Have You Got What It Takes to Retire?

According to a recent Ameriprise Financial study of 10,000 American adults between the age of 40 to 75, only 23 percent have actually crunched the numbers on readiness for retirement but a whopping 75 percent feel they are on the track to retire. Are you a member of the small group or the large group or both?

If you are one of the 23 percent, have you run your numbers based on your expected income or based on your anticipated spending? I have met only one couple who accurately nailed their spending level. Back in 2001, they were a pair of engineers who tracked every dollar of outgo. Wherever they are now, I am certain they are ready for a comfortable retirement, even after having been through a divorce.

What’s the Number?

The number is 15.9. You need 15.9 times your final gross pay in some sort of savings on the day you retire at age 65. If you estimate your final gross pay to be $80,000 per year, you will need $1,272,000 on hand when you retire. This includes retirement accounts such as 401(k), 403(b), IRA’s, or other retirement accounts. It also includes any additional savings you have amassed for your retirement. Knowing where to stash all this money is the subject of my May 2013 column, Five Tiers: Investing for Retirement with Jene Tebeaux, CFP^®, CFA^®, CAIA® of Paragon Financial Advisors. (If you would like a copy of the article, send me an email at stewart@TexasDivorceCPA.com.)

While the Ameriprise study does not address spending levels, it assumes that you live within your means and that your spending doesn’t exceed your take-home pay. Remember, your take-home pay is less than your gross pay. We are also assuming that you wish to retain your current standard of living throughout retirement with due consideration of the inevitable eroding effects of inflation. The life expectancy used in the report was age 87 for males and age 88 for females. If you believe you might live longer, you should use a number higher than 15.9. A longer life expectancy depends in part on whom you picked for your parents and grandparents.

If you qualify for Social Security benefits, your number can be as low as 11 times your gross pay. This is because Social Security benefits are valued at 4.9 times your gross pay.

If you are a teacher who expects to get a TRS pension retirement check and you do not pay into Social Security, the 11-times-pay number might or might not be the number for you. Last time I checked, the TRS benefit was intended to be high enough to have included the equivalent of Social Security benefits.

If you will get any kind of pension or monthly retirement check such as an annuity, it gets a bit trickier to figure your number. (I am not talking about a Social Security check here.) You won’t need as much in savings and retirement accounts because your pension will fill in for your cash flow needs. For divorce cases, I frequently calculate the present value of pension benefits so that people can equate an annuity or pension benefit to a retirement account. Comparing an account such as an IRA or 401(k) or 403(b) to a pension benefit is like comparing apples to oranges. Calculating the present value of a pension is like converting the oranges to apples so you can compare apples to apples. Alternately, you can mathematically reduce your cash needs by your pension benefit and then use 15.9 or 11 times your adjusted gross pay number. You can do this yourself, but it can be tricky.

If You Don’t Have What It Takes

If you don’t have what it takes to retire and you are not going to inherit a substantial sum, there are three basic things you can do.

1. Retire later. The study shows that postponing retirement until age 67 will allow almost 50% of those surveyed to have sufficient retirement income. During the two years past age 65, you can contribute extra money to your retirement and have more time for investment returns to grow. Simultaneously, you have reduced your retirement needs because you will have shortened the number of years that you will live past your retirement date.
2. Save more and spend less. You may need to increase your personal savings. If you increase your savings rate by just 1% of pay every year for the next five years and maintain that higher savings rate until you retire, there is greater likelihood that you’ll be able retire at age 65 with enough income to meet your needs. This works best for younger people and not so much for those closer to retirement. Also, reduce your living expenses. Avoid retirement plan loans and early withdrawals.
3. Manage income after retirement. The results of this study are averages and not guaranteed to fit your unique situation. You may wish to have more retirement funds in case you live longer than the average ages noted above. To cover roughly six more years of living expenses, you need to save an additional 2.4 times gross pay. Back to the $80,000 gross pay – you would need $1,464,000 on hand when you retire. It is important to invest so as to self-insure against the risk of outliving your money.

People who save for retirement over long periods of time and invest wisely have a greater chance maintaining their standard of living throughout retirement. Being optimistic about your golden years is not enough. You have to crunch the numbers and take action based on the results of your calculations. Before you adopt and rely on 15.9 or 11 or any number as the right number for your retirement planning, I recommend that you visit with a fee-only financial planner to make sure you are on track to retire comfortably… and if not, what you can do to remedy that. This is one situation where ignorance is not bliss.