There was a discussion over in the Money Blog Network Forums about different ways to calculate how much to save to allow a particular monthly payment during retirement. Some people responded with future value and present value functions and the 4% retirement rule. These are perfectly legitimate ways of estimating what you'll need in retirement.
Almost in jest, I posted this for a formula:
“Save X% of your income, with X being as close to 100 as possible.”
Another blogger — Lazy Man and Money, actually — responded:
“Not bad, but not very fun either.”
Which is true. But being caught short in retirement is probably even less fun! I'd argue that there's a bigger chance of being caught short in retirement if you make any assumptions about how long you're going to live, how much the return on investment will be, or how much supplemental income you'll make, rather than saving every dime you can. You'll be doing the best you can for your financial future, then. If you can save 10% comfortably, why not save 20%? If you can save 20% comfortably, why not 30%? And so on.
You can also substitute “building a business” or “earning money” for “leisure activities.” The end result is the same — more money.
A big chunk of money lets you have the luxury of being more conservative with your investments. If you have $500,000 in the bank at retirement (not a bad amount, by any means) you'll need a pretty healthy rate of return — around 12% — to get more than $1,000 $5,000/month out of that without tapping into principal. If instead you have $5,000,000 in the bank, a 5% online savings account will throw off over $20,000 per month! That's a pretty nice allowance. (Now, you'd have probably about sixty accounts so that you stay under the $100,000 FDIC limit, but that's a detail. 😉 ) Even if all you can do is 1%, that's still $50k a year — several times the poverty level.
Forgoing present consumption for future consumption is never fun. Who will bail you out if you miscalculate, though?
If you have US$5 million, you would have to be paranoid to spread it around 60 accounts to keep under the $100K limit (presumably allowing for interest) as:
1. accounting for that number of accounts will be a pain
2. you will not get the higher interest rates associated with larger deposits.
Of course you would have to be comfortable with the idea that the real value of your nest egg will slowly decline as inflation eats away at it.
Thanks for the comment, Trainee Investor.
The example with the bank accounts was more to illustrate a low-risk investment. Presumably one could do a bit better than this, but bank accounts are accessible.
"If you have $500,000 in the bank at retirement (not a bad amount, by any means) you’ll need a pretty healthy rate of return — around 12% — to get more than $1,000/month out of that without tapping into principal."
What am I missing here? 500,000 * 12% / 12 = 2,083 not 1,000.
He assumed how much he would need to retire ($45,000) without considering inflation. For someone like me in their late 20s, $45,000 is going have much less spending power when I retire in 40 years.
I believe saving for retirement is one piece of the whole pie. My current retirement plan consists of a 401k with a 15% contribution (thats including a 4% match) and a 5% Roth (which is not maxed out yet, as my income is still low). That still assures me well over a million by 65 assuming my income never increases (lets hope it does!). But I also consider future investments as part of my retirement portfolio once my other savings vehicles are funded. I put another 10% into savings and another 5% into paying down debts like the car and mortgage. Once my emergency 6 mo savings is funded and my short term emergency savings funded and debts paid, I can put that 10-15% into long term investments (unless I have an emergency I suppose!)…then use the rest of my income for bills/spending accounts.
Having 4% out of your retirement accounts would be perfect for an income to pay all your fixed expenses, but it would be nice to have other investments to draw on as spending money so you don't have to worry so much about keeping its principle.
Here's what I don't get, though: why is there no desire to touch the principle? I understand the concept of 4% per year, but why? Isn't the goal to _use_ the money in retirement? If you have $1mm sitting in an account at 62, and still have the same amount at 92, can someone explain why? To me, the perfect amount to pull in retirement draws a small amount of principle each time, but leaves almost no principle remaining upon death. Of course, you cannot absolutely predict death, but if you arrange withdrawls until you're 110, you'll probably be pretty close!
I'm with Tom on this. I have no inclination to leave a great deal of money behind if I die when I'm old (should the fountain of eternal youth be out of order). I think its hard to get the amount out in practice and also that a lot of people want to leave a legacy – especially people who are currently in their retirement.
This is the basis of economics – give up in the short term to benefit in the long term. the problem being, of course, that nothing is that simple. I can scrimp and save, have no luxuries, and die at the age of 40 without ever enjoying life and leaving a nice huge inheritance – or I can balance it all out, have a healthy life of work and play, so if I die at 40 I may leave a little or nothing at all, but will have lead a good life.
It's really up to your own personal opinions – be miserly because money is what matters, or be wordly and have the experiences that live with you forever, even after the economy crashes (or soars, or whatever).
Cute.
I'm more of a 4% guy myself, though. 😉
"Who will bail you out if you miscalculate, though?"
We're going to find out, because with like 50% of Americans having less than $25K saved for retirement, it's going to get ugly.
Kurt, actually I think we both screwed up the calculation, but thanks for catching the mistake! (That'll teach me to do things in my head that late at night.) 12% per year is about 1% per month, which is about $5,000/month — not $1,000 like I had or $2,000 like you had.
As for not touching the principal, wouldn't it be nice knowing that you're wealth pays for your lifestyle? If your investments throw off $20k per month and you're only spending $10k/month, you aren't going to go broke.
Life expectancy is an important part of the equation, since not all of us can expect to solely live off of the income generated by our savings. Most of us will need to plan on drawing down that savings, so having an idea of how long we'll be drawing down is as important as knowing how much. And since life expectancies are continually, slowly creeping upwards, I find it difficult to say that you're ever saving too much.
"Kurt, actually I think we both screwed up the calculation, but thanks for catching the mistake! (That’ll teach me to do things in my head that late at night.) 12% per year is about 1% per month, which is about $5,000/month — not $1,000 like I had or $2,000 like you had."
My gut was right — my, um, calculator was wrong. What on earth did I key in there…
At least we're tied.
Oh, for some reason I was using the 5% from the second example! That's what I get for quickly looking up.
One thing people forget about when they are planning for retirement is that a lot of their income may not be taxed the same way their earned income is. So, for example, if you currently make $100,000 a year and pay an average tax rate of 33% (roughly 25% effective income tax plus payroll taxes), this is equivalent to the income stream you'd get by withdrawing $78,824 out of a taxable investment account, assuming you pay capital gains on everything (some of it would be your basis, of course).
Other source have different dynamics (roths will have zero taxes, IRAs will have the full 25%, but not the payroll).
Food for thought.
The kicker here is that it's almost impossible to predict how much cash you're going to need per month when you retire. Impossible to accurately calculate. We have no clue what things will cost 25 years in the future, especially health insurance! Who knows what our habits as old retirees will be (will we vacation more or less, eat out more or less, etc etc.)
So I am aiming for $1 million for starters and then I am not stopping once I get there.
Thanks for the link…
I guess my point could be summed up in an answer to this… "As for not touching the principal, wouldn’t it be nice knowing that you’re wealth pays for your lifestyle?"
What if it takes you so long to save that your body and/or mind can no longer perform for that lifestyle?
I like the idea of not making any assumptions, but it's impossible not to do. One can't assume that bank's will be able to give you a safe 5% in the future. What if the US dollar loses so much of it's value that $20,000 a month doesn't get you very much? So much can happen…
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