By Jonathan Harner, CFP®
Retirement is like the ultimate prize at the end of a long, hard-fought race. But how do you know when you’re ready to cross the finish line? And once you do, how much can you spend to live the life you’ve always dreamed of?
Previously, it was widely believed that a 4% withdrawal rate was stable. This strategy allowed you to withdraw 4% of your retirement savings annually, helping your reserves to last for at least 30 years. The general consensus was that a person requiring $120,000 annually for a comfortable retirement could amass $3 million in savings, which would accomplish the goal of long-term financial stability.
But determining the exact amount of money for retirement is not a simple calculation; there is no linear formula. Market fluctuations, the cost of living, and inflation are key factors that can significantly affect your ability to retire. These three factors are interrelated and must be taken into account when determining your ideal retirement timeline.
The Impact of Market Conditions
When you’re in the accumulation phase of retirement planning, you’re not withdrawing from your accounts just yet; you’re only adding money. During this phase, the sequence of market returns doesn’t matter as much. You can have a mix of good years and bad years over a 10 or 15 year period and your returns will be the same overall because you didn’t withdraw any money during that time.
But when you finally retire and start taking withdrawals, sequence of returns begins to matter. If you experience a few bad years at the beginning of retirement, it could greatly reduce how long your money lasts.
Here’s a chart to show what I mean.
In this chart, you can see that Portfolio A, B, and C all start with the same $1 million balance, and withdraw the same $60,000 a year adjusted 3% annually for inflation. However, each portfolio experiences a different mix of high and low returns over the years. Portfolio A has positive returns in the beginning and ends up with $1.1 million left in the bank at age 90. On the other hand, Portfolio C has a few negative returns in the beginning and ends up running out of money around age 87.
Depending on your overall expenses in retirement, this math could work out the same way regardless of whether you have a $1 million nest egg or a $5 million nest egg.
The moral of the story? Even if you have a rough idea of how much you need to retire comfortably, you could still run out of money prematurely if you retire in a bear market and don’t have a proper cash flow plan in place. That’s why it’s critical to meet with a financial advisor who can stress test your portfolio and run various what-if scenarios to ensure your retirement assets will last even through the most turbulent of times.
The Impact of Cost of Living
Have you thought about where you’ll live once you retire? Will you stay in your current city or relocate somewhere new and exciting? The cost of living in Portland is about 30.8% higher than the U.S. average and around 18% higher than other cities in Oregon. Retire to Honolulu, Hawaii, and your cost of living would be about 77% higher than the U.S. and 46% higher than Portland.
See what I’m getting at here?
Where you choose to live in retirement matters. It plays a major role in how much money you’ll need to live comfortably. That’s not to say you should move to an area with a lower cost of living as soon as you retire—you also need to factor in which location will make you happy and keep you active. But if you choose an area with a higher cost of living, it is important to factor these costs into your retirement planning.
The Impact of Inflation
Inflation is known as the silent killer in retirement because it creeps up on you. You never really see it coming until you look back and realize that loaf of bread that costs $4 used to only cost $0.50.
It’s quite common for retirement to last 20 to 30 years. If we use an average 2% inflation rate each year, the $150,000 a year you live on now will be the equivalent of $223,000 in 20 years, and $272,000 in 30 years.
As you continue to save for retirement, keep in mind that you’re saving for today’s income and expenses as well as your future inflated income and expenses. Be realistic about how much you need to save and talk with a financial advisor about ways you can protect your nest egg from the eroding power of inflation.
Need a Helping Hand?
At Wichita Wealth Management, we firmly believe that there is no universal solution for determining when you can retire or how much money you will need to lead a comfortable life. To get to these answers, we begin by walking you through a thorough analysis of your financial status and goals, allowing us to identify the necessary steps for reaching your desired outcomes.
If you’d like a helping hand in determining your retirement timeline and the funds necessary to meet that goal, please feel free to schedule an introductory phone call by contacting me at 316-722-1010 or jonathan@wichitawealth.com. It would be my pleasure to assist you in finding the answers you need.
About Jonathan
Jonathan Harner is a CERTIFIED FINANCIAL PLANNER™ practitioner at Wichita Wealth Management, a fee-only, fiduciary financial advisory firm dedicated to helping their clients thoroughly prepare for retirement. Jonathan’s goal is to simplify the complex so his clients can experience confidence and peace of mind as they work toward and live out their retirement dreams. He specializes in developing and implementing tax strategies that maximize his clients’ money and builds a tax-efficient withdrawal plan for retirement. Jonathan loves finding opportunities for his clients to save money and is dedicated to continual learning and growing in his profession so he can provide solutions for his clients’ financial needs. When he’s not working, you can find Jonathan spending time with his wife, Annie, and their daughter, staying active in his church community, and participating in his two favorite (but vastly different) hobbies: CrossFit and Dungeons & Dragons. To learn more about Jonathan and how he can help you, connect with him on LinkedIn.