"When you plan to retire determines how long you must save for and how long investment returns can compound," writes Jeff Witz, CFP.
How much money do you need to retire? That’s the hot topic of discussion among physicians across the country. Many of them use online tools, some simply make a guess based on what their colleagues or relatives have done, and others follow what they have read or seen in various financial media. Unfortunately, these cookie-cutter, one-size-fits-all approaches are unlikely to achieve your specific goals, and you may risk running out of money too soon or leaving money on the table you could use to enhance your quality of life.
To increase your likelihood of enjoying retirement without financial worries, you need to have enough money saved based on your own situation. A variety of factors should affect your analysis, and inaccurate estimates for any of them can leave you with too little or too much in savings. Here are some of the more significant factors to focus on.
Retirement income needs. You can find various rules of thumb indicating you need anywhere from 60% to more than 100% of your preretirement income. On the surface, it may seem like you would need less than the latter amount.
However, look carefully at your current expenses and the amount you plan to spend each month or year before deciding how much you’ll need. If you pay off your mortgage, stay in good health, live in an area with a low cost of living, and engage in inexpensive hobbies, then you might get by with less than 100% of your preretirement income. However, if you plan to travel extensively, pay for health insurance, and maintain significant debt levels, even 100% of your previous income may not be enough. Also, depending on your age, can you rely on Social Security being available for you? You need to take a close look at your cash flows, expenses, and planned retirement activities to determine a reasonable estimate.
Retirement age. When you plan to retire determines how long you must save for and how long investment returns can compound. Many physicians would like to retire before the age of 65, but that typically requires significant personal savings. You want to be sure your retirement savings and other income sources will support you for what could be a lengthy retirement. Even reducing or extending your retirement age by a couple of years can significantly affect the ultimate amount you need.
Life expectancy. Most individuals consider average life expectancy when estimating the length of their retirement. Keep in mind that an average life expectancy means you have a 50% chance of living beyond that age and a 50% chance of dying before that age. Since you can’t be sure which will apply to you, it’s better to assume you’ll live at least a few years past your estimated life expectancy. Erring on the side of outliving your life expectancy will help ensure you don’t run out of money too soon. When deciding how many years to add, consider your own health and how long other family members have lived.
Rate of return. A few years ago, many retirement plans were calculated using high rates of return. At minimum, make sure your expectations are based on average returns over a long period. You might want to be more conservative, assuming a rate of return lower than long-term averages suggest. Even a small difference in your estimated and actual rate of return can make a big difference in your ultimate savings.
Inflation. Even modest levels of inflation can significantly affect the purchasing power of your money over long time periods. For example, after 30 years of 2% inflation, your portfolio’s purchasing power will decline by 45%. Although inflation has been unusually high recently, long-term average inflation rates tend to be lower. The Federal Reserve System typically targets a 2% to 3% inflation rate as healthy for the US economy. Consider a long-term average rate of inflation, because your retirement could last for decades.
Retirement tax rate. If you save significant amounts in tax-deferred investments that are taxable when withdrawn, your tax rate can significantly affect the amount you’ll have available for spending. You may find your tax rate is the same or higher after retirement depending on distributions from retirement accounts, business interests, investment properties, or changes to the US tax code between now and when you retire. It is best to overestimate your tax rate to ensure you have enough savings.
As you can see, there is no simple or universal answer to the retirement feasibility question. Many factors must be examined. Your financial adviser should be able to assist and give you the guidance you need to attain the goal of a successful retirement.