It, as usual, was quite interesting.
The simplest formula and one I've seen repeated elsewhere is to restrict withdrawels to 4% of your savings as of the start of your retirement. This comes from a study performed by professors at Trinity University. Basically, they measured the likeliness of retaining ones investment principal over a 25 year period based on various withdrawel rates. Here is a nice article discussing it.
It's very simple to apply this formula in reverse:
How much do you expect to spend every year while retired (and taxes to cover it) multiplied by 25.
This approach does assume you'll have your money invested in a manner that provides the following:
a portfolio with an expected return that matches inflation plus 4%
In his analysis, Bernstein looked at a thirty year period starting in the 1960s during a very disfavourable bear market (the worst scenario for a retiree - as the money has less time to grow) and projected the returns for various combinations of equity and bonds. He found that combinations of no less than 50% equity were most likely to retain sufficient capital through the expected 30 year period. Obviously having some bonds reduces the portfolio volatility, which can be very important during retirement.
For the next 30 years, Bernstein projects the real return (after inflation) of the average domestic large cap investment to be 3.5%. This means retirees will need a diversified portfolio which might include value investments, small cap value, foreign investments and even emerging market investments - obviously the percentage of the riskier investments should be smaller.
It also implies the need for regular portfolio rebalancing in ones old age.
Here is my question for you: Who will rebalance your portfolio when you're 65? What about 75? or 90?
In my family's situation, we probably spend abour $12k per month. Actually right now it's higher, but I'm not including college savings, retirement savings, etc.... Our yearly then is about $144k. If we gross it up by 50% for various taxes it comes to $216,000 a year. Multiplied by 25 means we need to have $5,400,000 in today's dollars when we retire to live comfortable at 4% of our earnings with a 50/50 stock equity mix.
Honestly, that sounds like a hard number to make. We might be able to do it, but we should probably set our expenditures at lower levels for the following reasons:
- We will have paid off our mortgage
- No more college savings (unless we help with the grandkids - but we might save separately for that)
- No more saving for retirement
- Probably little if any life insurance premiums (we'll have assets to pass on and our dependents should no longer be dependent)
- Little if any need for disability insurance (we'll keep LTC and health insurance)
- Taxes may be lower due to cheaper state income tax (won't live in NC at 8.25%) and less income (maybe more as capital gains).
If we factor those reduced expenses into the equation, our monthly spending might be something close to $9,000 per month, though I'll settle at $10,000 to have funds to travel and spoil grandchildren with. $120,000 per year income multiplied grossed up by 40% (assuming greater tax efficiency) = $168,000. Multiplied by 25 = $4,200,000, which is pretty much my targetted retirement plan in Quicken's financial planner -- however, with much less work.
How much do you need for retirement? How are you estimating the amount?
Do you know if you're on track? How are you analyzing it?