An Easy Way to See If You Have Enough Saved to Retire
Cash flow planning is a crucial part of your retirement plan, and much of it can be boiled down to one math equation.
It’s the pivotal question that all soon-to-be retirees should answer: Do we have enough saved to last us? One simple calculation can help give you some clarity.
“As you can see, at its core, cash flow analysis is a simple exercise. It’s also an incredibly important one that helps you recognize your cash flow needs and their timing.” That’s a quote from my last article, Retirement Planning Is Cash Flow Planning, where I explained how cash flow planning could prepare you for retirement. Today I’d like to lead you through a more detailed exercise that can help illustrate the process that we go through to determine if you have enough investments to support your retirement lifestyle.
One Couple’s Retirement Analysis
In this exercise, we’ll use a hypothetical couple who both recently retired at age 66. After completing an extensive review of their expenses, they determined that their cost of living is $54,000 a year, not including income tax. Their combined Social Security benefits equal $40,000 a year, and they have no additional income (pensions, part-time employment, etc.). At the beginning of their retirement at age 66, they have $550,000 in after-tax investments. To keep this example from becoming too complicated, we’ll assume that this couple does not have any IRA or 401(k) investments. If they did, we would need to plan for required minimum distributions and taxes on distributions from those plans.
If the taxes on their investments and Social Security are $8,000 per year, their total cost of living would be $62,000 ($54,000 plus $8,000). Their expenses ($62,000) outweigh their income ($40,000) by $22,000 a year.
A Revealing Retirement Math Equation
Does our couple have enough in investments to cover that shortfall and carry them through retirement?
Generally speaking, they can find out by multiplying that $22,000-per-year annual shortfall by 25. I call the product of that mathematical equation the “Magic Number,” because it’s an amount that should provide the income needed to last throughout retirement at a 4% withdrawal rate per year. In our hypothetical couple’s case, their magic number is $550,000. That means that 4% of $550,000 equals the $22,000 that they need to support their retirement lifestyle.
With careful planning and discipline, we believe they should probably be fine. If they had less than $550,000 in investments, we would suggest they cut their cost of living, find other sources of income, delay retirement, or some combination of the above.
Your Results May Vary
This is a very simple example, which is for general guidance only. When working with clients, we use a more detailed version of the above exercise that adds variables such as inflation, tax brackets, expenses and money coming in the future, an emergency fund, insurance, etc. We also suggest the cash flow plan be updated at least annually, or as situations change.
Investment activity is one of those changing situations, and a more detailed analysis should also address the account losses that can accompany account drops. For example, if an account drop caused our hypothetical couple’s investments to fall to $400,000, they would need to reduce their cost of living or get part-time work to make up for the fact that the new amount that they can withdraw at 4% is $16,000, not the $22,000 that they were taking out.
We seek to address this problem with a buy, hold and protect investment strategy, which is designed to protect your principal and any gains that you have made. A stop loss for your stocks would be an example of a “protect strategy.” Such a strategy, though not perfect, is intended to protect investments during bear markets.
As you can imagine, I strongly advocate you utilize a buy, hold and protect strategy if you are retired or retiring soon. But no matter your investment strategy, it’s wise to prepare for retirement by analyzing your potential cash flow and making any necessary changes.
About the Author
Ken Moraif, CFP®
CEO and Senior Adviser, Retirement Planners of America
Ken Moraif, CFP, is CEO and senior adviser at Retirement Planners of America, a Dallas-based wealth management and investment firm with over $4.3 billion in AUM and serving over 8,000 households (as of May 2019). He is also the host of the radio show "Money Matters with Ken Moraif," which has offered listeners retirement, investing and personal finance advice since 1996.