| Sources of income The big day has arrived and you are now ready to start enjoying your time away from your job. Critical mass is Bob Brinker's definition of that point where you no longer need to work in order to provide your income needs. Another way of saying this is that you have worked for your money and now it is time for your money to work for you. At this point you have the choice of whether or not you WANT to work. Prior to your retirement did you give serious thought as to your sources of retirement income? And have you given thought to which will last longer..your money or your life? Typical sources of retirement income include:
Expenses One way to determine the annual income that you need during retirement is to track your current expenses for 6-12 months. Doing this will give you a very good idea of what your spending patterns are and where you may have to make adjustments in the future. Be sure to include federal, state, and local income taxes. Current expenses can give you a good idea of what you will need in retirement. While income taxes may decrease, quite likely medical expenses could increase, particularly if you retire before age 65 and you are paying your health insurance costs. If at age 65 you are not eligible for Social Security benefits, you can still buy into Medicare Part A at a current (2000) cost of $301per month. While termites can eat your house, the odds are that you won't be able to do the same. To fund your living expenses you need liquid assets, the kind that can be converted to cash relatively easily. Therefore, while your home is part of your net worth, I would not consider it a liquid asset and would exclude it as a source of income for retirement needs. What goes first..you or your money You can estimate your lifespan based on family history and by consulting Appendix E in IRS Publication 590. This publication is the one you would use to calculate Required Minimum Distributions (RMD) from investments such as IRAs and 403(b)s. A conservative approach for retirement planning is to expect to live until age 90-95. An exception to this rule is Mike Ditka who looks forward to reaching 135; if he can do it so can we. Now that you have an idea of your expenses, your expected life span, and your net worth , do you have enough to live on? A starting point is to estimate your pension and Social Security annual benefits. Subtract this from your estimated annual expenses and you are left with the amount that you need to provide from personal savings (investments). A caveat here is that not all pensions (such as mine) are indexed for inflation or cost-of-living increases. This means that if your monthly pension right now is $500, it will still be that amount in the year 2050. Every mutual fund prospectus states (somewhere) that past performance is not a guarantee of what could take place in the future. However, not too many people I know can tell me what will happen in the next hour let alone the next year. Thus, my planning is based upon historical information such as that shown in the following chart which shows average annual rates of return on various investments and inflation from 1946-2003
Asset allocation will definitely have an effect on your portfolio's overall performance. A 50/50 allocation of stocks and long term government bonds would provide an expected 10% portfolio growth rate. However, a more conservative portfolio allocation would provide an 8% portfolio growth rate. Assuming 4% inflation and 8% portfolio growth, the following chart will give you an idea of what percentage of your financial assets you may withdraw each year.
Here is an example using today's dollars. You are age 60 with an estimated life span of 30 additional years and annual expenses of $35,000, including income taxes. Your pension and Social Security will provide $20,000 annual income, leaving you with $15,000 to provide from your savings and investments. You will need to have $274,200-$327,510 in liquid assets available at the beginning of your retirement.
Another approach is to know that you have $400,000 in liquid assets and want to determine how much you can withdraw annually. I will use the same age and life expectancy as in the above example, but allow for 50% remaining after 30 years just in case you live another 30. For simplicity, you will make your annual withdrawl on the first day of your retirement. Multiplying $400,000 X 0.0458 allows you to withdraw $18,320 the first year. $400,000-$18,320 = $381,680 $381,680 @ 8% growth = $412,214 at the end of year 1 $412,214 X 0.0458 = $18,879, the amount you would be able to withdraw at the beginning of year 2. The Crystal Ball The above example does not provide an absolute guarantee that your assets will last since the stock market, based upon the Dow Jones Industrial Average(DJ) and the Standard & Poor's 500 Index (S&P), can be a bit bumpy. You need to be prepared for severe declines such as took place during 1973-74 when the S&P lost 40-45% of its value. Like show business, the timing is very important because this situation is more detrimental to you if it happens early in your retirement years. |
Social Security