Disclaimer: This post will fly directly in the face of all conventional wisdom with regards to planning for your retirement. I’ve been directly involved in all sides of the retirement planning industry (stocks, qualified plans, all types of annuities, insurance, discounted cashflows, bonds, mutual funds, structured deposits, separately managed accounts, private equity etc.). And I say all that not to impress you in any way… but just to let you know that I’ve peeked behind the curtain, seen the Wizard and I’m not impressed.
Now that we got that out of the way, I can spend less time talking about what’s wrong with the retirement planning advice business and more time talking about what we can all do better. What we can do better for our clients, for ourselves and for everyone we know.
Somewhere along the way, retirement planning and particularly retirement income planning came completely off the tracks.
When exactly did this train wreck happen?
I’ve done my homework and it’s really hard to put a finger on the exact date when things went awry, however, the problem really began to rear its head sometime in the early 1980’s. This is when corporate boards and executives decided it would really be in the best interest of their employees (nudging each other with elbows) to adopt defined contribution plans (IRS subsection 401k) in lieu of the defined benefit plans (or more commonly known as pensions) that had been the norm for the previous 60 years or so.
So, this immediately put the responsibility of providing a retirement income squarely on the shoulders of the employee.
Please don’t misunderstand me. I’m very much in favor of personal responsibility and seizing the opportunity to control your own destiny.
You Are Responsible For Your Retirement Income
In other words, I would never suggest that my retirement or yours is the responsibility of an employer or of the government for that matter.
The problem with almost all of the advice that people have been given over the last couple of decades is that it heavily relies on a “pie in the sky” rate of return assumption. Most financial “gurus” will suggest that if you save at least 10% of your gross earnings and earn a 10% average rate of return, then you’ll be all set.
I disagree with that assumption.
Within that flawed logic, you are too heavily relying on the rate that you earn over your working life. I hate to break the news to you, but you have absolutely no control over that rate. Furthermore, to average 10% you’d have to do something akin to a very successful streak of winning at the blackjack tables in Vegas.
And whoever came up with some static percentage as a “rule of thumb” for how much of your income should be dedicated to retirement savings? This figure can vary wildly depending upon how much money you make, how much income you need later on, and what your goals are.
That’s perhaps the weakest link in the strategy.
Honestly, this is just the wrong way to solve the retirement income problem.
So, what’s the right way to figure this out?
I’m glad you asked.
Actually, it’s pretty easy and it is a throwback to a bygone era when people actually used absolutes to plan for the future. Who’da thunk?
Okay I’m done being sarcastic…I promise (scout’s honor)
What’s old is new again.
I’m suggesting the way you should really plan for your future retirement is to figure out how much money you’ll need to live comfortably in the future. How do you do that? Well, the best methodology is to be realistic.
Determine what expenses you’ll have–to the best of your ability, how much you’d like to have for leisure etc. Then you’ll just back into how much you need to save to create that income.
You don’t have to be a math wizard like our resident mathemagician, Brandon Roberts. In fact, you can use a few different online calculators to help you and have your answer in a matter of minutes.
Simple Strategy to find your “number”
1. Go to http://immediateannuities.com –Fill in your resident state, what age you plan to retire (the calculations are based on your life expectancy) and the amount of monthly income you’d like to have when you get there. For now, just ignore the “joint life/spousal information”
2. Press Calculate and a new page will pop up with tons of information. Scroll down to the option that says “Single Life Income with Installment Refund Paid to Beneficiaries (“IR”)” This is the best number to use for figuring out how much you’ll need.
Your screen will look like this:
3. Now you have the “number” that you’ll need to have in your bucket to generate the income you desire. HOWEVER, this is only if you retired today. So, in other words, you’re not quite done.
5. Don’t be intimidated. You should see this:
6. You’re going to take whatever the amount was from immediateannuities.com and plug it into the FV (future value) field.
7. In the rate field, put in 4. This is the rate we’re going to inflate the money over the next however many years. We use 4% because that’s what the CSO tables use and we’re comfortable with that.
8. Then we put in the number of periods. In my example, I used 32 periods because I was performing the calculation on myself. I’m 35 and planning to retire at 67, thus 32 years away.
9. Finally we click the button labeled “PMT” and the number we need to save on an annual basis to generate the inflation adjusted income we’re searching for will appear in the PMT field. In my example, it’s $14,501.
So, what does all this tell us…
It tells us that we better get serious about stashing away some cash to take care of ourselves down the road.
Many traditional financial planning types will propose that my methodology is archane, crude, and far too simplistic. They’ll say that using a 4% rate assumption is far too conservative a number and that the market has averaged closer to 8% throughout history. (If you believe that then you should check out my post on compound annual growth rates.)
But what if you assume an 8% return and only average 6%?
I’ll tell you what…you’re either not retiring when you wanted to, or you’re accepting a lower standard of living in retirement. Those are your only two options at that point.
I don’t know about you, but I’d rather plan on earning a lower rate over my lifetime and be pleasantly surprised when I do better. See, if I plan on 4% then I’ll save more money than a guy who plans on 8%. The engine of my plan is driven by the amount of my savings and is not as dependent upon an unrealistic rate of return.
In that scenario, who has more control?
I can control how much I save; he can’t control what his rate of return will be.
So, next time you hear some talking heads blabbering on about how to plan for your retirement, keep in mind that the way it was done years ago, is still the right way. Plan on what you know you’ll need to generate the income you want, and save enough money factoring a very conservative interest rate to get you to your destination.
Then you don’t need a company pension, you’ve saved enough money to make your own pension that works every time. This sort of planning doesn't rely on some overly complicated models based on probability and statistics.
There will come a day when we all have to generate an income from our retirement savings, that’s not probable–that is a certainty. And you’ll be much better off having a certain strategy to get you there.
If you’d like to learn more about how we help people plan this way, contact us—we’re always happy to help.