By ROB WILLIAMS
OCTOBER 05, 2017
Did you know that the vast majority of lottery winners blow through their money very quickly, some within just five years of their payday.1 Why? It’s simple: They fail to plan ahead.
Retirement savers face the same risk, though the average saver has far less at his disposal than lotto millionaires. Most of us understand that we need to save for retirement, and to do it, we’ve been diligently setting aside a portion of our income on a regular basis for years. But it’s far rarer—and no less important—to have a plan on how to convert savings into retirement income.
Creating income during retirement may sound daunting, but it doesn’t have to be. We recommend that you approach this challenge with three simple steps to help guide you into and through retirement: plan, allocate and distribute.
Here, we’ll take at a look at the first of these three steps: Planning.
Creating income during retirement may sound daunting, but it doesn’t have to be.
Your life, your plan
No two retirement plans are going to be the same. We each have different goals, resources and circumstances.
Your plan should encompass your vision for your retirement: what you want to do and what resources you will need to help you meet those goals. It should also involve an assessment of your savings and whether you will have outside income sources available.
Here are questions to ask yourself before you begin the planning process:
- How do you see yourself spending time in retirement?
- How much have you saved?
- What future expenses are unavoidable?
- How much do you expect to earn from a pension or Social Security?
With the answers in mind, you can move forward with the first part of retirement planning: determining whether your desired spending is achievable, given the amount you’ve saved.
How much will you need?
To evaluate whether you’ll have the money to maintain the standard of living you want, you first need to anticipate your annual spending.
One school of thought says you’ll need 75–80% of your current income. That’s based on the assumption that during retirement, certain costs—such as mortgage payments or work-related expenses like clothing and commuting—might decrease or go away. However, while some costs may be reduced, others, such as travel, entertainment and health care, may increase. Therefore, it might be safer to assume that you will need roughly the same level of annual income that you have now, minus the amount you currently save for retirement each year.
As an example, let’s take someone earning $100,000 a year and saving $10,000 for retirement. Based on the 75–80% school of thought, that person would anticipate spending between $75,000–80,000 a year in retirement. But it’s safer to assume that person will spend $90,000 annually—that is, $100,000 minus the $10,000 she is currently allocating to retirement savings.
How much can you afford to pay yourself?
Another approach is to create a more detailed budget, and more detail becomes more important as you near retirement. When you create a budget, we recommend you approach the process by breaking anticipated expenses into two groups: essential and discretionary.
Essential expenses are those you can’t do without, such as housing, food, clothing, utilities and health care. Discretionary expenses include travel, entertainment and gifts. Be sure to factor in taxes and extras, such as health care costs, long-term care and financial responsibilities to children or elderly parents. If you own your home, set aside a little extra for expenses like major appliance replacements, improvement projects and other major repairs that may occur during your retirement. You might also include known or planned future one-time expenses, such as travel early in retirement, or a large purchase.
Once you have an idea of how much you’ll spend, you can begin to calculate whether you’ll have the resources to sustain that level of spending. Before you do this, tally up all sources of income other than your portfolio, such as Social Security, pensions, rental income, etc. Then subtract that amount from your estimated expenses to determine how much of your income will come from your existing savings.
For example, let’s say you’re shooting for $90,000 in annual spending. Assuming that your non-portfolio income will amount to $30,000 per year, you will need $60,000 a year from your portfolio.
According to the Schwab Center for Financial Research, if your portfolio is roughly 25 times as large as the amount you withdraw from your portfolio in the first year of retirement, you can feel reasonably confident that your savings will last 30 years.2 So to generate the $90,000 in our example, you would need an aggregate portfolio of approximately $1.5 million ($60,000 x 25).
This is a general guideline. Another, even better approach, is to work with a financial planner to work with you through the steps above, and create your own personalized financial calculations and plan. As you near retirement, it’s a great time to discuss options and build your plan.
The planning stage can be revealing. While some investors will find themselves on target, others will discover that their current vision is out of sync with their savings. That’s never a welcome realization, but it does provide the incentive to think carefully about your spending or to delay retirement in order to bridge the gap.
It’s also important to remember that retirement income planning isn’t a one-time activity and a retirement plan isn’t a “set it and forget it” document. Rather, your retirement plan should be a working document that is reevaluated annually to account for any changing needs, preferences, spending, taxes, inflation, market conditions and life expectancy. For example, you might be comfortable spending a bit more early in retirement, if you think you’ll be able to reduce your spending later. It’s helpful to think about and talk with an advisor about alternatives as you create and regularly review your plan.
Savings falling short?
If you find that your current vision for retirement is not in sync with your savings, start thinking about different ways you can bring the two together.
Step up savings:
Take advantage of your full-earning years to put extra money away.
- Contribute the maximum to your 401(k).
- Consider opening and and funding an individual retirement account (IRA) with automatic monthly contributions.
- Make additional catch-up contributions if you’re over 50.
- Earmark bonuses, raises and tax refunds for retirement.
- Consider opening a SEP-IRA if you’re self-employed.
Spend a few more years at your current job to help preserve savings.
- Keeping your company health plan may reduce or eliminate the need for pricey private coverage before you’re eligible for Medicare.
- Working longer may allow you to delay taking Social Security. You can begin collecting benefits as early as age 62, but your payment amounts will increase the longer you wait. You’ll get your highest monthly payments by starting to take Social Security at age 70.
One of the most impactful things you can do to help your savings last is to prioritize and manage spending.
- When creating your retirement budget, ask yourself which expenses are truly essential, and which are “nice to haves.”
- To establish a comfort level with your current plan and spending rate, determine whether you’ll be able to change spending if necessary. Flexibility can have a major impact on your plan.
This may sound like a lot of work, but remember the story of the average lottery winner. You only retire once, and the stakes in having a plan are even higher. Following these steps will help guide you through the process so you can plan confidently.
1. Patt Morrison, “Lottery Winning 101: How to Not Blow $500 Million,” Southern California Public Radio, March 29, 2012.
2. This is a general estimate only. It is recommended that investors use a retirement plan calculator with Monte Carlo simulations for a more refined, customized estimate.
Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations.
This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, please consult with a qualified tax advisor, CPA, financial planner or investment manager.