Far too many people don’t start thinking about retirement until it’s too late to do anything about it. But is it ever really too late? And when you do begin to contemplate what retired life means to you, are you looking at the right things?
What do people think they need to retire?
Let’s start with the most popular question people ask: “How much will I need to save before retiring?” It turns out the average American has an over-inflated view of what this number is. Recent headlines shouted out a number of $4.3 million. Do most people really need this number?
“Short answer, most do not,” says Jason Grantz, Managing Director at Integrated Pension Services in Highland Park, New Jersey. “Surveys are often guided by the framing of the question—intentionally or unintentionally—guiding people towards the desired answer. That said, the internet and social media are the primary sources for most people to get their ‘information’, and if the internet says $4.3 million, most people will believe that.”
It shouldn’t surprise you that this particular survey reports such a high number. Look at what’s affecting people the most. This will answer the question, “Why do people think they need so much for retirement?”
“Because they think inflation will outpace how it has been appearing historically,” says Michelle Richter-Gordon, Co-Founder of Annuity Research and Consulting in New York City. “So, nominal income generated will need to be substantially higher than in the past to support the same lifestyle, which means more money needs to be saved if the retiree is not planning to annuitize.”
But inflation alone doesn’t explain this perception. It goes much deeper than that. Before you begin your own retirement calculations, it may be helpful to see what is prompting others.
“The typical American probably believes they need $4.3 million to retire because that is what trusted sources are telling them,” says Irene E. Leech, Associate Professor, Consumer Studies at Virginia Tech in Blacksburg, Virginia. “They do not trust that they will receive Social Security. They realize that they will not have defined benefit retirement income and that they will be somewhat limited by the ups and downs of the market. They may think that a higher level of inflation is likely. They may also believe that Baby Boomers are going to drain many shared resources, leaving them to take care of themselves.”
What factors should you look at to determine what you need to retire?
Given this as a background, the first thing you need to do is to know what to measure. You really can’t depend on someone else to tell you what you need. Sure, you can get advice. It’s always helpful to get input from a knowledgeable and objective third party. But don’t think they will give you the answer that’s right for you.
“The industry has failed at simply getting each person to tell you what type of retirement they want,” says Tom Kmak, CEO at Fiduciary Decisions in Tigard, Oregon. “Only when you have that can you estimate what you will need. For example, assuming—as some providers do—that people will retire at age 65 is not supported by the data. So, advisors must ask people what they want, and then the advisor can help them…one individual at a time. Not in age cohorts or income cohorts or other cohorts. In my opinion, such hyperbole of many of these ‘models’ make advisors look greedy… ‘give us all your money so you can survive retirement!’”
Even within the survey that yielded the $4.3 million bullet point, there was some variance. Respondents of the Baby Boomer generation said they only needed $2.2 million for retirement. Understanding the reason for this difference in response will give you a hint of what might be the most important factor you need to consider.
“Baby Boomers are at or much closer to retirement when compared to the average population,” says Clint McCalla, Senior Wealth Advisor at LourdMurray in San Diego. “They effectively have a shorter time horizon for inflation to impact their assets and overall cost of living. In contrast, a Millennial has a much longer time horizon which includes the time to retirement and their retirement years. As a result, Millennials must save more to achieve the same standard of living now experienced by Baby Boomers.”
What should people focus on to determine what they really need to retire?
Once you identify the broader factors of your age and your expected retirement date, it’s time to concentrate on the details. This represents the toughest challenge for most people.
“The most important aspect people should focus on to determine what they need in retirement is the income they need,” says Brett Bernstein, CEO & co-founder of XML Financial Group in Bethesda, Maryland. “The income/expenses they need to cover in retirement will determine what they need to have/save for retirement.”
The first step is to identify the components of both your retirement income and your retirement expenses. The income represents the source of the money that will fund your expenses. Break out the various features of what your life will look like in retirement. Some of these will have costs associated with them; others will be where the income comes from.
“To determine what you really need to retire, you should focus on factors such as your desired lifestyle in retirement, anticipated healthcare costs, inflation, current savings, investment growth potential, and fixed sources of retirement income such as social security and pensions,” says Ray Prospero, a partner advisor at AdvicePeriod in Riverside, California.
One of the best ways to do this is to ask yourself a series of questions.
“People should focus on their specific plans and what they know about their own probable health issues to determine what they really need to retire,” says Leech. “Will your current housing work, or will it need to be replaced or adapted? What do the things that you plan to do in retirement cost? What help might you need to employ to live as you want in your later years, and what are the costs for that help in the location where you plan to live? After determining what it will cost in retirement, evaluate what resources are available. Instead of focusing on a ‘magic’ number, focus on your plans and costs where you live.”
Finally, don’t forget discretionary items. You don’t have to accept a bare-bones, comfortable retirement. Add in the fun things you want to do that help define your ideal retirement.
“Clarifying the desired retirement lifestyle is the most important aspect of preparing for retirement,” says Kevin Estes, founder and financial planner at Scaled Finance in Bellevue, Washington. “Considerations like living location, extensive travel, and overall life design are crucial. First, estimate the yearly expenses of the chosen lifestyle. Subtract any anticipated non-portfolio income during retirement. The resulting shortfall is what needs to be funded. A high-level estimate is that a diversified portfolio may need to be at least 25 times the uncovered annual expenses. For example, if a couple’s desired lifestyle requires $100,000 in yearly expenses and expects $50,000 in after-tax Social Security benefits, they might only need $1.25 million to achieve financial independence. However, every situation is different.”
If you’re used to creating budgets for projects at work, you’ll know what to do next.
“Add up all your fixed and other unavoidable expenses and find your monthly number,” says Stephen Davis, CEO of Total Wealth Academy LLC in Houston. “Then add $5,000 for fun, romance, and travel, and there is your number.”
Whatever number you determine you need to attain to retire, it’s always best to build a little contingency into it.