Will Your Retirement Income Be Enough?

How much money will you need to retire? Probably more than you think.

Extended life spans, reduced employer benefits, lower stock market returns and increased costs of living (especially medical-related ones) have all upped the sums required for those sunset years. Unfortunately, most Americans are doing a poor job of securing their future. The Employee Benefits Research Institute reports that if current trends continue, by 2030, the annual shortfall between the amount retired Americans need and the amount they actually have will be at least $45 billion. According to a recent survey from Allianz Life, 28% of workers between ages 55 to 65 are concerned they won't be able to cover basic living expenses in retirement. If you want to avoid having to flip burgers at age 75, one of the best things you can do for yourself is to calculate now how much you'll need in the future.

Can you retire with $1 million dollars? Of course you can. Truth be told, you might be able to retire with much less. Then again, you might not be able to retire with $1 million or $2 million or perhaps even $10 million. It all depends on your personal situation.

Typically, we see three categories of people trying to decide if they are ready to retire:

1. "Of course you can retire! Live it up and enjoy!" If you are at least in your 70s with reasonable expenses, there is a good chance you and your $1 million fall in this category.
2. "The probability for your retirement looks good. Just don't go crazy and buy a Porsche." If you are at least 62 and have always lived a frugal lifestyle, then you and your $1 million are likely going to fall in this category.
3. "Let's redefine retirement for you." This is just about everyone else, including early retirees with $1 million living frugally and 70-year-olds with $1 million spending lavishly.

Many advisors and financial professionals boil the answer down to one number, also known as the holy grail of retirement analysis: the 4% sustainable withdrawal rate. Essentially, this is the amount you can withdraw through thick and thin and still expect your portfolio to last at least 30 years, if not longer. This should help determine how long your retirement savings will last, and will help you determine how much money you need for the retirement you want. Of course, not everyone agrees that this withdrawal rate is sustainable in today's financial environment.

If you are 65 with $1 million in savings, you can expect your portfolio of properly diversified investments to provide $40,000 per year (in today's dollars) until you are 95. Add that to your Social Security income and you should be bringing in roughly $70,000 a year.

Now, if this isn't enough for you to maintain the lifestyle you want, you have come to your unfortunate answer rather quickly: No, you cannot retire with $1 million.

Now wait a minute, you say, what about my spouse, who is also getting Social Security? What if I'm 75, not 65? What if I want to die broke? What if I'm getting a government pension and benefits? What if I'm planning to retire in Costa Rica? There are many "what ifs," but the math is still the math: if you plan on needing a lot more than $40,000 from your retirement nest egg, then the probability of a successful retirement on $1 million is not good.

And early retirement, meaning before Social Security and Medicare kick in, with only $1 million, is extremely risky. You leave yourself with so few options if things go terribly wrong. Sure, you can go to Costa Rica and eat fish tacos every day. But what if you want to move back to the U.S.? What if you want to change? Having more money set aside will provide you with more flexibility and increase the likelihood of continued financial independence to do what you want within reason until the day you die. If you are forced to stay in Costa Rica or get a job, then you didn't make a good decision and plan.

Many books and articles discuss longevity risks, sequence of returns, healthcare costs and debt. But knowing how much you need to retire still boils down to projecting your future expenses until the day you die. Ideally, that yearly figure will add up to less than 4% of your nest egg.

So a $1 million dollar portfolio should give you, at most, $40,000 to budget. If you are forced to take out more than $40,000 adjusted for time during your retirement, you are tempting fate and relying on luck to get you by. So, if you want at least $40,000 per year, $1 million is really the least amount of money, the bare minimum, you should have before you launch into retirement.

"If you’ve only saved $1 million and are withdrawing 4% or more in retirement, you are most likely tempted to expose your accounts to more risk to make up for the lack of savings. With more exposure to a volatile market, there is a greater chance your retirement accounts will incur substantial losses during market corrections," says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

Retirement planning means maximizing your lifestyle while maintaining a high probability of being able to maintain that lifestyle until the day you die. So scraping together a bare minimum nest egg is like an explorer heading into the jungle for a week with just-enough supplies. What if something happens? Why not take extra? "People do not plan properly for income in retirement because they don’t really think about Social Security properly, they compartmentalize their assets, they don’t think about how everything they own can create income, they fail to appreciate the power of leverage in retirement. It is not especially risky to have just $1 million in retirement assets if you own things that can be turned into retirement income," says Tracy Ann Miller, CFP®, CEO and chief portfolio officer, Portfolio Wealth Advisors, Oklahoma City, Okla.

