Am I Ready to Retire? Finding Your Sweet Spot

If you could trade places with Warren Buffett, would you do it? While you would immediately be worth billions of dollars, you would also be 88 years-old. Perhaps you would consider trading places with a recent college graduate? You may be 22 years old again, but you could also be starting over: career, family, lifestyle, and location, coupled with the fact that the average college graduate has more than $28,000 worth of student loans (Institute for College Access and Success), it may not be worth it for you to go back?

While these are some extreme examples, the point is that your answer probably depends on your current situation and its relationship to the alternative. Factors such as your age, financial situation, and life perspectives affect how you would answer switching places with another. These considerations often factor in financial planning as there is no right or wrong answer, only “your” answer.

We do financial planning for clients every day, and we hear many of the same questions. Many clients come to us asking, "what is normal when it comes to retirement? When is the typical time to retire? What does everyone do in retirement? How much does everyone spend? How much does the average retiree travel? When do people start Social Security? How much do most people save each year?"

Often, clients come in looking for answers based on what their friends, neighbors, and co-workers are doing. However, we view our job as providing the roadmap to get to the “right answer” for their own personal situations. The answers to their individual situations may differ, but their roadmaps may be similar.

Ultimately, one’s roadmap can be viewed as an algebra equation. There are many variables to this equation, some we can control and others we cannot. So, it’s important to isolate the variables we can control, and incorporate the ones we can’t, to get to the right answer. Most of the time, the question of which variable we need to solve for differs with each family.

The Key Variable: Spending in Retirement

Spending is often the last variable solved for in retirement, but it may be the most critical. Many falsely assume that the age or timing of retirement is more important to the success of the outcome. However, your lifestyle may be the biggest determinant on when you can retire, and if you will be fulfilled during retirement. One thing we have consistently found is that most people underestimate what they will spend annually. They also fail to leave any room for unexpected expenses that could come about in the future.

An old rule of thumb was that 4% is the proper amount of your assets that you can spend each year in retirement and maintain corpus. However, there are a few things wrong with this generalization. First of all, if your assets are tax-deferred, you could be losing 10-50% of your distribution to taxes, depending on how much you pull out each year and the state you live. Also, the 4% rule came from a time in history when bonds were paying 5-6% per year. Now they are yielding less than 2% in many cases. These two things alone can cause a massive over-assumption.

On the flip side, many facets of life may bring about reduced expenses in retirement. Rotating on to Medicare may cut your health expenses by 75%. You may eventually pay a mortgage off. Your kids will (hopefully) be off the payroll. Others don’t account for the general slowing in their spending habits because of age and the reduced desire to do expensive activities, such as travel.

Before you take the retirement plunge, it is VITAL that you spend some time examining your current and future spend rate to make sure you can have a successful retirement. It’s challenging for someone to ratchet back their lifestyle to fit their budget into the funds they've saved for retirement after the fact. This self-examination may be eye-opening and humbling, but one that you could regret not doing after taking the retirement plunge.

Timing of Retirement

Sometimes the timing of retirement is out of one’s control. Sometimes, due to an unfortunate illness, family issue, or loss of a job forces retirement under duress. In this case, the variable we solve for in the retirement equation is someone’s age. This could potentially require adjustments in the spend or lifestyle to accommodate. Often this is not an ideal scenario and requires some planning immediately so as not to jeopardize the future.

Others who have an exact age in their mind for retirement need to plan as early as possible. Savings rates must be met and monitored to make sure that you are advancing at a pace that will allow for it to happen. If retiring before Medicare eligibility, one of the most significant expenses will probably be healthcare. Is this being factored in? Those who retire “early” may have a lot of changes occur over the years in the tax code. Do their funds have the ability to be flexible upon distribution? This means having the ability to “tax optimize” your funds needed from various accounts such as Roth IRAs, IRAs, 401-ks, and taxable accounts. This allows you to minimize your taxes on distributions in any given year whatever the tax code changes bring.

Sometimes people continue to work because they don’t know if they have enough to retire. It’s essential to, at least, establish a timeline in the future and work back from it. If not, you cannot reasonably plan, and savings becomes arbitrary and lacks direction. Often this leads to more immediate gratification in the present and a lack of savings because one doesn’t know how much it will take in the future. This is an “ignorance is bliss” concept that too many people use in their retirement approach.

Managing to a Number

Often, many people tend to base retirement on getting their savings to a number. Arbitrarily let’s say that this number is $1,000,000. A person saves to the point that their assets reach $1,000,000 and then at that point, they feel that they can retire.

The problem with this is that the number you need has more to do with how much you spend, and how long you will live. One variable is easy to calculate (spending), and one is not (life expectancy). Does the amount saved fit a reasonable timeline?

Predicting the Future

Even with advanced planning, you may find that you have over or underestimated some assumptions in retirement. These assumptions and their compounding effect over time may be critical to the success of your outcome. We find that many overestimate the returns that they will receive. For example, since 1926, the S&P 500 has returned 10.14% annually as of 6/30/2019. We see many people use that historical proxy as the basis of their future returns. This proxy is overly simplistic and contains a massive oversight. Generally, we would recommend that your portfolio will inevitably include some more conservative investments like bonds and other asset classes that aren’t the S&P 500. This time period also takes us through the industrial and technological revolution in a country with rapid economic growth. That growth is now decelerating (albeit still growing at a good pace) from its industrial boom period. A reasonable rate of return must be ascertained with more than historical factors in mind.

If you plan to retire, there are many other “future” assumptions that need to be taken into consideration. What are the assumptions for travel, living expenses, long-term care, medical costs, and taxes? On the income side, what are the assumptions for social security, pension, rental income, or even a future business sale? These all have an impact on today and future years as when factoring in assumptions for growth rates and inflation. Many of these assumptions are general, but most can vary from family to family.

YOUR Retirement Sweet Spot

Another thing our experience has taught us is that it's okay not to know exactly when you will retire, what you need, or even how much you will spend to the penny. What is important is that you make some reasonable assumptions and make sure you leave enough room or “cushion” for the unexpected.

However, to create a roadmap to your destination, you need to pick a starting place on the map. There will inevitably be some forks in the road as time passes, but planning will allow you to navigate those twists and turns easier. Most importantly, planning for everything you know, while leaving some room for error, will give you peace of mind for when you finally decide to retire!

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Please remember that past performance may not be indicative of future results.  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 (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, 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 serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.