A lot of Americans are struck ill thinking about how much money they need to retire. Several trade associations within the financial services industry have noted the lack of preparation both consumers and financial advisors et. al. have as it relates to turning your heard earned and saved dollars into retirement income. This problem has sparked a massive revamping of academic instruction among the industry’s best-known degree/certificate granting institutions.
This has accomplished some success in at least changing the conversation as it relates to retirement planning, but there’s still plenty of room for additional awareness and today I want to drive home a significantly important point about what it will really take to achieve comfortable retirement income.
It’s all about Cash Flow
Ultimately retirement (as is the case with your life prior to retirement) is often a success or failure largely due to ones ability to produce adequate cash flow. If the term “cash flow” itself seems a tad cryptic or daunting, think simply of income instead.
So said another way, retirement success is all about your ability to adequately provide for yourself by generating adequate income once retired. For years, pensions supplemented by social security and some degree of personal savings did a fine job of generating said income. Today, we’re mostly on our own (i.e. no pension).
We Impress ourselves way too easily
Probably the biggest threat to Americans’ retirement prospects is our relative ease of complacency or downright low expectations when it comes to just how large we think our own nest eggs should be. 401(k) account balances of a few hundred thousand dollars leave way too many people with warm and fuzzies as they think about their savings success.
Sad truth is, unless retirement is at least one decade away (and honestly it would be much better if it were more like two or more), a few hundred thousand dollar account balance should cause nothing but serious angst about what you are going to do in retirement. And here’s why…
How Much do I Need: a $50,000 Example
I want to present everyone with the following example for retirement income using the following example:
Let’s assume a normal American family needs to generate $50,000 per year in retirement income above and beyond what he and his wife will earn from social security. How much money will he and his wife need to generate such an income? Do me a favor and estimate this yourself before scrolling down to see the answer.
Before we can actually answer this question, we have to first address two variables concerning rate of return on the money that generates the income and length of time husband and wife will live.
According to the mortality tables I pulled up from the Society of Actuaries, the life expectancy assuming ultimate mortality (meaning all people of all health situations) for an American age 65 is 19 years. We’ll use that figure to assume husband and wife will both be dead by that time. We’ll use a constant 4% assumed interest rate on the money used to generate income.
So now that we know those two pieces of information, how much money do we need?
The answer is $682,964.
Now I want to be clear about what this number represents. It’s a lump sum used to generate retirement income…that’s it; nothing more.
- It’s NOT a source of funds to fix the roof on the house.
- It’s NOT an account from which you take money to buy a car and pay cash.
- It’s NOT a place to go looking if you want to go on vacation.
- It’s ONLY for the purpose of generating retirement income and it can only generate $50,000 for 19 years.
In other words, if you want to have an emergency fund beyond just the income you need to retire and you are in our hypothetical Mr. and Mrs. situation, you are going to need much more than just $682,842. You’d also better die in 19 years because at that time you’ll be completely out of money.
So what if we want to add a few years to buy ourselves some extra time? Let’s add five years and now assume both are dead by year 24.
They now need $792,842. Again, this is just for income, it’s not for bailing a kid out of trouble because he or she finds him/herself in an unfortunate financial situation.
Now, here’s the more depressing figure. What happens if all of this retirement money is in a 401(k) or traditional IRA where taking it out of the account will bring with it an income tax liability?
Making reasonable assumptions about social security income and its taxability given the income goal, I figure a need for $828,020! And this figure assumes required minimum distributions never cause you to withdraw more money than you want to and incur a higher tax liability (lofty assumption).
Retirement, it’s more Expensive than you might think
Retirement will be the singularly most financial disastrous event in your life. But that’s okay, it’s supposed to be. It's far too easy to be impressed with a low six figure account balance, but this sum of money doesn't come close to affording a comfortable retirement for most people. Don't get impressed with yourself too early…it could destroy your golden years.
If you'd like more insight on a great way to think about retirement planning, see this article we published a few years ago as a great starting point.