So, once you have your $1 million, concentrate on what you can control or, at least, influence. You can't control when you die, but you can affect your health costs by doing your best to stay healthy until you qualify for Medicare. You can't control investment returns but you can affect the range of returns. You can't control inflation but you can affect your fixed costs and your variable costs.

A few quick bits on expenses and spending. To a certain extent, retirement planning is the art of accurately matching future income with expenses. People seem to ignore certain expenses. For example, family vacations and a grandchild's wedding gift count the same as dental surgery and car repairs in retirement planning, but people neither include these enjoyable expenses when they are projecting their costs nor do they recognize how hard it is to cut them. Try telling one child that you can't help with his nuptuals after paying for your other children's weddings!

"Often pre-retirees credit themselves with more control over spending than is realistic. Life’s wants quickly become needs. Rather than despair over spending more than you predicted, I suggest saving more to provide a reserve for these and other unforeseen contingencies," says Elyse Foster, CFP®, founder of Harbor Financial Group in Boulder, Colo.

If you want to retire with $1 million, it is going to come down to a combination of: 1) how you define retirement; 2) your personal inventory of everything in your life, such as assets, debts, medical, family; and 3) what the future holds.

You can retire with $1 million dollars, but it's better to be safe than sorry – shoot for $2 million. You want to make sure your retirement years are not merely a struggle for existence.

Let's look at the retirement-money issue another way: not in terms of how big a sum you should have, but how much you should be socking away annually.

Ten percent is the historical recommended savings rate. However, there is an extreme mismatch between this optimal savings rate and the actual savings rate among Americans today. According to the St. Louis Federal Reserve Bank, and other reports, the U.S. consumer's savings rate is less than 5%.

Let's look at how these assumptions could play out for a future retiree.

We'll start with how saving 5% of your earnings during your working life would play out when it's time to retire. 

Let’s assume that Beth, a 30-year-old, makes $40,000 per year and expects 3.8% raises until retirement at age 67. Further, with a diversified portfolio of stock and bond mutual funds, Beth expects a return of 6% annually on her retirement contributions. 

With a 5% savings rate throughout her working life, Beth will have $423,754 saved up (in 2051 dollars) at age 67. If Beth needs 85% of her pre-retirement income to live on and also receives Social Security, then her 5% retirement savings are significantly short of the mark.

To match 85% of her pre-retirement income in retirement, Beth needs $1.3 million at age 67. A 5% savings rate doesn't even place her savings at 50% of the funds she'll need.

Clearly, a 5% retirement savings rate isn’t enough.

Keeping the above assumptions about her salary and expectations, a 10% savings rate yields Beth $847,528 (in 2051 dollars) at age 67. Her projected needs remain the same at $1.3 million. So even at a 10% savings rate, Beth misses her preferred savings amount. (For more, see: How to Save More for Your Retirement.)

If Beth pumps up her savings rate to 15%, then she reaches the $1.3 million (2051) amount. Adding in anticipated Social Security, her retirement will be funded.

Does this mean that individuals who don’t save 15% of their income will be doomed to a sub-standard retirement? Not necessarily.

As with any future projection scenario, we’ve made certain conservative assumptions. Investment returns might be higher than 6% annually. Beth might live in a low-cost-of-living area where housing, taxes, and living expenses are below the U.S. averages (see Least Expensive States to Retire In). She might need less than 85% of her pre-retirement income, or she may choose to work until age 70. In a rosy case, Beth’s salary might grow faster than 3.8% annually. All of these optimistic possibilities would net a greater retirement fund and lower living expenses while in retirement. Consequently, in a best-case scenario, Beth could save less than 15% and have a sufficient nest egg for retirement.

