Find out in 5 minutes if you have enough to retire

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My 4 year old daughter loves to work around the house to earn money. Perhaps we are a little early with these lessons. Nevertheless, when she earns money, it comes in an envelope with the words “baby doll” on it. One thing that children understand that adults seem to have forgotten is that money itself has no intrinsic value; it’s what it gives us that actually matters.

As adults, we tend to forget this until we face impending transitions such as buying a home, sending our kids off to college, and the big one: retirement. When our portfolio is hit by a major downturn, we begin to question whether we can still afford the target.

In the next few episodes, I’ll teach you a five-minute exercise to see if you have (roughly) enough to retire. Note that there are lots of rules of thumb and assumptions in this exercise that may not apply to you. If you want this to be much more complicated, it can and probably should be if you decide to walk away from work. But if you just want a spot check to see where you stand, this should do the job.

1. Figure out your expenses

If you earn more than you spend, you have earned the luxury of not having to budget. Budgeting is not an exercise that people enjoy. Unlike your working years, budgeting in retirement is not optional. Take out too little and you’ve inadvertently paid for your kids’ country club memberships. Pull out too much and you’ll run out.

Here’s a simple trick: Look at two years of annual statements from your bank accounts. Divide the total debits by 24. That’s it. This is an accurate depiction of your monthly expenses. This should include everything except what you pay for before it hits your bank account (taxes, health insurance premiums, group life insurance, etc.).

2. Break up the monthly amount to account for taxes

It is likely that the majority of your retirement savings will be taxed in one form or another. Roth IRAs and municipal bonds are notable exceptions.

If your monthly expenses are $10,000 and your effective tax rate (how many cents you lose on the dollar in taxes) is 20%, divide $10,000/0.8 to arrive at $12,500 per month. That’s the gross amount you’ll need each month to end up with $10,000 in your bank account to cover your expenses.

3. Subtract Social Security and other fixed income streams

Let’s say you and your spouse receive $5,000 a month from Social Security. This leaves a gap of $7,500 per month ($12,500-$5,000) which must come from somewhere else.

If you have a pension or annuity, you must also subtract these figures. For this example, let’s say there is a pension of $2,000 per month. Therefore, we need to take $5,500 a month from our investments.

4. Divide by 4%

The next, most important question is how much we need to save in our investment account to be able to withdraw that amount each month. The 4% “rule” has gained more widespread attention in the last year as inflation has risen and markets have been tumbling, with people wondering if it still works. There are lots of different retirement income strategies that I believe are more effective at growing your savings. However, I have not found anything better than the 4% rule to quickly determine if you are in line to have enough money saved.

Using the numbers from step three, multiply $5,500 X 12 to get your annual loss amount: $66,000. Divide $66,000/0.04 (4%) and you get $1,650,000. If this example is your exact situation and you have more than $1,650,000, you probably have enough. If you have much less, you will have to work longer, spend less, or find another way to stretch your savings.

5. Verify your situation

As I have repeatedly pointed out, this is just a back-of-the-envelope framework. Here are a few of the main things that can interrupt it:

  • If you retire before you claim Social Security. In that situation, there is a gap between the income streams and the paychecks, which would result in a withdrawal rate of more than 4% in the early years.
  • If you need long-term care late in life. This is a risk for almost everyone. It can be matched by insurance or earmarked investments. Either way, it will create a need for more money.
  • If you have a really low risk tolerance. Bill Bengen, who created the 4% framework, assumed a 50% stock/50% fixed income portfolio. If you are not willing to have 50% of your money in stocks, you will probably need to withdraw less.

A financial plan is your roadmap. It will tell you if you have enough, (mostly) confirm that it will last, and point out any other gaps in your situation. It’s imperfect and life is always changing, so I wouldn’t walk away without a plan to confirm the numbers.

This article was written by and presents the views of our contributing advisor, not the Kiplinger editorial staff. You can check advisor records with the SEC or with FINRA.

Wealth Manager, Campbell Wealth Management

Evan Beach is a Certified Financial Planner™ professional and an Accredited Wealth Management Advisor. His knowledge is concentrated on the issues that arise in relation to retirement and how to plan for them. Beach teaches retirement planning courses at several local universities and continuing education courses for CPAs. He has been quoted in and published by Yahoo Finance, CNBC, Credit.com, Fox Business, Bloomberg and US News and World Report, among others.



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