectancy means you have a 50 percent chance of living beyond that age and a 50 percent chance of dying before that age. Since you can’t be sure which will apply to you, it’s typically better to assume you’ll live at least a few years past your expected life expectancy. Erring on the side of outliving your life expectancy will help ensure you don’t run out of money too soon. When deciding how many years to add, consider your own health as well as how long other family members have lived.
Rate of Return:
A few years ago, many retirement plans were calculated using fairly high rates of return. At a minimum, make sure your expectations are based on average returns over a very long period. You might even want to be more conservative, assuming a rate of return lower than long-term averages suggest. Even a small difference in your estimated and actual rate of return can make a big difference in your ultimate savings.
Inflation:
Even modest levels of inflation can significantly impact the purchasing power of your money over long time periods. For instance, after 30 years of just two percent inflation, your portfolio’s purchasing power will decline by 45 percent. While inflation has been unusually high recently, long-term average inflation rates tend to be much lower. The Fed typically targets a 2-3% inflation rate as healthy for the U.S. economy. Consider a long-term average rate of inflation, since your retirement could last for decades.
Retirement Tax rate:
Especially if you save significant amounts in tax-deferred investments that will be taxable when withdrawn, your tax rate can significantly affect the amount you’ll have available for spending. You may find your tax rate is the same or higher after retirement depending on distributions from retirement accounts, business interests, investment properties, or just changes to the U.S. tax code between now and when you retire. It is best to overestimate your tax rate to ensure you have enough savings.
As you can see, there is no simple or universal answer to the retirement feasibility question. Many factors must be examined. Your financial advisor should be able to assist and give you the guidance needed to attain the ultimate goal of a successful retirement.
Jeff Witz, CFP® welcomes readers’ questions. He can be reached at 800-883-8555 or at witz@mediqus.com.
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