What if the initial assumptions are too optimistic? A more pessimistic scenario includes the possibility that Social Security payments might be lower than now. Or Beth may not continue on the same positive financial trajectory. Or, Beth might live in Chicago, Los Angeles, New York or another high-cost-of-living region (see The Most Expensive States to Retire In) where expenses are much higher than in the rest of the country. With these gloomier hypotheses, even the 15% savings rate might be insufficient for a comfortable retirement.

If you've reached mid-career without saving as much as these numbers say that should have put aside, it's important to plan for extra savings or income streams from now on to make up for this shortfall. (For more, see How to Catch Up with Your Retirement Savings and The Income Property: Your Late-In-Life Retirement Plan.) Alternatively, you could plan to retire in a location with a lower cost of living, so that you will need less. You can also plan to work longer, which will augment your Social Security benefits, as well as your earnings, of course.

If you're looking for a single number to be your retirement nest egg goal, there are guidelines to help you set one. Some advisors recommend saving 12 times your annual salary. Under this rule, a 66-year-old $100,000 earner would need $1.2 million at retirement. But, as the former examples suggest – and given that the future is unknowable – there is no perfect retirement savings percentage or target number.

Instead of thinking in terms of specific nest egg amounts like $1 million)or savings rates, your first step in planning is determining how much you'll need.

Many studies indicate that retirees will need between 70% to even 100% of their pre-retirement income to maintain their current standard of living. So, a reasonable target is one that will provide you with an annual income similar to the income you have now. Then you need to consider a "safe" withdrawal rate. This is the percentage of your retirement nest egg you will withdraw each year during your retirement. As noted above, 4% is the traditional benchmark figure, but 5% to 6% might be more realistic. This provides a quick and dirty formula for determining the total amount you need to save by retirement: divide your desired annual income by the withdrawal rate.

When calculating your target nest egg, and how much you have to save each month to reach that target, there are many factors that come into play:

• Your current age.
• Intended retirement age.
• Life expectancy.
• Current earnings.
• Income sources during retirement.
• Amount of current retirement savings.
• Expected savings contributions.
• Cash outflows during retirement.
• Portfolio risk/return.
• Inflation.

Of all of these, perhaps the third-to-last is the most important – or at least, the most controllable. "Having a firm grasp on your living expenses is critical to retirement success. It is far better to understand your situation when you can be proactive and make adjustments, rather than waiting for a crisis to erupt and being forced into action. As it is said, 'an ounce of precaution beats a pound of cure,'" says Jack Brkich III, CFP®, founder of JMB Financial Managers, Inc., in Irvine, Calif.

Once you have an idea of how to determine how much you need, it's time to start using the tools available to you. Today, those defined-benefit plans have become virtually extinct, shifting the burden of retirement savings away from corporations and onto the employees. So bone up on the tax-advantaged benefits of of 401(k) plans, IRAs and Roth IRAs, and figure on how to maximize their use.

No one knows the future or what savings rate is enough. Nor do we know our eventual investment returns. But savers can control how much they save – and understand how returns compound. Because of the magic of interest generating interest, the earlier you start, the less you'll have to save on a monthly basis.

Clearly, planning for retirement is not something that you do shortly before you stop working. Rather, it's a lifelong process. Throughout your working years, your planning will undergo a series of stages in which you will evaluate your progress and targets and make decisions to ensure you reach them. 

A successful retirement depends largely not only on your own ability to save and invest wisely, but also on your ability to plan. Remember, stuff happens in life. Do you really want to start this 30-plus year adventure with the bare minimum? Just getting by isn't a good way to start decades of unemployment and diminishing employability. If something unexpected happens, what are your options? Re-enter the workforce, change your lifestyle or get more aggressive with your investments? This is the equivalent of doubling down in blackjack: it can work, but we wouldn't bet on it – more than once.

"Retirement should be a change of occupation, a chance to do what you want to do. We all only have so much time to do something until our bodies fail us and we can do less and less," says Wes Shannon, CFP®, founder of SJK Financial Planning, LLC, in Hurst, Texas. How much income you'll need in retirement is hard to know, and tricky to plan. But one thing's for sure: It's much better when you are over-prepared than when you wing it.