Whether your retirement is just around the corner or years away, ensuring your preparations are in order can be the centerpiece of an effective retirement strategy. This is especially critical when you consider that approximately 4 out of 10 households are predicted to run short of money in retirement.
While you may feel like you have a nest egg prepared for retirement, even those with a large amount of savings can be derailed without proper planning. Do you know what your budget will be in retirement and are sure your savings can meet your spending needs? Have you planned for things, such as healthcare, which may be out of your control? Are you spending nearly every dollar that comes in?
The question becomes not how much money do you have saved for retirement, but how can you assess your approach? Read on for 3 steps you can take to find out.
Cash Flow is King
It’s important to understand the principle of cash flow. Cash flow is the net amount of cash moving in to and out of your accounts at any given time. The key word here is “time.” Cash flow can be best understood through the lens of a given timeframe.
Keeping a close eye on your cash flow may provide you with a better understanding of your financial flexibility. The biggest balancing act retirees face is “money in” versus “money out.” Knowing this metric is central to building a strong retirement strategy.
There are 4 main types of cash flow to consider when creating a retirement strategy: the interest your accounts accrue, the dividends you may receive, the capital gains you may receive from the sale of an investment or property, and finally, your original investment.
Step 1: Identify Your Retirement Vehicles
If you’ve been saving and contributing to your retirement funds over the years, you should be on the right track! You may find it a helpful first step to identify and evaluate the strength of your savings from those years. Gathering this information can take a bit of effort, but it’s an important undertaking.
If you have been through the death of a spouse, a divorce, or have been working for many years, there may be accounts that you have forgotten, left behind, not consolidated into your new accounts or didn’t realize existed. Try to identify prior jobs, banks, insurance policies, etc. that might have been overlooked as the years passed to help you locate any potential missing assets. Many states have a way to find unclaimed funds from old bank accounts, etc. Check the Treasurer’s office in your state or other states you have lived to see if they offer a way to find unclaimed funds. This is a good place to start, but don’t hesitate to contact your accountant or financial advisor for help.
There are 4 general sources of retirement income in retirement:
- Social Security
- Personal Savings and Investments
- Retirement Accounts
- Continued Employment
Step 2: Estimate Your Costs
With your income sources in mind, it’s time to think about expenses. Knowing how much you expect to spend in retirement is crucial to establishing a strategy that works for you. However, estimating future expenses and creating a pragmatic budget for a lifestyle you don’t have yet can be difficult, even for the math whizzes among us. Luckily, there is a simple method that doesn’t require a spreadsheet.
First, take a look at your current annual income. In general, retirees spend about 80% of their current income per year in retirement, so if your estimated pre-retirement income is a hypothetical $100,000 a year, you can plan on spending about $80,000 annually in retirement.
Sounds simple enough, but you still have to budget beyond that amount. Think of your 80% as a place to start. This idea is for informational purposes only and should not be considered a substitute for a more comprehensive retirement strategy.
Next, consider the factors that will come into play once you retire. Things like changes in your lifestyle. Will you travel more? Take up new hobbies that require extra funds? Remember to factor in your anticipated medical care costs.
For a more precise estimate of your costs, consider repeating this exercise, but over a 3-year and 5-year time period. This may help you see how consistent your spending is, in order to further anticipate the costs, you could accrue in retirement.
Step 3: Time for Some Math
Now for the fun part: you’re going to compare your estimated costs against your scheduled retirement disbursements. At this point, you may come to the realization that your cash flow is less than your anticipated retirement costs. While it can be unsettling, this is valuable information that you can use to modify your strategy, with the help of your advisor.
However, if you have been working with a financial professional for a while, you may have a more positive outlook about what’s ahead. As always, we are available to help or answer any questions you may have.
Save Enough, Withdraw Enough
With life expectancies growing, it’s understandable that Americans may worry about saving too little for retirement, not planning properly for their wealth to sustain them through retirement or running out of money halfway through. But with careful preparation, you can allow for a well-balanced withdrawal strategy. Ultimately, the longevity of your savings comes down to two factors: how much you have saved, and how quickly you take money out of your accounts.
One strategy is to only draw down the investment gains you experience and leave your principal balance alone. Another approach is to follow the 4% rule, which recommends that you withdraw 4% of your account balance in your first year of retirement, then increase your withdrawal rate each year to allow for inflation. So, a retiree with a $1 million portfolio could take out $40,000 in year one. This example illustrates the concept of the 4% rule and should not be considered a substitute for a more-comprehensive retirement strategy.
Keep in mind the Required Minimum Distributions (RMD) you must take in retirement. The Internal Revenue Service (IRS) publishes RMD tables to help determine the amount you should withdraw and illustrate the minimum age one must be to withdraw annually from certain retirement accounts to avoid tax penalties. Are you update to date on the rules regarding RMDs?
Have a Conversation
Whether you’ve been prudently tucking away your nest egg for years or find the thought of tallying up all those figures overwhelming, it’s important to keep the conversation open.
Discussing the future with your financial professional can help you keep a clear picture of what lies ahead and get over any mental hurdles. Together, we can work toward a cash flow strategy that lasts well into retirement and beyond.
Please remember that different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this content, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for you or your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Searcy Financial Services, Inc.
The content of this letter does not constitute a tax or legal opinion. Always consult with a competent professional service provider for advice on tax or legal matters specific to your situation. To the extent that a reader has any questions regarding the applicability of any specific issue discussed in this content, he/she is encouraged to consult with the professional advisor of his/her choosing.
Published for the blog on January 31, 2020 by Searcy Financial Services, your Overland Park, Kansas Fee-Only Financial Planner and Investment Manager.