Making It Work
Richard Quinn | Jul 30, 2019
I’M ONE OF THE LUCKY Americans with a pension. I know firsthand the sense of financial security that comes with steady monthly income.
Others don’t have it so easy. I worry a great deal about the majority of Americans—including my four children—who have no pension, and instead will rely on Social Security and their investments for their retirement income. My fear: Even if these folks are saving regularly, they don’t really understand how to invest or how to manage their nest egg once retired.
Consider a couple earning $60,000 a year who retire at age 66. The main breadwinner’s Social Security benefit might be $18,000 a year. Add spousal benefits, and we’re looking at $27,000 for the couple. Their goal is to replace 100% of their income in retirement.
That means our retired couple must generate investment income of $33,000 a year. To do that, they’d need retirement savings of $825,000, assuming a 4% withdrawal rate. What would it take to amass that much? They’d have to save $711 a month—or 14% of pretax income—for 40 years, assuming they earn a 4% annual after-inflation rate of return. Here’s a closer look at what’s involved:
1. Moving parts. A calculation like this involves a host of variables:
- To reach your target nest egg, you may need more than 40 years. Stay flexible.
- Investment gains will vary from year to year and there’s a good chance your long-run after-inflation annual gain will differ from 4%.
- Saving more in the early years, when you’re single and with fewer financial commitments, will give a big boost to your nest egg.
- I target 100% income replacement. Others say 80% or even 70%. That sharply lowers the required savings rate. If your goal is a 70% replacement rate and you still get $27,000 from Social Security, you’d need to amass just $375,000, instead of $825,000. But before you aim that low, take a hard look at the lifestyle you want in retirement and what debts you may still be carrying at that juncture.
2. Saving diligently. While socking away 14% of income might seem daunting, it could be less onerous than you imagine.
- You may get an employer’s matching contribution in your 401(k) or 403(b) plan. If your employer kicks in just 3%, that lowers your required savings rate to 11%.
- Saving on a pretax basis will minimize the impact on your take-home pay. If you’re in the 22% tax bracket, every $100 tax-deductible contribution to your 401(k) reduces your paycheck by $78, not $100. You might save out of pretax income when money is tight, while switching to after-tax Roth contributions when things are better, so you also have a pool of tax-free retirement money.
- Save automatically, both through your employer’s plan and by setting up automatic contributions to your favorite mutual funds. This will compel you to save before you get a chance to spend. You’ll then be forced to live on whatever remains—provided you don’t rack up the credit cards.
- If your 401(k) has an auto-escalation feature, sign up. When you get a raise, your contribution percentage will automatically increase.
- Help your take-home pay situation by using a health savings account or flexible spending account for health care bills. By putting pretax money in one of these accounts, you save not only on income taxes, but also 7.65% for Social Security and Medicare payroll taxes. A health savings account could become a strategic part of your retirement plan.
3. Investing prudently. You job isn’t done when you meet your savings goals. You also have to make smart investment decisions.
- In my opinion, whether you invest through an employer’s plan or elsewhere, you should seek out low-cost index mutual funds.
- Many retirement plan participants select target-date funds. With these funds, the investment mix changes as you get closer to your target retirement date, going from more to less aggressive. Target funds can be a good choice: You set it and forget.
- While it’s important to track your investments and rebalance your portfolio periodically, especially as you near retirement, it’s a mistake to micromanage. Investing for retirement is not day trading. Even looking at your account too often is a mistake. It may cause you to make unnecessary changes.
- Don’t be a victim of short-term panic. All those people who claim to have lost their retirement savings during the Great Recession only did so if they panicked, got out of stocks at low prices and missed the long bull market that followed.
4. Spending it. There’s one final challenge: generating retirement income and making your money last as long as you do. Using our example, we need to generate $33,000 a year, equal to $2,750 a month, from investments. But how?
- Consider an immediate annuity. I know annuities get a bad rap. But according to a Schwab calculator, $825,000 can buy a 66-year-old couple around $3,700 a month for life, with the income continuing until the second spouse dies. Note that this income doesn’t rise with inflation.
- If you skip the annuity and generate retirement income on your own, you’ll need to be disciplined. Still, if you really have amassed $825,000 and follow the 4% rule, you’ll have $33,000 in investment income the first year, $33,000 plus an increase for inflation in the second year, and so on. What if you follow this withdrawal strategy? History suggests you shouldn’t run out of money.
- You need emergency money, separate from your retirement investments, so you don’t take unplanned withdrawals for unexpected expenses, especially during a big dip in the markets.
Richard Quinn blogs at QuinnsCommentary.com. Before retiring in 2010, Dick was a compensation and benefits executive. His previous articles include Righting Wrongs, Basket Case and Bad to Worse. Follow Dick on Twitter @QuinnsComments.
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If saving 14% and no SS taxes @ 7% I would think a conservative $48000 is all the couple would need to live on. Won’t be saving or paying SS taxes in retirement.
Good advice. One point I would make is that the dual career couple is now the norm, so the lower wage earner may do better taking his or her own SS benefits instead of spousal benefits. This would likely increase the average couple’s SS benefits by at least $2,000-$3,000.
Also, while I’m a fan of fixed immediate pay annuities, I would not recommend that all of the $825,000 in your example be allocated to this one form of income.
How does one plan for rising taxes and/or reduced benefits…to be sure many states and our federal government are broke…record tax revenues and record deficits is a formula for disaster…and don’t forget the bull market correction that’s not if but when.
Excellent column. Immediate annuity(or deferred annuity) is very good. For some people employing a Qualified annuity makes sense.
With $825,000 I would just buy all AT&T common stock and collect about $50,000 a year in qualified dividends, a dividend that has been increased every year for 34 years straight (that’s right even during the great recession of 08-09). I am perfectly comfortable with the ups and downs of the share price as long as I can collect that dividend (without touching the principal).
Too much unnecessary specific stock risk. AT&T could lower that dividend due to a changing business climate. They have a ton of debt. Why treat your retirement like a roulette wheel?
All companies (and western Governments) have a ton of debt including the insurance company that you would buy an annuity from (what happens if the insurance company goes broke?), and if you buy bonds then you are buying debt. The question is whether the debt is manageable, and AT&T has been paying it down quite a bit lately, they’ll have $30 billion of the $40 billion they borrowed to acquire Time-Warner paid off by the end of THIS year, and all the while they will still be able to pay the generous dividend, and of course increase it in mid December like they have done for 34 years straight.